Figure 7-7: Swings in real consumer spending (PCE) drive changes in real capital spending
Rising and slowing growth in consumer spending on goods and services (real PCE, black line) trigger–usually with a 6- to 12-month lag time–far greater swings business investment (real capital spending, green line) in the facilities and equipment that produce those goods and services. Consequently, consumer spending is a highly effective leading indicator of future volatile swings in capital spending (see shaded ovals). This is a relationship poorly understood by many economists, particularly “supply-siders,” who incorrectly view capital spending as the key driving force in the economy. Note that capital spending, as the laggard in the economy, remained strong during the early to mid stages of many bear markets (vertical yellow bars). This often deceived unwary investors, well past cyclical, into believing that economic growth was proceeding. Conversely, capital spending typically remains suppressed well past the end of bear markets.
Current Comment:The recent recovery in real consumer spending to Y/Y gains (see Figure 7-3), has led to a rebound in industrial production and services inventory pipelines have been restored. This will inevitably lead to some rebuilding of capacity. Y/Y capital-spending comparisons by late 2010 will therefore almost certainly increase, with surprisingly favorable profit comparisons in that sector. However, given the length and depth of the recent decline and their effect on underlying business confidence, longer-term gains in the capital sector may prove more grudging.
