- America has a problem: its infrastructure is crumbling.
- Bank of America expects increased restoration and building projects in the next decade.
- Here's how investors can take advantage of this overlooked growth opportunity.
While there's been a lot of buzz recently about the election, AI and Big Tech, and the Fed, one foundational issue hasn't been getting much attention: the country's aging infrastructure.
According to the American Society of Civil Engineers, 42% of US bridges are at the end of their typical service life. Parts of the nation's electric grid are over 100 years old, well past their 50-year life expectancy. After the last decade of underinvestment and neglect, roads, dams, water systems, and other infrastructure will inevitably need large amounts of rebuilding in the next.
This means that investors can take advantage of an "old school" capital spending boom in the coming years, according to Bank of America's head of US equity and quant strategy Savita Subramanian. Seemingly boring infrastructure players such as building products, industrials, transportation, construction, and electrical equipment could all be seeing a comeback in the coming years.
Going 'old school'
There's unavoidable demand for more capital spending in the coming years. US infrastructure has been suffering from severe underinvestment, with manufacturing capacity dropping around 1% from the period between 2008 to 2022. However, US manufacturing activity hasn't slowed down — on the contrary, it's been picking up since 2018, putting increased strain on ailing infrastructure. In 2023, US construction spending increased by over 50% year over year. Reshoring, the trend of bringing previously outsourced manufacturing operations back domestically, is in full swing as nearly 2 million manufacturing jobs have come to the US since 2010.
With robust economic indicators in the manufacturing industry, massive restoration and investment in infrastructure are inevitable to the sustained health of the US economy.
And there are already signs of it happening. Infrastructure spending is slowly reversing its decadelong decline, increasing slightly in 2023.
Government stimulus such as the CHIPS Act created tax incentives for construction and reshoring investments. Bank of America estimates that $400 billion of infrastructure megaprojects are either planned or in progress in North America.
Traditional infrastructure might not seem as sexy as the newer AI data centers, but Bank of America believes traditional infrastructure has stronger growth prospects than AI infrastructure. It's unclear when AI technologies could be effectively monetized, making continuous investment a risky endeavor. The current electric grid could also become a bottleneck, as data center energy demand is projected to increase by 10-12% a year. In Bank of America's opinion, growth for the Big Tech players may already be largely priced in.
On the contrary, "old school" capital investment trades at a discount. The heavy focus on technology and AI has resulted in investors overlooking traditional infrastructure investment. Since 2018, the overwhelming amount of capital flows into US equity funds has entered the technology sector, while industrials, commodities, and infrastructure investments have been anemic.
It appears that the market hasn't fully realized how critical traditional infrastructure players will be as reshoring and building projects pick up in the next few years. Various manufacturing beneficiaries are trading at a discount relative to the S&P 500, such as building products, industrials, ground transportation, and other construction companies. According to Bank of America, the discounts that these companies are trading at are even steeper than those of the 2007 market peak before the Great Financial Crisis.
Invest in industrials and materials
In particular, Bank of America identified the industrials and materials sectors as the best investment opportunity within traditional infrastructure. The industrials sector spans companies that produce the goods used in constructing and manufacturing, while the materials sector includes companies involved in the mining and refining of metals, chemicals, and other raw materials.
In terms of valuations, both sectors are priced relative to forward earnings estimates at below-average levels when compared to the S&P 500. The industrials sector trades at a relative forward PE of 0.98, and materials trades at 0.92. Respectively, that's 3% and 9% below the relative historic P/E average, indicating that there's room for upside in the future.
Some specific industries within those sectors are especially undervalued, such as construction materials and metals & mining. These two industries have a 24% and 16% upside compared to their average historic relative forward P/E.
Investors looking to increase their exposure to industrials and materials do so by purchasing Industrial Select Sector SPDR Fund (XLI), iShares US Industrials ETF (IYJ), Materials Select Sector SPFR Fund (XLB), or Vanguard Materials Index Admiral (VMIAX).
