Opportunities in Thematic Investing
- Infrastructure: Opportunities in Aging Infrastructure
- U.S. Housing: Homebuilders & Home Improvement Have More To Do
- Autos: Cars Have Tighter Supply Chains
- Planes: Airplanes Take Off
- Fiber Optics: Dark Fiber Lights Up
|MCALINDEN RESEARCH PARTNERS |THEME TRACKER||
Theme Tracker: The Opportunities In Thematic Investing
November 27, 2013
It isn't just baby boomers' bones that are getting creaky. The nation's roads, factories, and automobiles are too. Taken as a whole, the average age of the total US capital stock is 20.3 years, the highest since the post-war years of the 1940s. As bridges collapse and pipelines leak, the revitalization of aging infrastructure is on the agenda, creating new thematic investment opportunities. What follows is a closer look at that data, which the government just updated, along with corresponding baskets of securities for housing, aircraft, autos, and fiber optics.
Finding Thematic Opportunities
Each year, the US Bureau of Economic Analysis tallies up all the spending on fixed assets and consumer durables, crunches the statistics in their database back to 1901, and provides an estimated age of those assets that are then broken down into smaller categories. The data comes with a lag: the most recent year available is 2011. Even with the lag, this data can show potential inflection points that can be better defined by other macro data and by market action.
At first glance, the story told by the total capital stock appears straightforward: the average age surged during the Depression, dipped during the war years, gradually declined during the 1950s and 1960s, then started rising again with a noticeable surge during the last recession.
But the overall picture can be better analyzed by looking at the individual parts. The government divides the capital stock data into three major categories: government, private sector, and consumer durables. They make very different contributions.
First, the government alone accounts for that dramatic dip during World War II, as massive defense outlays pushed the average age of government assets to a mere 10.1 years. Since then, the average age of government assets has been drifting up, a logical consequence of all the dams, roads, and buildings that the government has built over the years, most of which have very long lives. The average age of government assets is now 23.1 years and no doubt will continue its secular uptrend for some time to come before finally leveling off.
Next, the private sector's capital stock aged dramatically during the Depression and through all of World War II, peaking at 27.2 years. But once the nation's productive energies were redirected, the average age slid for a few decades to 19.2 in 1981 before turning back up. The key point for now is that the private sector accounts a lot the surge during the past recession, pointing to possible thematic ideas.
The third category is consumer durables, which the government defines as a tangible product that can be stored and has an average life of at least 3 years: cars, televisions, hammers, and the like. Since 1950, the average age of consumer durables has been remarkably steady, averaging 4.3 years. It is currently 4.6 years, at the upper end of its 6-decade range and also hinting at possible thematic opportunities.
In addition to three broad categories, the government dissects the capital stock data into dozens of smaller groups. Here is where the investable opportunities can be found, starting with one of the current bedrock themes at McAlinden Research.
Homebuilders & Home Improvement Have More To Do
Since 1965, the average age of US housing was 27 years, plus or minus a year. The average age dipped to the lower end of that range during the housing boom but then reached a post-war high during the bust when homebuilders hit the brakes on new construction.
New home sales have since turned up, pushing the months' supply near all-time lows and already leading to shortages in some parts of the country. House prices are rising at the fastest pace since 2006 and new permits are at a five-year high. Housing starts have recovered from the April 2009 low of an annualized 478,000 units per month to 883,000 today, but that is still well below the long-term average of 1.5 million, leaving a gap in the country's supply of new housing that has yet to be filled. Some of the recent data has been soft, particularly the recent drop in pending home sales. However, homebuilder confidence remains buoyant, housing permits and house prices are at cycle highs, and the thematic drivers remain intact.
As a direct play on construction, the homebuilder stocks have more than doubled since the early days of the housing recovery in late 2011. The momentum has flagged in the last few months with the group as a whole trending sideways and lagging the market's broader rally. But homebuilders have a lot of work ahead of them before the shadow demand is fully met and the budding recovery in wood prices could be a harbinger of another leg up.
A related housing play within the retail sector, the average age of house & garden equipment also hit a multi-decade high of 4.8 years.
That surge coincided with a record 56% plunge in total home sales during the recession: the drop in housing turnover meant that fewer rakes and paint brushes needed to be sold.
With the housing recovery well underway, a basket of home improvement stocks continues to do well both on its own and relative to a broad basket of general retailers.
Airplanes Take Off
The average age of airplanes in the US has also hit a new high of 12.7 years. While the service life of an airplane like the Boeing 747 can be 20 years or more, the rise in the average age is a reminder that many planes that are now in the air are using technology from the 1970s. Newer planes weigh less and can fly farther, helping airlines to cut down on their jet fuel expenses, which can be incentive enough to update their fleets.
Globally, while Europe's airline business is mature and slowing, demand is booming in Africa, the Middle East, and Asia. In Iran, thanks to global sanctions, the average age of an airplane is north of 20 years; the prospective partial lifting of sanctions against Iran could uncork tremendous pent-up demand for parts right away and new civilian planes in the near future, depending on the outcome of international negotiations over the next six months.
An ETF of aerospace and defense stocks has delivered strong performance in 2013, solidly outperforming the S&P 500 Industrials Sector in the first half of the year and showing a resumption of that relative strength more recently. Many of these firms are also exposed to the decline in traditional defense spending in the US and Europe. Some of the reduced outlays are being offset by stronger spending in other parts of the world, as well as by the widespread adoption of drones and other new technologies throughout the globe. The boom in civilian aircraft demand remains the core driver as the stocks embark on their next leg up.
Cars Have Tighter Supply Chains
The average age of US cars on the road is at a record 4.3 years, according to the government's statistics (and private-sector estimates are even higher). While the steady improvements in quality help explain the secular uptrend in the average age of cars, US car sales plunged during the recession but have since roared back. Americans are again driving more miles and there are more cars on the road, but the total number of cars remains below the 2008 peak despite population growth, suggesting there is still pent-up demand to be met.
US car sales were up 10.4% in October from a year ago, despite the partial government shutdown, and are exceeding expectations in November. Globally, car sales are re-accelerating in China and sales are up two months in a row in Europe for the first time since 2011, although sales are still in a slump in India. The partial lifting of sanctions against Iran could also be a boost for the car-makers, restoring up to $500 million in lost trade over the next six months according to the US government.
Sales plunged in the US during the recession, prompting many car-makers to shut down factories rather than wait for better times. As a result, the robust recovery in US car sales means that production is out-pacing the addition of new capacity, spurring manufacturers to add extra shifts and plan new factories. The car parts supply chain is particularly stretched, as is the production of the machines that go into the car factories. In the US, the number of tool shops alone has been cut by a third since the 1990s and tooling capacity is set to lag demand by up to 40% within five years. After the supply disruptions from Iceland's Eyjafjallajökull volcano in 2010 and Japan's earthquake near Fukushima in 2011, getting alternative suppliers is becoming an even greater challenge as global car demand heads higher.
As a group, autos and auto parts have already had a good year in 2013. In light of the strong sales growth and tightening supply constraints, we expect that outperformance to continue into 2014.
Dark Fiber Lights Up
The average age of computers and other technology held steady at about 4 years until the late 1990s. At that point, the threat of Y2K spurred companies and governments to make massive outlays to double the number of digits used in software to represent a year in order to avert potential disaster when the calendar ticked over from 1999 to 2000. In the end, it was a non-event, but the boom in spending pushed the average age of technology equipment down to a post-war low. Arguably, perhaps a decade's worth of capital spending on technology was pulled ahead. In the latest data, tech is getting old again and is at the upper end of its historic range.
While the Y2K bubble inflated all tech in the late 1990s, the boom and bust in communications equipment was turbo charged. During that period, the giddy ambitions of companies led to a massive overbuild of fiber optic cable that weighed on the sector for years to come. After hitting a record low during the boom, the average age of communications equipment today is at a record high of 6.1. In the last several years in particular, the surge in video streaming has lit up all that dark fiber and inaugurated a new cycle for fiber optic cable.
As an industry group, the fiber optics stocks have already hit a home run this year, albeit with higher volatility compared to the other infrastructure baskets.
Of these four themes, the fiber optics basket has pulled back in recent weeks and created a fresh entry point. The capital stock data gives us stronger conviction that the other three themes - housing, autos, and planes - still have more to go. The aging infrastructure story will undoubtedly be a source of new themes as well, in the US and abroad, which we will explore and share as we find them.
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Warren Hatch, PhD, CFA
Portfolio Management and Global Investment Strategy
McAlinden Research Partners
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