On Monday the Dow Jones posted its biggest one-day gain in history. So is America’s nightmare over?
Not by a long shot. But what could be worse than the threat of financial meltdown? “How about a total depletion of local government finances that pay for the things that make up the very fabric of American society?” asks James Doran in The Observer.
In short, US states are running out of cash. Across the country, state governors are facing the possibility of not being able to pay their policemen, teachers and firemen this month. That’s because, when the world’s credit markets went into deep freeze, local governments had their lifeline – the municipal bond market – cut. And this source of funding is critical to the daily running of government. Since tax revenues vary from month to month, states raise cash to build bridges or pay their bills by issuing municipal bonds.
The trouble is that investors are just too scared to buy this type of paper at the moment. Take last month – some $6bn in new municipal debt issuance was expected, but only $100m came to market, with New York, Massachusetts and Missouri all ending up short of capital in recent weeks. So much so, in fact, that two weeks ago Californian Governor Arnold Schwarzenegger was forced to write to Hank Paulson warning he’d need a $7bn emergency loan so that his state could make ends meet.
So, unless Washington weighs in with a huge bailout for the municipal bond market, public services in America are set to be stripped to the bone. And that means that projects to build new bridges, repair roads and lay water pipelines are likely to be cancelled as states, fearful of civil unrest, divert precious funds to pay police and firemen. As such, California, for example, may find it difficult to resist the temptation to dip into the $20bn that it has set aside for rebuilding its threadbare infrastructure. It seems that the urgent task of replacing America’s rusted water mains and faltering bridges may well have to wait a little longer.
All this work can’t be put off for too much longer. America’s 700,000-mile network of water pipes is more than 100 years old and is in a state of utter disrepair. In 2006, rusted pipes led to more than 3.5 million people in the US falling ill from Escherichia coli poisoning and from toxins released from over 40,000 sewage spills, according to the US Environmental Protection Agency. And of the 756 steel deck bridges spanning US waterways, at least 80 of them are in the same state of disrepair as the bridge that fell into the Minnesota river last year, claiming the lives of 13 school children.
That’s why the Democrats are attempting to resurrect a plan announced last May to invest $150bn in road, bridge and water systems construction. “But that was then and this is now,” says Andrew Ross in the San Francisco Chronicle. Individual states have been recklessly loading up on debt for too long – doubling the $200bn in tax-supported debt they held in 1998 in just a decade. Now that property tax revenues are dropping off – New York is expecting to lose a third of its total next year as Wall Street is pared back – they will have to face the consequences of borrowing binges. Some cities are already toying with bankruptcy, says Joe Mysak on Bloomberg. Last year, $300m in municipal bonds defaulted. So far this year the figure is more than five times that sum. We look at the impact of all this on US infrastructure stocks below.
How the crunch will affect our infrastructure tips
US infrastructure firms have fallen along with the broader markets over the last fortnight. Our favourite US water infrastructure stock, Northwest Pipe (Nasdaq:NWPX) – the leading US manufacturer of large diameter and high-pressure steel pipes – tipped at $35 in May last year, has fallen from $62 to $41 in recent weeks. But it’s better placed than rivals, having recently reporting a record order backlog of $264m. On a forward p/e of 12.4, it remains cheap.
Bridge builder Granite Construction (NYSE:GVA) has also taken a big fall and is now valued on a forward p/e of 11. Then there’s Insteel Industries (Nasdaq:IIN), which produces the steel structures used to reinforce bridges. A 100% gain since we tipped it has since been wiped out.
So, while these companies are cheap and will be kept busy on selected high priority projects that can’t be sacrificed, the risk of project cancellations is high. Overall, then, we recommend that potential buyers now wait until problems in the municipal markets have been resolved. Once that happens, don’t miss out on a hugely compelling investment story – the rebuilding of America’s infrastructure.