U.S. Investment in Traditional Equipment Is Hot

Even with climbing fuel prices, rising interest rates, and many businesses looking to cut costs, investment growth is giving the manufacturing sector an extra boost this year. Manufacturing output is expected to increase nearly 5.0% and a primary recipient will be the machinery sector. To put this in perspective, new orders for machinery have surged. Year-to-date through the first quarter, total new orders were up 11.8% versus a year earlier. Almost all machinery categories enjoyed an increase, some at a whopping rate: construction machinery, 9.8%; mining and oil and gas field machinery, 22.6%; industrial machinery, 25.4%; photographic equipment, 7.3%; HVAC equipment, 18.0%; metalworking machinery, 16.0%; power equipment, 3.9%; and material-handling equipment, 9.8%. Shipments have also been on the rise, but orders have been stronger and order backlogs have been expanding.

Near-term prospects for machinery investment come largely from the pressure to improve productivity and efficiency, especially when competition is usually global and fierce. In addition, if we are correct about the long-awaited rebound in nonresidential building construction (up 3.2% in 2006 and 6.5% in 2007), this will provide additional support to industrial equipment, material handling equipment, and HVAC equipment. However, the rebound in construction machinery is beginning to wind down, as is the farm equipment cycle. The demand for energy-related equipment remains strong. Power equipment continues to limp along without support from major generating capacity additions. Diesel engine demand has been strong, supported by on- and off-highway markets, but that will be changing as we move through 2006 and into 2007.

While this year's investment growth in traditional machinery appears to be accelerating, the so-called high-technology sector that includes semiconductors, computers and peripherals, and communications equipment is expected to see a slight slowdown in spending growth. In 2004, investment in information processing equipment rose 13.6%. Last year, spending growth slowed to 13.0%, and this year is on track to slow further, to 11.5%. The changing structure of business investment will have a profound impact on the mix of capital goods from an output perspective. The relative easing of demand growth in high-technology industries will slow output growth in computers and electronic equipment to 17.1%, 2.8 percentage points lower than it was last year. Note that the high-tech output figures also include dramatic adjustments for technological improvements. It would be misleading to translate them as a direct measure of the volume or number of units produced.

Even though business investment will garner most of the attention this year, the consumer will continue to be the foundation of the economy. Healthy employment gains remain the principal factor behind the consumer's ability to shop. In April 2006, total non-farm payrolls were just above 135.0 million, more than 1.8 million higher than in April 2005. Furthermore, payrolls should climb by another 1.5 million by the end of this year.