Macro

The sector to watch when the economy turns lower

Jane Fu

Singapore Sales Trader

At the beginning of this month, the Organization for Economic Co-Operation & Development forecasted that the world economy would grow by 3.3% in 2019 and 3.4% in 2020, These estimates were 0.2% and 0.1% lower for the two respective years compared to the OECD’s last forecasts set in November. Meanwhile, China lowered its goals for economic growth to a range of 6 to 6.5% for 2019, the lowest pace in nearly three decades.

US personal income had fallen for the first time in more than three years in January, signalling sluggish growth in the world’s largest economy. There is a common view that the world economy is experiencing a slowdown. Investors have valid reasons to believe that, amidst this economic downturn, the bull market in stocks is also coming to an end soon, and that it is time to adjust portfolios towards “late cycle” plays. One opportunity we would like to highlight is infrastructure companies. Here’s why:

Most governments spend massive amounts maintaining their current infrastructure systems. On top of that, trillions more need to be poured into building additional infrastructure to support economic growth. It is widely believed that increasing spending on infrastructure projects can provide a buffer for any slowdown in economic growth. This belief is certainly reflected by the actions of China’s government. During the recent National People’s Congress, Chinese premier Li Keqiang unveiled that the government will pump some 800 billion yuan into building railways and another 1.8 trillion yuan into roads and waterway projects. Beyond this, the ongoing ‘One Belt, One Road initiative is a massive infrastructure project that aims to link China physically and financially to other economies across Asia, Europe, Africa and Oceania.

The US government is making similar efforts. Back in 2016, after president Donald Trump took office, his infrastructure plan was a key component of his populist pitch. However, as other political goals such as the removal of Obamacare, trade policy and immigration issues shifted his focus, the infrastructure plan failed to materialise. In the middle of last year, for instance, Trump said that his “significant” infrastructure plan would likely have to wait until after the midterm elections. Now it is time to place this topic back on the table, and this effort will likely prove successful as many years of underinvestment in this area have left US infrastructure in a state of relative disrepair.

Apart from such top-down efforts, demographic shifts also provide support for infrastructure spending. This is especially true in developing nations where an expanding middle class and increasing urbanisation drives the need for additional transport and entertainment infrastructure.

Governments usually have finite budgets to spend on infrastructure and it has been widely observed that there are often significant gaps between the spending and budget required, especially in developed nations like Australia, Canada and the European countries. That’s why more governments are outsourcing infrastructure projects to private companies, allowing them to earn income by operating these assets after they are built.

On top of the fundamental demand for infrastructure projects, infrastructure stocks usually offer unique advantages. They usually offer above-average dividend yields, for instance. The chart below shows compares dividend yield between the S&P500 index and the S&P Global Infrastructure index (SPGTIND); it is obvious that the infrastructure index offers higher dividend yields.

Figure 1: Dividend Yields (2007-2019)

Source: Bloomberg

Stability of return is another advantage. According to data compiled by Vanguard, the three-year rolling return on global infrastructure names, represented by the FTSE Developed Core Infrastructure Index, is much stable than that of global equities, represented by the MSCI World index. The return on infrastructure is less sensitive to the economic cycle.

Figure 2: Rolling three-year average return on assets

Source: Vanguard Research

Last but not least, infrastructure itself is a well-diversified sector. Take the FTSE Core Infrastructure indices, for example: these contain 10 sub-categories (Pipelines, Railroads, Transportation Services, Broadcasting & Entertainment equipment, Travel & Tourism, Fixed Line Telecommunications, Mobile Telecommunications, Conventional Electricity, Gas Distribution, Multiutilities, Water, Specialty REITs, Telecommunications Equipment).

In the current environment, investing in sectoral ETFs may be preferred to individual equities selected from the broad global list.

One ETF to watch at is GII, the SPDR S&P Global Infrastructure ETF, which invests in large and mid -cap stocks, focusing on companies within the infrastructure industry. It is rivalled by IGF, and the iShares Global Infrastructure ETF, which possess larger market capitalisation. 

Finally, investors looking to go long the ‘One Belt, One Road’ narrative might consider OBOR, the KraneShare One Belt One Road Index ETF. This fund tracks the MSCI Global China Infrastructure Exposure Index and aims to identify potential beneficiaries of the initiative.
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