American business is holding back on investment, and that is holding back the economy.
After growing 5.9% last year, such corporate outlays — including for equipment, software, commercial buildings, factories and mines — have downshifted, laying economic growth prospects clearly at the feet of consumers. Household spending, which accounts for almost 70% of gross domestic product, didn't skip a beat in the second quarter and is poised for another solid showing in the third.
Nonresidential investment, on the other hand, has slowed abruptly — falling an annualized 0.6% in the second quarter, the weakest performance in three years. With profitability moderating, global economies grasping for growth and the negative repercussions from antagonistic trade policies, companies have precious little appetite to ramp up expenditures on facilities and equipment.
That is part of the reason Federal Reserve policymakers cut interest rates Wednesday for a second straight meeting. Economists surveyed by Bloomberg in September see a 35% chance of recession in the next 12 months.
While business investment makes up about 15% of GDP — small potatoes compared with households — consecutive quarterly declines are rare "outside of recessions or shortly after recessions," JPMorgan Chase chief U.S. economist Michael Feroli said in a recent report.
"Profitability — defined as the rate of return on invested capital — has decreased in recent years," Feroli wrote. For the past 50 years, he said, the nonfinancial corporate sector's return on invested capital has mainly averaged 7.5% to 9.5%. "Over the last few years it has been moving toward the lower end of that range."
Randall Stephenson, chief executive of telecom giant AT&T Inc., said the weakness in investment may eventually filter through to consumers.
"It shouldn't be a surprise to anybody that business investment starts slowing down" amid trade tensions, Stephenson said at a Goldman Sachs investor conference Tuesday. "I don't think we're headed to a recession, but we're definitely slowing down. And you can't have that kind of slowdown in business investment and not find its way into the consumer, ultimately."
While American consumers remain the bedrock for the economy and show few signs of flagging, the investment retrenchment and corporate profitability concerns are making the U.S. more vulnerable to a recession.
Golle writes for Bloomberg.
