by Calculated Risk on 4/27/2007 07:14:00 PM

Earlier today I pointed out some important good news in the GDP report; both components of non-residential investment rebounded slightly.

This post compares residential investment with both of the components of non-residential investment: structures, and equipment and software.

Important Note: On both graphs, residential investment is shifted into the future. Historically investment in non-residential structures follows residential investment by about 5 quarters, and investment in equipment and software follows residential investment by about 3 quarters. For more on these lags, see: Investment Lags.

Click on graph for larger image

The first graph shows the YoY change in Residential Investment (shifted 3 quarters into the future) and investment in equipment and software. The normal pattern would be for investment in equipment and software to now turn negative.


The second graph shows the YoY change in Residential Investment (shifted 5 quarters into the future) and investment in Non-residential Structures. The normal pattern would be for investment in non-residential structures to turn negative later this year.

Since the typical pattern is for non-residential investment to follow residential investment, the onus is on those arguing that this time is different than "typical". I should include myself since I've only put the odds of a recession at a coin-flip - so I'll try to explain why I think a soft landing is possible (the other side of the coin).

I think one of the keys to '07 is investment in non-residential structures. It is possible that the big investment slump in the early '00s has left many markets with too little supply of commercial and office buildings (and other non-residential structures). There have been several articles recently about rising commercial and office rents and low vacancy rates. As an example, from the LA Times: Businesses pinched as commercial rents soar in Southland

Sizzling demand for offices, warehouses and retail space is hitting Southern California and other major urban centers. ...Office rents have climbed more than 25% on average in the last three years in much of Los Angeles County.
...
Vacancies have plunged to well below 10% in many areas, making it harder for businesses to find space. Only 3% of the region's industrial space — used for warehouses and factories — is available, a level that is considered drastically low.

Therefore it is possible that investment in non-residential structures will decouple (at least somewhat, and for a short period) from the typical pattern.

For equipment and software, I think we are still in a technology fueled productivity boom, so it is possible that investment in software and equipment will stay healthy, and not follow residential investment. This is what happened in the '90s (first graph); residential investment slumped somewhat, but investment in equipment and software stayed strong.

Of course the typical pattern may hold, and then the U.S. will most likely have a recession.