The following originally appeared on our Covestor site:
Value investors are often criticized for myopically focusing on bottom-up company fundamentals and ignoring the larger macroeconomic picture. While it is true that the typical recession is unlikely to seriously impair the value of most companies (especially those with strong balance sheets), we do believe it is important to be cognizant of the larger themes playing out in the global economy. A positive macro trend can reduce or even eliminate losses if you are wrong on an investment (effectively increasing the margin of safety), while a negative trend can turn a mistake into a disaster.
The investment world is currently obsessed over a never-ending series of European sovereign debt crises, a US fiscal cliff to fall off of, and the apparent end of the Chinese investment supercycle. While these events are important, over the coming months we will instead explore in some detail important trends that are more underappreciated and how they influence our thinking and portfolio positioning. As a preview, here in brief are three such trends we see in the US:
1) Nascent Housing Recovery – There has been a lot of buzz in the media recently about a potential housing recovery. The home builder sentiment index is hitting levels not seen since 2006, and if you squint at the single-family housing start data, you can see that they are no longer scraping along the bottom, although we have a long way to go before we get back to something approaching normal. We do not know yet if the uptick in construction is permanent, but any setback will likely be short-lived. The magnitude of pent-up demand for new home construction and the effects this demand will have on the broader economy are not fully appreciated by the market. In short, we believe that housing is becoming scarce and that the “right” housing (i.e., not abandoned Detroit homes or bubble-era structures far from population centers) is especially in short supply.
2) Ongoing Energy Revolution – Over the last five years or so, domestic production of oil has rebounded, arresting a decline that had spanned decades. The latest figures from the US Energy Information Administration show that US petroleum production in the week ending November 16 reached 6.71 million barrels per day, the most since 1996. Most of this new production is coming from shale and other tight (i.e., not very permeable) formations in which the twin techniques of horizontal or directional drilling and hydraulic fracturing (“fracking”) have proven to be truly disruptive technologies. Natural gas markets have been experiencing a similar production boom that has brought US prices down from over $10/mcf in 2008 to under $2/mcf earlier this year. From an investment perspective, there are opportunities on both the production and the consumption sides, as users of energy benefit from cheap domestic prices.
3) The Coming Manufacturing Renaissance – For many years, Americans have heard how large companies have been “shipping jobs overseas.” For the most part, this common refrain is true: growth in the real value of US manufacturing output has slowed over the last 15 years, and far few workers are needed than 30 years ago when the country’s production levels were half of today’s.
As most people are aware, China has been a primary beneficiary of this process, becoming the workshop of the world. Less well known are the dramatic changes now occurring within the Chinese labor force. The average hourly wage of a Chinese factory worker has increased fourfold from $0.50 in 2000 to $2.00 in 2010 and could reach $4.50 by 2015, while productivity is only increasing at roughly half that rate. In contrast, over this period manufacturing labor costs in the US have only increased ~2.5% when accounting for productivity gains. Couple this with the relatively high cost of transportation from Asia to North America and other supply chain headaches that are common when sourcing from Asia, and we believe it will make increasing sense to manufacture in North America goods that are ultimately destined for a North American market.
These three trends are not the only significant forces shaping the investment landscape. However, as stated above, we believe they are underappreciated and worthy of further investigation.