How Deep is the Spending Valley? By Stephen Stanley

The current economic environment is without question the worst in at least a quarter century. The abrupt tightening in credit conditions has helped to bring about an awful set of economic fundamentals. Moreover, the series of financial market events seen in September and October has spooked business and households, leading to a sharp falloff in discretionary spending. As a result, the near-term outlook for capital spending is quite gloomy. The main question is whether business spending will continue to contract well into next year or rebound quickly. Business capital spending is broken into two main components within the official GDP data: outlays for equipment and software and nonresidential construction. The trajectories of the two often diverge radically. In the most recent recovery, spending for equipment and software bottomed out in early 2003 and posted solid gains from the spring of 2003 through late 2006, as businesses reloaded after sharply curtailing outlays in the wake of the late 1990s tech bubble. Meanwhile, nonresidential construction tends to lag the economy significantly. In fact, it is often the last sector to turn in an economic cycle, and recent experience was no exception. This category was essentially flat from 2003 through 2005, finally beginning to grow in 2006 and was still going strong through the summer of 2008, as builders worked through what had been a huge pipeline of projects even as their order books dried up.

In the final quarter of 2008, both equipment spending and nonresidential construction may have contracted together for the first time in nearly five years. On the equipment side, firms have gotten very careful with their budgets, and any outlays for non-essential equipment was likely put on hold. As a result, the period could rival the spring of 2001 as the worst quarter since 1980. Nonresidential construction appears to be in the process of turning drastically. Not only are developers finding it incredibly difficult to obtain financing, but with the economy contracting, the supply of office, retail and industrial space suddenly appears excessive. Thus, capital-building activity may have declined in the fourth quarter after 12 consecutive increases.