Opinion

James Saft

The U.S. factory renaissance and your portfolio

May 15, 2013

May 15 (Reuters) – The possible coming rebirth of U.S.
manufacturing might turn out to be the most important investment
story of the next decade, up-ending the winners and losers of
the former world order.

The U.S.’s share of global manufacturing output fell by 23
percent in the 40 years to 2010, as China rose, outsourcing
boomed and a new highly integrated global supply chain was born.
This has utterly remade the U.S. and global economies, affecting
everything from how much and how U.S. workers make money to how
most companies are organized and compete.

Now a combination of factors – from cheap U.S. energy to new
technology to a falling wage gap – may partly reverse some of
those changes, bringing some manufacturing back on-shore.

If, and to the extent, this happens, literally every
investment in your portfolio will be affected.

RENAISSANCE OR CYCLICAL UPTURN?

First off there is a host of solid reasons to think U.S.
manufacturing may finally be catching a break. The
low-hanging fruit of globalization has mostly been gathered, and
while we can’t expect a return to the U.S. dominance following
World War II, many of the advantages enjoyed by U.S. competitors
have been eroded.

Energy is a great example. The discovery and exploitation of
shale gas and other new energy sources in the U.S. will likely
give manufacturers close to the source a real and ongoing cost
advantage. Consultants PWC have estimated that an additional one
million manufacturing jobs may be created by 2025 solely due to
the advantages of cheap shale and demand for the products used
to extract it. That alone is 1/6th of all the manufacturing jobs
in the U.S. which disappeared between 1998-2010.

At the same time, the wage gap between China and the U.S.,
once vast, has been narrowing sharply. While Chinese factory
workers cost just 3 percent of their U.S. counterparts in 2000,
by 2015, according to Boston Consulting, they may cost 17
percent as much. And while productivity per worker hour is
growing in China, it is not keeping up with wage growth. Taking
all costs into account, Boston Consulting says that South
Carolina, Alabama and Tennessee are among the least expensive
manufacturing locations in the industrialized world.

Technological change may also benefit the U.S., notably the
rise of 3-D printing, a form of manufacturing where products and
parts are literally sprayed into existence by laser and other
printers, rather than being hewn from solid metal. It makes the
most economic sense to site 3-D plants close to markets and in
places where intellectual property rights will be best
protected, two arguments in favor of the U.S.

To be clear, this is a speculative play. New energy sources
may well be found elsewhere, wage growth might accelerate in the
U.S. and any number of other roadblocks can and probably will
arise. What now looks like a secular shift may turn out to be
just a cyclical recovery in manufacturing, and possibly a
short-lived one.

HOW TO PLAY IT

One huge beneficiary of all of this will be the U.S.
Treasury and its securities. Higher tax revenues and growing
employment will make deficit issues easier to handle, while an
improving trade balance should benefit the dollar.

While energy production and related companies will be an
obvious beneficiary, expect better growth in manufacturing to
also help chemicals and capital goods firms.

But, just as the hollowing out of manufacturing hit
everything from house prices to banks in the mid-West, so will
the benefits of a reversal be widespread.

“Due to the strong multiplier effect of manufacturing jobs,
the beneficiaries of a U.S. manufacturing renaissance will be
found in small and midsize U.S.-focused industrial suppliers and
in other sectors of the economy,” Shirley Mills, of fund manager
The Boston Company, argued in a recent paper.

That means everything from component suppliers to retailers
to banks.

Catching the flip side of this trade, lightening up on those
who will be hurt, is just as important. The obvious losers are
emerging market countries and companies, which will be at a
relative disadvantage and which, if manufacturers, may have to
cope with rising wages and falling profit margins.

You might also want to look skeptically at some of the
classic U.S.-listed, globally diversified companies which have
done so well in the past decade or two. If re-shoring – the
bringing back to the U.S. of manufacturing – becomes
economically compelling, the global supply and production chain
many of these companies have built will be an expensive and
counterproductive sunk cost.

Your best bets therefore may be the smaller and midsize
publicly traded companies which have never been able to
diversify production internationally.

Like offshoring, this is likely to be a big and slow-moving
trend, so making slow but significant changes to portfolio
holdings over time is probably the strategy which offers the
best risk/reward combination.

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