As of Q4'2024, we've noticed that Private Fixed Investment (PFI) has made a divergence from Personal Consumption Expenditure (PCE). In our accompanying prepared graph (which illustrates "real" or "net of inflation" figures), since Q1'22 through Q4'24 real PFI and real PCE were broadly positively correlated except during 2H'22 and now recently Q4'24.
To better understand the components and significance of PFI as an economic indicator, we refer to Chapter 6 Private Fixed Investment from the Bureau of Economic Analysis, "Private fixed investment (PFI) measures spending by private businesses, nonprofit institutions, and households on fixed assets in the U.S. economy. Fixed assets consist of structures, equipment, and intellectual property products that are used in the production of goods and services. PFI encompasses the creation of new productive assets, the improvement of existing assets, and the replacement of worn out or obsolete assets. The PFI estimates serve as an indicator of the willingness of private businesses and nonprofit institutions to expand their production capacity and as an indicator of the demand for housing. Thus, movements in PFI serve as a barometer of confidence in, and support for, future economic growth."
In 2022 the Fed began its rate hiking cycle, where we witnessed a rapid rise of the effective Fed Funds Rate (FFR) from 0.08% in March 2022 to 4.33% by December 2022. This rapid increase initially weakened confidence in economic growth, but after a period of more than a year, PFI investment rebounded as higher interest rates were fully digested by the economy.
Now almost three years since the Fed began raising rates, businesses and consumers are clearly having second thoughts on the amount to allocate to fixed assets. Keep in mind that PFI includes residential real estate, which is having a particularly challenging time give the new level of mortgage rates as compared to where most homeowners refinanced years ago. This increases transactional friction within the real estate market which directly correlates to a reduction in PFI.
Further below, there's a chart that we came across in our research that provides great context for the impact of PFI versus PCE when evaluating economic conditions. Specifically, is weakness in PCE more or less impactful than PFI on creating recessionary conditions for an economy? The data is compelling in that PCE may show continued sustainability even while PFI rapidly deteriorates and therefore may be considered the primary contributor to recessionary conditions.
With the above in mind, we continue to be defensively positioned across our strategies with greater allocations towards lower valuation segments of the equity markets domestically and globally. These areas though not immune from economic conditions, present current pricing that is not overly optimistic. This may provide an expectation of a pricing floor while other areas that are overbought (e.g., higher valuations) may experience greater downside pricing volatility with the news of diminishing private investment.
