The Great Comeback No One Will Believe

Something surprising stirs in the US economy. Something no mainstream pundit would’ve dared predict. Something most people probably won’t believe.

US manufacturing is staging a comeback.

Caterpillar, the world’s largest maker of earth-moving equipment, gave us some tangible confirmation in the latest earnings roundup. Based on the business it sees, Cat expects US construction spending will increase in 2012 for the first time since 2004. And Eaton, another large industrial, followed that up by saying it expects its markets to grow faster in the US in 2012 than anywhere else. If it plays out that way, it would be the first time since the mid-2000s that the US led the way.

These are the first robins of spring. Forget the official data. This is real economics. As hard as it may be to believe, US manufacturing is coming back. There are other clues.

A new report by Cushman & Wakefield, a commercial real estate services firm, points out that new leases for industrial property “returned to levels not seen since prior to the 2008-09 recession.” Tenants signed new leases for 306 million square feet, up 14% from a year ago and the most space signed since 2007.

What drives leases for industrial space? Let Jim Dieter, an EVP at Cushman & Wakefield answer: “Manufacturing is the main driver within the industrial landscape.” Busy factories mean more rail and truck flow. It means fuller warehouses. It means looking for more space.

How to explain this? Isn’t China eating America’s lunch?

I found a recent paper by Reynders, McVeigh Capital Management that points to a few reasons for the sudden revival that jibe with what I’ve heard from the companies themselves. The report is called “Workforce Rising: Why US Manufacturing Is Poised for a Comeback.”

One is that the wage gap is shrinking. It isn’t that much cheaper to move to, say, China anymore. The nearby chart nicely sums up what’s happening. As wages have gone gonzo in China, its wage edge melts away. US manufacturing wages were 22 times that of China’s in 2005. Today, that wage gap is under 10 times and likely will be under five by 2015.

Transportation costs figure into this too and cut further into China’s advantage. As the price of oil has stayed north of $100 a barrel, the cost to ship anything is high. As author Jeff Rubin says, “With every dollar increase in the price of the bunker fuel that powers the containerships that ply the Pacific, China’s wage advantage becomes less and less important.”

So those are two reasons for the manufacturing revival in the US. There are two more compelling reasons that have to do with what’s in the ground. Let’s start with one of my favorites: water.

In a world where fresh water is scarce, such as in China and India, the US remains water-rich by comparison. Around the world, “Many regions are already approaching ‘peak water,’ a condition under which usage rates surpass the natural rate of replenishment,” the authors write. “Importantly for the manufacturing sector, the US is home to the largest reserves of water on the planet.”

People in the US tend to ignore this lucky circumstance. Manufacturers don’t. They use lots of water to make everything from jet engines to minivans.

In addition to water, the US has plenty of cheap natural gas. As we’ve talked about before, this is bringing back firms that use natural gas to make things. The McVeigh report notes how Nucor began building a $750-million plant in Louisiana. It plans to superheat natural gas and mix it with scrap iron and iron ore pellets to make steel. If you burn natural gas, you want to be in the US.

Even the automakers are coming back. GM will invest $2.5 billion in US factories. Until recently, that money was going to Mexico. Ford signed a new contract that calls for $16 billion in US investments and 12,000 new jobs by 2015. The foreign automakers are coming too. Mercedes plans to spend $2.4 billion by 2014 to expand an Alabama plant that will add 1,400 jobs. You get the idea.

I like this whole story because it will surprise a lot of people and, hence, has some value as a contrarian observation. In September 2010 (letter No. 79), I wrote a letter with the headline “The USA — Still a Nation of Builders.” The main point, as I wrote then, was “to leave you with a different perception of American manufacturers. They are not like dinosaurs on their way to extinction. In fact, some of them are great investments.” I showed a number of ways in which US manufacturers were doing quite well.

The thesis landed with a thud. It was mostly ignored. If anything, I heard people tell me how it couldn’t be so. Nevertheless, I urged my subscribers at Capital & Crisis to buy Globe (NASDAQ:GSM), a low- cost US manufacturer, which went on to double.

A lot of investors will miss the opportunity to cash in on this rebound in American manufacturing, simply because the idea is so counter to what they think they know. When it’s obvious to everyone what’s going on, of course, it will no longer be a worthwhile investment theme. But for now, US manufacturers get little respect and offer a good pool of potential investment ideas.

Regards,

Chris Mayer
for The Daily Reckoning