Do you remember the Fire Phone, or the Coolest Cooler? What about the Microsoft Kin or Juicero? No, well you’re probably not alone.
For the record, Amazon took a US$200 million hit on the failed phone, while the cooler, which included a party speaker and blender, delivered only two-thirds of its promised 60,000 products, despite raising US$13 million in funding. The Kin, created by Danger, which Microsoft bought for about US$500 million, failed spectacularly. Finally, Juicero, which gathered US$120 million in venture capital, fell flat on its face after consumers discovered they could juice the fruit just as easily by hand rather than spending US$700 on a fancy machine.
All these ideas came post-2008 during a time when money was cheap. Investors were attracted to frivolous, fun, fantastical opportunities. Silicon Valley was typically the epicentre for these tech start-ups, attracting some of the world’s best talent in the process. However, despite paying a fortune in wages, many of these companies failed to turn a profit and, if you are particularly cynical, also produced productivity-harming distractions like social media and digital games.
Not all these ideas were failures, of course; there have been some astronomical successes - same-day delivery via the click of a button remains a miracle of modern convenience. But as we barrel into 2023 and survey the tech drawdown and investment opportunities of the next 12 months, it’s apparent that the world has shifted. Technology is being challenged by the real economy which, by broad definition, includes all businesses that produce goods and services and distribute them to the market.
Low-rate funded capital funnelled the best and brightest into creating algos for cryptocurrencies and Mark Zuckerburg’s news feeds but that left a shortage of engineers in resource extraction, for example, and led to critical underfunding in areas such as infrastructure and energy. The conflict in Ukraine has also woken governments up to deficits in defense spending. Suddenly, getting a blue tick on Twitter seems insignificant.
The disparity in spending between tech and infrastructure is obvious but, in hindsight, is still alarming. While the Canadian government versus Facebook is hardly apples for apples, it paints a picture. The former’s infrastructure spending for 2021-2022 was about CA$29 billion, while the social media giant’s operating profit from 2021 was reported to be US$46.7 billion.
Fast forward to the present day and with the cost of money more prohibitive because of inflation and rising interest rates, capital be will harder to obtain and margins will be squeezed. Instead of promises of future growth, fundamentals are back; metrics like steady earnings growth, good balance sheets, and cash in hand suddenly matter. Given the prospect of continued market volatility, the ability to deliver returns and value over the next decade will be more alluring than some start-up dream.
It’s the return of the real economy and, specifically, infrastructure. Here’s why:
Major firms and lenders in North America are predicting a tough year ahead. Barclays Capital Inc. is of the opinion that 2023 will go down as one of the worst for the world economy in four decades. Ned Davis Research Inc., meanwhile, puts the odds of a severe global downturn at 65%. Most experts believe a hard landing caused by central banks winding up their rate-hiking cycle looks unavoidable.
Not all infrastructure is the same, of course, and public and private markets feature many kinds of companies. But given the gloomy market outlook, regulated assets (those owned by a utility but controlled or regulated by a government agency) that enable the transmission and distribution of utilities are more defensive and typically feature higher income and lower leverage to GDP. They are less correlated to traditional markets, boosting portfolio diversification.
The dire need for infrastructure spending is set to underpin growth in this sector for the next decade. For “don’t fight the Fed”, read don’t fight fiscal policy. In the U.S., Congress passed the Bipartisan Infrastructure Law (Infrastructure Investment and Jobs Act), which promised to invest US$55 billion to “rebuild America’s roads, bridges and rails … ensure every American has access to high-speed internet … and tackle the climate crisis”. In Canada, the Federal government has committed over $180 billion over 12 years to improve public transit, trading ports, broadband networks, and energy systems. Being aligned with this level of spending is prudent.
Energy security and the race to net-zero
Russia’s invasion of Ukraine highlighted the need for energy security after consumers were hit with the effects of supply constraints via high gas prices. This requires countries to build substantial infrastructure but governments, which typically would build the facilities if not necessarily maintain them, are finding it harder to set aside assets. The private sector, and significantly energy and transportation companies, will therefore drive this growth, highlighting an essential services sweet spot for investors.
The other energy story is the pledge to make the world net zero by 2050, a goal agreed on by G7 countries. As an investor, this is a major trend when looking for stable and predictable growth. The infrastructure to achieve this has the potential to provide cash flows underpinned by either government regulation or long-term contracts. President Joe Biden, for example, wants to reduce emissions by 50% by 2030 with about half of U.S. power coming from solar plants. This will take hundreds of billions of dollars of investment in electricity transmission to make that happen. Staying south of the border, another tailwind can be found in the U.S. Inflation Reduction Act, which allocated almost $350 billion to zero carbon energy and emissions reduction technology alone.
This is a snapshot at what lies ahead in the infrastructure space. Talk to your advisor to learn more about investment opportunities and strategies that might be right for you. Given the areas such as technology and thematic ETFs, shifting a portion of your allocation could help de-risk your portfolio.
Faced with economic turbulence and rising costs, the world’s need for productivity and value is increasing. Change is in the (cleaner) air. It’s time to leave fantasy growth stories behind and focus on the fundamentals – infrastructure is the perfect place to start.