Flying high over Trumpsville

Visiting ‘Trumpsville’ … I mean the US … in June was, as anticipated, another journey of unexpected delights. Five days, three cities and 40+ meetings with companies was all about deciphering ‘Main Street’ vs ‘Wall Street’ and trying to build on my understanding of this unconventional president and what’s next in his cornucopia of tweet-initiated polices.

The economy has been slowing since mid-2018 and the unresolved trade dispute with China is certainly impacting the economy in the US and elsewhere around the world. This dispute started in the spring of 2018, resulting in the USD rallying, the 10-year yield remaining largely flat, US equities outperforming massively, US tech broaching new highs, the US Federal Reserve (the Fed) sounding hawkish, gold tanking, and emerging markets falling precipitously.

The next stage in the trade war began in May 2019 with the tweets from Trumpsville sounding more like a full-blown cold war. Since then the USD has rolled over, the 10-year bond yield is back to around 2%, gold has broken out and emerging markets (ex-China) are doing well.

However, the issue in the first week of June during my visit was not the trade dispute with China but the Trump-created discord with Mexico over uninvited guests. The proposed tariffs on Mexico was of more concern to both industry and the consumer given the very large amount of trade that crosses the border – including a plenitude of food. However, thankfully, by week’s end, the US president had solved the problem he had created and the people of the US were now … ahem … better off.

It seems that virtually all companies questioned on the trade dispute with China is that an escalation is not their base case. The underlying issues around free trade, access to markets, IP protection, etc. are likely to remain issues for years given no easy solution. The heartland of USA industry is literally hoping that this dispute does not escalate. Unfortunately, I wasn’t unable to gain any real insight from the many meetings that I had on how and/or when this conflict will end.

An escalation of the tariffs will likely see substantial stimulus from both the Fed and the People’s Bank of China (PBOC), as well the likelihood of a number of other central banks easing. The current problem with a potential escalation in tariffs is that there is lot more going on than just this issue. In addition, the increase in tariffs will be occurring when global growth is near 3%, not the 4% when this dispute started. UBS is of the view that an escalation to 25% tariffs on remaining imports would subtract about 90bps from USA GDP and 120bps from China GDP.

All these concerns are in the context that as we move through July 2019, the US economic expansion is the longest on record, covering some 34 expansions since 1854. It is noteworthy that the last four expansions have been in the top six on record.

Another way to look at it is that the US economy has only been in recession for 34 months since November 1982 (440 months in total), which is just 8% of the time. The move away from agriculture to a more diverse economy and a Federal Reserve that became more active are all reasons for economic cycles to be extended.

Labour

Labour shortages have been a keen discussion point for US industry for a number of years and the meetings in June saw no change in this growing issue. It was interesting that for the first time a company actually suggested that the pay scale needed to be increased to encourage workers to enter the workforce. For example, drivers (transport) are in constant shortage. Charts 2a – 2d show the elevated job openings for a number of industries that are near or at multi-year highs.

Eleven states, including California, Colorado, Illinois and Washington, D.C. have now legalised marijuana for recreational use for adults over the age of 21, and 33 states have legalised medical marijuana. Although cannabis is now legal in many states in the US, it is still considered a Schedule 1 drug under the Controlled Substances Act (alongside heroin, LSD, peyote and ecstasy to name a few).

Here’s the challenge. Banks are regulated federally, so the disconnect between state and federal legislature causes problems for the legal cannabis economy. Banks that provide services to a legal marijuana business face possible criminal prosecution for ‘aiding and abetting’ a federal crime and money laundering. Banks may choose to service a legal cannabis operator, but the red tape required is immense and thus most banks choose to not deal with them.

The interesting side issue of all this, which I gleaned from this trip, was that many potential workers are failing drug and alcohol tests both at work and when applying for jobs. Many of the lower skilled roles, particularly in industry such as factory workers, drivers, etc. require this test. One company noted that an incredible 50% of applicants for jobs are failing the test. This is exacerbating the labour shortage.

Weather

Weather is often cited as an excuse for companies to account for missing earnings estimates, with Boral using this a number of times over the past couple of years. However, it was notable that a number of companies called out weather, especially in the ‘sun belt’ (incl. California, Arizona, Texas and Florida).

Flooding and heavy rains impacted a number of industries including transportation — both road and rail together with construction and building. This is just another headwind together with the tariff situation that has slowed the economy.

From the perspective of James Hardie Industries (JHX) and Boral Limited (BLD), both overweight positions in the portfolio, the outlook appears fine without being rosy based on the feedback we received from competitors, suppliers and customers.

The drop in the bond rate is making housing much more affordable as the 10-year has fallen from above 3% to around 2%. The feedback from home builders is consistent from the last few years in that the cycle remains slow and steady with little excess in the system and no build-up of inventories.

Many home builders have essentially imitated the successful D.R. Horten model and introduced a low price point product to match where the demand sits. There appears decent growth in both first homeowners and the first move up segment.

JHX siding is balanced between home construction and the restoration and remodel (R&R) market. Louisiana Pacific noted that although wet weather slowed down housing starts in spring, the R&R market remained strong. Both lumber and pulp prices have rolled over and thus should help margins for both companies.

Infrastructure seems to remain a state-based game at present given the political chasm between the Democratic Party and the Republican Party on how the infrastructure will be funded. Both sides, and virtually everyone we’ve spoken to over the past 10 years, concede that the US drastically requires substantial expenditure on infrastructure.

However, states are finding ways to fund the infrastructure, including increasing road taxes in California and legalising both cannabis and casinos in Illinois. In our view, Boral should eventually be a large beneficiary of the increase in infrastructure expenditure in the form of aggregates and fly ash.

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