For the last half-century, US manufacturing languished as companies outsourced their operations to cheaper locations overseas, leaving behind swathes of economically decrepit Rust Belt communities.
Politicians on both sides of the aisle have been promising for years to bring back American jobs and revitalize the economy. Now, it looks like that’s finally happening.
Manufacturing spending has sharply risen in recent years, increasing over 20% in the last year and over 200% since May 2020. John Osterweis, founder and co-chief investment officer of $7.2 billion Osterwies Capital Management, sees this development as a sign of a revitalizing domestic manufacturing sector.
Osterweis Capital Management
Rust no more
In the last few years, the US has been moving away from globalization and back toward domestic production.
Favorable legislation is one factor. The passage of the Inflation Reduction Act, the CHIPS Act, and the Infrastructure Investment and Jobs Act boosted the domestic infrastructure, semiconductor, and clean energy sectors through initiatives such as subsidies and tax incentives. In particular, the CHIPS Act poured over $50 billion into American semiconductor research, development, manufacturing, and workforce development.
These pieces of legislation are all indicators of the larger trend of reshoring, the second factor that’s reviving manufacturing.
Goldman Sachs and Bank of America have identified it as a long-term theme in the world economy. Companies are keen on bringing jobs and supply chains closer to home, especially after the Covid pandemic exposed the downsides of having interlocked and geographically dispersed supply chains. Earlier this year, annual US imports from Mexico surpassed those from China for the first time in 20 years. Reducing international dependency is also a goal of the CHIPS Act, as the US relies primarily on East Asia for semiconductor chip production.
Corporate supply chain restrategizing, combined with government stimulus, has clearly put the wheels of reshoring into motion. Nearly two million reshoring and foreign direct investment jobs have been announced since 2010, according to Bank of America.
The omnipresent shadow of AI is the third factor helping to boost US manufacturing as it transforms the technology industry into a more capital-intensive model. The data centers powering AI require large upfront investments, and the race to develop AI technology has turbocharged the manufacturing-heavy semiconductor industry. This trend isn’t stopping anytime soon: Big Tech companies such as Alphabet, Amazon, Meta, and Microsoft are planning to increase their capital expenditures from $120 billion in 2023 to $180 billion in 2024.
All of these factors are pointing toward a reindustrializing US economy.
Investing in reindustrialization
For many investors, a manufacturing-focused market might be unfamiliar territory.
The US manufacturing sector has been declining for much of recent history, with the manufacturing portion of US GDP shrinking from 16% to 11% in the period between 1997 and 2021, the Osterweis note said. Capital-light industries such as technology, media, consulting, and healthcare replaced heavy industry, creating a service economy.
According to Osterweis, investors should expect increased cyclicality going forward.
The earlier shift to a service economy resulted in longer stretches of economic expansion, with three of the four longest economic expansions in the last 150 years occurring after 1982. Economic expansion periods have roughly doubled over the last 40 years, from four to eight years.
Osterweis Capital Management
Offshoring created more efficient supply chains that allowed companies to better match inventory supply with demand. Osterweis believes this led to longer and smoother economic expansion cycles. The shift to a service economy also reduced the impact of inventory cycles on the overall US economy.
Now, with increased investment in AI and several initiatives to revitalize domestic manufacturing, Osterweis believes the US could see a return to shorter expansion periods.
Investors can buckle up for more frequent economic fluctuations by increasing their concentration in quality growth equities. Osterweis identifies quality growth businesses based on three characteristics: a unique competitive advantage, robust free cash flow to reinvest in the business, and a strong management team. Investing in quality growth businesses not only drives strong returns but also protects against the ups and downs of business cycles.
Osterweis also sees AI as a sustainable trend and recommends investors continue holding semiconductor companies. Specifically, Osterweis implements a defensive strategy by investing in Nvidia competitors that offer similar products at cheaper price points. He also recommends investing in companies further up the semiconductor value chain. Investors with diversified semiconductor holdings can better protect themselves from a potential sector pullback or a cyclical downturn, which Osterweis believes is likely after the current wave of aggressive semiconductor spending dies down.
ETFs such as American Century US Quality Growth ETF (QGRO), WisdomTree US Quality Growth ETF (QGRW), VanEck Semiconductor ETF (SMH), and First Trust Nasdaq Semiconductor ETF (FTXL) can give investors exposure to these areas of the equity market.
