Intangible Investment Is Keeping Overall Business Investment Afloat by Eric Bush, CFA – Gavekal Capital
The composition of business investment in the US has dramatically shifted since World War 2 and this shift is very much ongoing. Overall business investment as of 3/31/2016 (latest data point for all referenced series in this post), accounted for 12.4% of GDP. Business Investment has been on the decline since making a cyclical peak of 13% on 9/30/2014. However, this decline would have been much worse if not for business investment in intangible property products.
Investment in intangible property products, which accounts for 1/3 of total gross private nonresidential business investment in the US , has increased by 2.6% year-over-year while total business investment has declined by 0.3% year-over-year . In fact, intangible property products investment has grown on a year-over-year basis every quarter since 12/31/2009. Unfortunately, the same can’t be said for the other two components of business investment: structures and equipment. If we remove intangible property products and focus just on the other two investment categories, structures and equipment (we will call this tangible business investment), we see that tangible business investment has declined by 1.6% over the past year. Currently, tangible business investment is declining at the quickest pace since 3/31/2010. If these trends persist until the end of the year, intangible investment will pickup another percent share of overall business investment.
Intangible Business Investment
What is shocking is that while intangible business investment continues to take a greater share of overall business investment, nearly all of these intangible investments are invisible on individual company’s balance sheets and are instead treated as a current period expense. Treating intangible investments in this way creates a gigantic mismatch of information between companies and investors and leads to the Knowledge Effect. As Baruch Lev, director of Vincent C. Ross Institute of Accounting Research at NYU Stern School of Business, stated in a Barron’s article last weekend, treating intangibles investments as expenses “contaminates” current earnings and leads to a lack of predictive value for classic accounting measures.