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Investment and Recessions

Summary:
A long, long, long time ago - almost twelve years ago - I wrote Investment and Recessions, explaining the usefulness of New Home Sales as a leading indicator.Here are some updated graphs. My view is new home sales and housing starts are two of the best leading indicators for the economy (but not always).The first graph shows the change in real GDP and Private Fixed Investment over the preceding four quarters, shaded areas are recessions. (Source: BEA) Click on graph for larger image.A couple of observations:1) Since 1948, private fixed investment has fallen during every economic recession.2) Private fixed investment has fallen 14 times since 1948, with only 11 recessions.So what happened during the periods around 1951, 1967 and 1986 to keep the economy out of recession? These are the

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A long, long, long time ago - almost twelve years ago - I wrote Investment and Recessions, explaining the usefulness of New Home Sales as a leading indicator.

Here are some updated graphs. My view is new home sales and housing starts are two of the best leading indicators for the economy (but not always).

The first graph shows the change in real GDP and Private Fixed Investment over the preceding four quarters, shaded areas are recessions. (Source: BEA)

Investment and Recessions Click on graph for larger image.

A couple of observations:

1) Since 1948, private fixed investment has fallen during every economic recession.

2) Private fixed investment has fallen 14 times since 1948, with only 11 recessions.

So what happened during the periods around 1951, 1967 and 1986 to keep the economy out of recession? These are the periods when private investment fell, but the economy didn't slide into recession. The answer is generally the same for all three periods: a surge in defense spending. The defense spending in the early '50s was due to the Korean war, in the mid '60s the Vietnam war, and in the mid '80s a general defense build-up helped offset a small decline in private investment. The mid '80s also saw a surge in MEW (mortgage equity withdrawal) that also contributed to GDP growth.

Investment and RecessionsThe second graph shows the separation of private fixed investment into residential and nonresidential components.

This graph shows something very interesting: in general, residential investment leads nonresidential investment. There are periods when this observation doesn't hold - like '95 when residential investment fell and the growth of nonresidential investment remained strong.

Another interesting period was 2001 when nonresidential investment fell significantly more than residential investment. Obviously the fall in nonresidential investment was related to the bursting of the stock market bubble.

But the most useful information is that typically recessions are preceded by declines in residential investment. Maybe we can use that information.

Investment and RecessionsThe third graph shows the YoY change in New Home Sales from the Census Bureau.

Note: the New Home Sales data is smoothed using a three month centered average before calculating the YoY change. The Census Bureau data starts in 1963.

Some observations:

1) When the YoY change in New Home Sales falls about 20%, usually a recession will follow. The one exception for this data series was the mid '60s when the Vietnam buildup kept the economy out of recession.   Note that the sharp decline in 2010 was related to the housing tax credit policy in 2009 - and was just a continuation of the housing bust.

2) It is also interesting to look at the '86/'87 and the mid '90s periods. New Home sales fell in both of these periods, although not quite 20%. As noted earlier, the mid '80s saw a surge in defense spending and MEW that more than offset the decline in New Home sales. In the mid '90s, nonresidential investment remained strong.

Conclusions:

1) New Home Sales appears to be an excellent leading indicator.

2) Currently new home sales (and housing starts) are up solidly year-over-year, and this suggests there is no recession in sight.


Bill McBride
A full time blogger, Mr. McBride retired as a senior executive from a small public company in the '90s. Mr. McBride holds an MBA from the University of California, Irvine, and has a background in management, finance and economics.

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