When markets get tough, it is important to focus on the big picture — that is, to look at the greater economy for clues on how to invest.
The one undeniable reality is that, in turbulent times, equity markets exhibit a great deal of irrational short-term behaviour. It generally takes time for markets to fully understand what is happening in the economy, which in the end is the only thing that accurately predicts market moves.
Right now, market participants are trying to figure out two key things: how bad the economic downturn will be and where the next wave of capital spending will go. The answers to these two questions are critical for investors who want to outperform the market.
The 1990s were characterized by massive spending on electronic infrastructure, be it fibre-optic lines or business office software. The underlying theme was that we had entered a digital age and if the modern company, government or person was to work effectively in the new age, things had to be redesigned.
Whether it was computer programs that linked your office to the Internet or Cisco routers that handled information going from place to place, significant capital spending was required. These investments paid off very well for most companies as productive growth has been at a near-record pace.
Although I think much more money will be spent on these types of projects over the next few years, I believe the explosive growth in electronic infrastructure is likely over. One of the unforeseen consequences of all this spending was the rapid increase in the demand for electric power to feed all these devices.
Coupled with a lack of spending on traditional power projects, places like California are on the verge of power crises. It has been more than 10 years since the last power plant was built in California, but that is about to change in a big way. These new facilities will need new transmission lines, natural gas pipelines and service roads.
As a result, we think the next big wave of capital spending will be in the nuts and bolts of the economy and the companies that will benefit from this spending will be engineering, construction and facility management companies. Names I like in these groups are SNC Lavalin, Jacobs Engineering and Bracknell.
It should go without saying that if a protracted recession develops, these companies will also feel the pain. However, unlike most other endeavours, major projects like power plants generally go ahead no matter what, both because of the extensive planning necessary to get things going and the fact that the government contracts most of these projects.
Governments are traditionally reluctant to cancel labour-intensive projects in bad economic times. Although many of these companies have already moved higher over the last few months, they still represent good value as I believe the growth in these industries is only getting started.
(Evan Spiropoulos is a portfolio manager of the Norrep Fund, a public small-cap fund managed by Hesperian Capital Management.)
