Do robots dream of golden sheep?
As we head into spring, we are reminded of new beginnings. Like most people of a certain age in the northern hemisphere, we have been pottering about in our gardens. Pulling out old growth and planting the new. It seems to us that the American economy has been in the throes of a decades-long process that mirrors spring planting, in a way, but that this process has been lacking clear direction.
In the middle of the last century, American industrial might reigned supreme. Most competitors had seen their industrial capacity destroyed by the war, and it took decades for them to recover. American enterprise had almost no meaningful competition in certain sectors. The US built an extensive network of roads, airports and ports that helped transport goods across the country and the world.
Since the 1980s, these advantages have steadily eroded. Transportation policy has been mired in a morass of special interest jockeying by the oil industry and suburban communities. No meaningful public transport project has been undertaken in the US since the mid 20th century. The contrast with other wealthy economies is staggering: Europe, Japan and China have each managed to build extensive high speed rail networks. Meanwhile, transport policy discussions here revolve around adding lanes to aging urban roads. The decline of our transport infrastructure and how unsuitable it is for today’s needs was brought to dramatic light recently with the collapse of the Francis Scott Key Bridge in Baltimore. This is not the first bridge collapse in the country’s history. The cause in this case is complex and has as much to do with deregulated shipping as it does with US infrastructure. Tellingly though, it will take years to rebuild the bridge with estimates much longer than they were for the bridge’s original construction.
We were also reminded of the decline in American industrial capability by a recent report on the installation of industrial robots. Chinese plants are installing five times as many industrial robots as Japan per year, and the US is even further behind. The fact is that most industrial supply chains are now centered in Asia. US industry is at a significant disadvantage in many segments, except in certain specialties such as electronics and weapons manufacturing. Even the advantage previously enjoyed in very complex industries such as commercial aircraft manufacturing appears to be fading. Though manufacturing has grown in nominal terms, it has become a much smaller portion of the US economy in terms of overall contribution to GDP and employment. In the 1950s, over 35% of the US workforce was employed in manufacturing, today that number is under 10%.
What has replaced it of course are service industries. This includes IT, financial services, healthcare, hospitality etc. This re-alignment has had an impact on the relative success of communities. Former industrial powerhouses such as the mid-west, have seen declines in wealth and well-being. Service industry focused regions, such as the North-East and West coast, have enjoyed remarkable growth. The advantages that accrued to US manufacturing centers from dominating global trade, have steadily migrated to US service centers which play a major role in global services, whether they operate in capital markets, or data center software.
This realignment has already had a major impact on US politics, and will likely continue to. The lack of industrial work opportunities will continue to have a material impact on communities previously organized around such economic activity.
From an investor’s perspective, this means investors focused on the US will have fewer profitable opportunities to invest in sectors where the US does not have a competitive industrial policy and is losing ground to industrial sectors based in Asia or Europe. Investors focused on US markets will find better opportunities in services focused industries that have a larger footprint and where American companies remain globally competitive.
In terms of near term and broader factors that affect the market, despite the Fed’s rate hikes, inflation remains stubbornly high. The US yield curve now suggests rates may remain where they are for another 6-9 months, with rate cuts occurring in late 2024 or possibly 2025. This is in stark contrast to the beginning of 2024 when the prevailing market view was for 6 rate cuts beginning in the spring.
With long term rates drifting higher again and inflation appearing remarkably sticky, investors have shifted back towards what worked last year – growth stocks, particularly tech companies in the AI space, despite increasingly stretched valuations. This has come at the expense of value/income stocks which have been pummeled yet again to start the year. We expect this trend of growth over value will reverse if/when the Fed begins easing interest rates.
Investors have also recently started to diversify into commodities as oil prices move higher again and precious metals, most notably gold, are attracting increased attention. Gold’s surge is likely a result of several recent trends: central banks diversifying away from bonds, Chinese investors seeking stability in a slumping economy where the real estate market is imploding and macro investors sensing the beginnings of a possible paradigm shift towards commodities as a hedge against entrenched inflation. When looking back at the 1970’s (the last time inflation was this pervasive), gold outperformed equities and bonds.
While it’s difficult to know for sure whether we are entering an environment similar to the 1970’s, we can’t rule it out so long as the economic data shows inflation re-emerging. The next few months of data will be important in shedding light on where things are headed. While growth stocks continue to be favored in this environment, we believe value stocks will have their due and it’s important for investors to maintain a diversified portfolio with exposure to bonds and commodities.
Best,
Subir and Louis