Friday, January 11, 2013

America the Producer?

In my last article I highlighted the following:
  1. The Bush-era lower taxes have added a general stimulus to the economy, enabling individuals to purchase more products and services because of a higher after-tax income.
  2. The larger government outlays as a percentage of GDP have driven growth rates above what is naturally sustainable in segments like defense and construction; and has enabled a woefully inefficient healthcare industry rife with fraud and over-billing. 
  3. The aggressive monetary policies that have fueled falling interest rates have added significant stimulus to the economy, especially in industries requiring debt financing like housing and autos. 
Given my belief that taxes paid per individual continues to go up, government spending per individual decreases, and monetary policies back-off; I do not find retail, defense, construction, housing or autos overly interesting. Although, I concede that monetary policies could keep interest rates low for an extended period and thus investing in housing and autos could prove quite rewarding. I just don't want to try to get into Bernanke's briefcase every time the market falters.

What I do find interesting is an apparent shift in manufacturing between goods produced domestically versus overseas. Due to a number of economic forces, both macro and micro, there is the beginning of a shift towards domestic manufacturing, in my opinion. Numerous individuals have argued this trend recently, highlighted by Charles Fishman in the December edition of The Atlantic. Indeed, after manufacturing output rose 10% in the first quarter of 2012 the trumpets sounded about America's manufacturing resurrection, only to fall flat for the remainder of the year. So this trend is by no means certain and definitely not smooth. With that said, I plan to explore the argument further.

Macro forces pushing a shift away from overseas to more domestic manufacturing include:
  • Higher oil prices, increasing shipping costs
  • Lower natural gas prices in the US, reducing domestic manufacturing costs
  • Rising China wages, which have increased five-fold since 2000 in US dollars
  • Slack US labor markets and weakened unions in the US, enabling lower domestic labor costs
  • Rising US labor productivity, enabling lower domestic labor costs
  • Falling dollar relative to China Yuan, making Chinese products more expensive
In addition to these macro forces, companies are finding numerous hidden costs to separating domestically-based product design and overseas production of their products. Over time, the assembly of products has tended to become needlessly more complex, increasing production costs and offsetting the overseas advantage of lower wage rates. As Mr. Fishman put it, "it was like writing a cookbook without ever cooking."

Macro forces paired with fundamental business interests should eventually make for a powerful trend, in my view. Furthermore, the President is also focused on improving the manufacturing capabilities of the country, and thus political interests are aligned with economic trends. Finally, the on-going efforts of the Federal Reserve likely continues to weaken the US dollar over the long-term, adding further support to moving manufacturing back within domestic borders.

So there appears a fairly complete argument driving the growth of domestic manufacturing above GDP growth. The key phrase is "above GDP growth."

The consensus seems to tilt towards healthy GDP growth in 2013, driving favorable earnings growth. The key assumption supporting these views, in my view, is price stability. Given the Federal Reserve's decent track record over the past few years to balancing the deflationary and inflationary forces in the economy (where I have been wrong in my investment thesis), I believe assuming price stability in 2013 is the easy argument. However, changes in fiscal policy and increasing discord within the Federal Reserve may result in more volatile prices going forward. In the next few articles I plan to look into the following topics:

(1) The assumption of price stability
(2) Expected economic growth
(3) Interesting companies likely benefiting from domestic manufacturing

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