In a world of macroeconomic flux, we maintain our optimistic outlook on infrastructure.

There are more simultaneous major macroeconomic events going on right now than there have been in recent memory. War in Ukraine continues. The world is still recovering from the pandemic and global supply-chain disruptions. Major cities in China are once again in lockdown in an attempt to fight Covid-19. Inflation is running high as a result of all of these factors, and the US Federal Reserve (Fed) is raising interest rates in response to concerns about high inflation becoming embedded in the economy.

It’s enough to make any investor’s head spin. But, in our view, infrastructure could be an attractive focal point.

Understanding an unusual year

Several global events going on simultaneously are causing massive economic ripple effects, aggravating already elevated inflation pressure.

Russian energy

In response to the Russian invasion of Ukraine, Western nations implemented sanctions against Russia. These sanctions have had significant implications for the energy sector because Russia is a major energy exporter, especially to many European countries. Now, many of those countries are seeking independence from Russian energy.

This desire for energy security dovetails with the shift toward renewable energy that’s been underway for years. The confluence of these two factors suggests that the transition to less fossil-fuel-dependent energy could speed up.

War in Ukraine

Food-price inflation has also increased as a direct result of the war. Not only is Ukraine a grains exporter, but also the exports important chemicals used to make fertilizer. This has knock-on effects in other countries that can’t access these supplies — a dynamic that’s likely to persist as the conflict continues.

The war is the cause of inflation, yes, but it’s also a harrowing reminder that things like this can happen. Investors may be waking up to the idea of political-risk premiums, growing wary of some areas of the world where regimes are inherently more volatile.

Chinese lockdowns

Elsewhere, in China, Shanghai and many other areas are once again in lockdown. China continues to maintain a “zero-Covid” policy that requires draconian measures to fight a Covid variant as transmissible as Omicron.

We don’t think that China is going to ease its approach to Covid containment anytime soon. Shutdowns, especially in a big city like Shanghai, are a major impediment to economic activity. And disruptions to China, a huge economy, disrupt supply chains worldwide.

Stalling globalization

If the past few years have taught us anything, it’s that the world is intertwined. War in Ukraine impacts energy around the world, Chinese Covid-containment strategy hampers global supply chains and, when it comes to macroeconomics anyway, no nation is an island.

This is perhaps why we’re seeing trends toward globalization stalling and in some instances reversing. The tough-to-absorb effects of global supply-chain disruptions have inspired some countries to try to boost domestic manufacturing.

Inflation, monetary policy and the risk of recession

While these macroeconomic factors have put upward pressure on inflation, energy and supply-chain disruptions aren’t what worries the US Federal Reserve (Fed) the most. Those events are outside of Fed control. The Fed’s most concerned with what it can (seek to) control — the inflation the US is generating itself because of labor market tightness.

The Fed has reacted to inflation by introducing an interest-rate hiking cycle. At the March Fed meeting, a 0.25% hike was introduced, followed by a 0.50% hike in May. Markets are pricing in five more interest-rate increases throughout the year, two of which are expected to be 0.50%.

The purpose of these rate hikes is to slow growth to tame inflation. But it’s a delicate balancing act trying to slow growth without pushing the economy into recession. And, unfortunately, the Fed doesn’t have the best track record of engineering soft landings like this.

So, recession risk is very real. And the fact that the economy has remained robust so far and the strength of the macroeconomic data doesn’t diminish this risk. In fact, it just speaks to how hard the Fed is going to have to work to cool the overheating economy. Recession isn’t inevitable, but the path to avoid it is narrow.

In infrastructure we trust?

In the face of all of these macroeconomic challenges, we see potential opportunities in infrastructure. Historically, global listed infrastructure companies’ EBITDA¹ growth has largely outpaced the EBITDA growth of the companies listed in the MSCI World Index, which is representative of global equities (Chart 1) and we think this pattern could continue.

Chart 1: Global listed infrastructure vs global equities

Year-on-year EBITDA Growth: GLIO Index v Global Equities

Industrials

In our view, one promising segment of infrastructure is in the industrials sector. We think that there may be attractive opportunities among companies that own transportation related infrastructure, such as roads, rails and airports.

Roads, for one, are back to pre-pandemic traffic levels in cities that have lifted Covid-19 restrictions. Earnings generated by roads tend to withstand inflation because with many road contracts, tolls can be raised alongside inflation, providing some protection for investors.

Airport traffic continues to lag behind roads, but it’s picking up. According to the Transportation Security Administration, US airport traffic is up 83% from its 2020 lows.² European airports are back to about 80% of their pre-pandemic traffic rates and it’s possible that full, regular traffic could return by 2023 — a year earlier than initially expected.³

Communications

We see another infrastructure opportunity at the intersection of communications and real estate — cell towers. Wireless towers enable cellular networks to operate. As the mobile phone companies expand their 5G coverage, we believe that it will be a tailwind for the tower companies. We think that the 5G rollout will continue over roughly the next decade, so this opportunity should persist for some time.

Towers tend to be resilient to inflation as well. In the US, tower companies can raise their prices by 3% per year, inflation or not. In Europe and in some emerging markets, tower companies can generally raise prices as inflation rises. Considering that inflation is above 3%, these European tower companies are in an even more advantageous inflation-protection position than their typical US counterparts.

Utilities/Energy

Even in a complicated, volatile market like the one investors face today, we see opportunities for investment in utilities. Utilities are recession resistant because, no matter what happens, people need to turn their lights on. In addition, utilities are well positioned to take advantage of the energy transition. Several of the companies have opportunities to invest in wind, solar, storage, etc.

One of the biggest areas for opportunity among infrastructure investments is within energy. At the time of writing, more than 70 countries worldwide, including the biggest polluters — the US, China and the EU nations — have set net-zero carbon emissions targets.⁴ Policymakers in many countries across the world have embedded green energy into their policy plans.

The world won’t be able to execute this transition toward more renewable energy without significant infrastructure investment. This makes renewable energy one of the brightest spots of the infrastructure outlook.

As mentioned, this is especially true in light of the war in Ukraine, which has prompted the EU to commit to cutting Russian fuel imports by two-thirds by the end of this year. And now, within the EU, they have proposed reducing the permitting process for renewables from four or more years to one year.

Accessing the opportunities

Infrastructure includes many essential services and many of its sectors demonstrate strong cash flows and resilience against inflation. It’s also accessible through both public and private market investment. With all of the potential across these sectors, despite the myriad events contributing to global market volatility, our outlook on infrastructure is optimistic.

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