INSIGHTS

On October 26, 2016

Constructive on Infrastructure

One of the more under-served areas of the economy has been the maintenance and construction of infrastructure in this growing U.S. economy. Over the past few elections, we have seen an increase in rhetoric pushing this initiative with very little follow-through. For example, gross government investment from 1970-2008 grew at an annual rate of nearly 7%. Since 2008, the amount of gross investment has declined by 3.7%. Over that time frame GDP has grown by $3.7 trillion, or nearly 25% from $14.6 trillion to a current nominal rate of $18.4 trillion. With growth comes more economic activity and a quicker degradation of existing infrastructure.

To be fair, the government investment as a percentage of GDP has been declining for some time. This can be explained by a multitude of things, but namely is the gains in efficiency in production, development of longer shelf life for new projects and moderating growth in population. However, after a period of neglect, the cost to fix and maintain projects begins to build up.

The average gross investment as a percentage of GDP has been 4.50% since 1966 – a level we have been below in all but two quarters since 1992. A simple extrapolation of this deviation means that we have been under-serving infrastructure by an average of 0.5% annually since 1992 which equates to a potential $1.4 trillion needed to make up for the last 24 years.

This issue will become more pressing, especially given that the Federal Reserve and its accommodative policy is slowly and methodically reversing. This process is one that reminds me of the quote: “The chains of habit are too soft to be felt until they are too hard to be broken.” It won’t happen overnight, but the process is well underway and is being corroborated by the inflation figures both nationally and internationally as well as movements in those countries which have seen their negative yielding sovereign debt oscillate fairly violently between negative and positive yields.

With the Fed transitioning, fiscal policy and its poor track record recently will come to light. Infrastructure improvements and maintenance will become a more popular political topic with an economic multiplier that can become somewhat addictive to politicians once implemented.

As significant as the opportunity is here in the United States, the same neglect has gone on globally according to McKinsey Global Institute’s report, “Bridging global infrastructure gaps” June 2016:

• $2.5 trillion is invested annually in transportation, power, water and telecommunications systems. They estimate they need a $3.3 trillion just to maintain expected growth rates.


• 60% of that need will come from Emerging Market countries.


• Power and roads will be the biggest needs totaling over 50% of the spending needed in the next 15 years.


• It is estimated that a total of $49.1 trillion will need in the next 15 years. If the current run rate is continued, the annual cost will be $350 billion that will eventually need to be made up.

This imbalance and under-investment will also come at a time when basic materials, labor and commodity prices could all cause these levels to be higher in costs. Over the past few years we have seen supplies of commodities and basic building materials become strained in supply due to under-investment from lower commodity prices. When the demand for these goods reverts back to even a moderate level, prices could spike. When you couple this with the length of time these projects take, and the resignation that government projects are always more expensive than the estimated initial investment, this could set up a 5-10 year time frame when commodities and basic materials outperform other investments.

Some of the best opportunities are the ones that are disregarded, written off as obsolete, finite in competition and have little replacement competition. Couple that with time and long economic cycles and you begin to see how few opportunities that have those characteristics present themselves. We continue to favor commodities, basic materials of both the raw investment and the companies that stand to benefit from this potential re-invigorated aspect of the global economy.

CRN: 2016-1003-5566R

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