The Inevitable Infrastructure Renewal

We are currently in the second longest bull market in history and the fourth longest period of economic expansion since 1945. Even so, we are constantly faced with questions about the health of the US economy, which quite frankly can’t be that strong given that we are now in the seventh year of near-zero interest rates. This is a topic that has been well hashed out by many commentators, and it isn’t my intention to put you to sleep by going over it again. Instead, I would like to focus on one issue that most agree would stimulate increased economic growth. Our nation’s infrastructure is in dire need of repair, and greater efforts to improve our roads, bridges, power grid, etc. are essential to both our short- and long-term economic vitality.

Keynesian economics teaches that during times of slow economic growth, the government should step in and increase its spending as a means of replacing lost demand. Government spending is one of the four major components of Gross Domestic Product, and it includes spending at the federal, state, and local levels. In 2015, aggregate government spending contributed about 17.7% to our country’s GDP, making it the second biggest component of GDP behind consumer spending. Interestingly, that 17.7% contribution last year was below the contribution from government spending in 2005, prior to the financial crisis. In that year, aggregate government spending accounted for 19.0% of GDP. That’s right. Governments were contributing more to our GDP when the economy was growing at a 3.3% clip than last year when the economy grew at an anemic 2.4% pace. How would Keynes have reacted to this?

During periods of recession or slow growth the federal government needs to be the one to increase its spending. State and local governments generally have mandates to balance their budgets, which limits their ability to spend when tax revenues fall as a result of slow economic growth. Which brings up the next logical question. Are there any glaring areas of neglect that could use some federal government investment?

A 2013 study by the American Society of Civil Engineers concluded that America’s infrastructure, which covers roads, water, waste, schools and transit, received a D+ rating on a school scale of A to F. The report estimated that it will require an investment of $3.6 trillion (in 2010 dollars) by 2020 to bring America’s infrastructure up from its current “poor” status to “good” – a level of investment that would create a $1.6 trillion funding gap. However, if spread over a number of years the investments are not crippling in the context of an $18 trillion economy. This is especially true if Congress is able to successfully address the long-term problem of entitlement spending, which would provide more fiscal flexibility in the near term.

It is generally agreed that the nation’s roads are in particularly bad shape. In the World Economic Forum’s ranking of global infrastructure, American roads have dropped from seventh place a decade ago to a current ranking of fourteenth place. A recent article in The Atlantic magazine said that, “more than half of fatal vehicle accidents in the United States are due in part to poor road conditions.” In addition, one in nine bridges is currently considered structurally deficient with an average age of fifty years. I could continue on with other troubling examples of our crumbling infrastructure, but I think you get my point – It badly needs repair.

Sound infrastructure is essential for a healthy American economy. The near-term effects would be felt very quickly as increasing infrastructure investment boosts GDP while supporting local communities, growing employment and household incomes, and increasing exports. In the longer term, infrastructure is critical for our economic vitality as well. According to Moody’s, by improving transportation and power efficiencies, new infrastructure will return $1.44 for every dollar invested. Improving our infrastructure will also benefit the environment as commuters won’t spend as much time in their cars, waste water won’t leak and the power grid will not squander electricity. (Ironically, one of the factors inhibiting infrastructure investment is environmental red-tape.) If we instead neglect these investments and our infrastructure is allowed to decay, we will be faced with reduced competitiveness and slower long-term economic growth.

The facts are on the table. All we need now is for the politicians to get out of the way of one another and deliver a national vision. This will require concessions on both sides of the aisle. Conservatives must be able to relax their position of fiscal conservatism. Liberals, for their part, must agree to reduce the red tape that leads to project delays. Ultimately, though, the politicians must conclude that the investments are in everyone’s best interest. What better time than now to invest in the future when borrowing costs are close to all-time lows?

Increased infrastructure spending, we believe, will have positive investment implications as well. Several of the companies we hold in client portfolios would likely see sales and earnings improvements in the event of a more comprehensive program to improve the nation’s infrastructure. The most direct beneficiary might be a company called Valmont Industries, Inc. Valmont produces support structures that are used for roadway lighting, safety and traffic management, wireless communications (4G buildout), electrical transmission (power grid), and access systems used in the energy and mining industries. Another beneficiary might be Lowe’s, which is a home improvement retailer that also sells products and services to professional construction and building companies. Improved infrastructure would likely spark better rates of new residential construction as well. Other beneficiaries might be United Technologies, which sells HVAC (heating, ventilation and air conditioning) systems, elevator systems, and security systems, to name just a few, and Danaher, which offers a wide range of manufacturing-related products and services to companies both within and outside the US. We believe that these names and companies like these will benefit from increased infrastructure spending.