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One relatively bright patch in the US economy since the recession of 2008 has been manufacturing. Exports are up 30% since 2009, and a surprising percentage of all private sector jobs added have been created to produce tangible goods. Though the decline of US manufacturing has been conventional wisdom since the rise of Japan in the 1970s and '80s, many observers are beginning to realize that in the coming decades the United States is primed to regain a comparative advantage in numerous industries that could prove the conventional wisdom false and lead to hefty profits for those who are ahead of the curve.

To understand why manufacturing will come back, it is first useful to understand why it went away in the first place. The answer is surprising to many-- it didn't. Since 1975, the value of goods produced in the United States has more than doubled in real terms. It is not apparent from the employment picture (down more than 40% in the same time), but the United States remains a manufacturing powerhouse, producing more in 2009 than Japan, Germany, Britain and Italy combined. Of course, there are nuances that naysayers can point to: since 1980, manufacturing has declined from 21% of GDP to about 13%, leaving America ahead of only the United Kingdom and France among major countries in that metric (Korea, Germany and Japan are above 20%, for reference). So the "decline" in American manufacturing is best described as a decrease in our manufacturing as a share of our GDP. What caused this? The common answers are relatively accurate: cheap labor in China and India, excellent design and quality in places like Germany, Japan and Korea, high energy prices in the United States, a persistently strong dollar and various other smaller factors. As I've already shown, it isn't necessary to blame "off-shoring" though some of that doubtlessly did take place. The United States is now producing more than twice as much (in dollars) with about half as much labor... a triumph of productivity, not necessarily a case of wanton corporate profiteering. Nonetheless, the factors that held the U.S. back have changed and in some cases reversed, laying the base for a golden-age for domestic manufacturing few see coming.

First, the exogenous factors are being mitigated. The business practices that made Germany and Japan so efficient and their products so good have migrated across the oceans, both through major investment by those nations (see auto manufacturing in the South as a prime example) and the natural diffusion of ideas. The labor price advantage, while still pronounced, is also decreasing markedly. Companies in China are increasingly being forced to move inland (raising transportation costs) to find cheaper labor, and the hourly wage for a laborer doubled from 2002 to 2008 (the US increase was much smaller). Perhaps most importantly, a bout of inflation has forced China to allow the Yuan to strengthen, cutting further into the pricing advantage enjoyed by Chinese goods. The United States is uniquely primed to take advantage of this trend.

The reason is literally beneath us. The future of North American fossil fuel production hasn't been this bright for decades, with shale gas (which powers factories across the country) flooding the market and depressing prices to incredibly low levels for the foreseeable future and even crude production is up 20% since its nadir in 2007, with Brent crude trading almost $10/barrel above crude in the United States (WTI). The price advantage in natural gas is even more extreme. Without any export capacity (until 2015 at the earliest), North America is filled to the bursting point with cheap natural gas, while in other areas this is simply not the case. In China, gas is sold for $5 per million BTUs, versus $3 in the United States. Europe, dependent on Russia's state-owned Gazprom, pays well north of $12 in many cases. This jaw-dropping disparity gives the United States a huge competitive advantage: some of the cheapest energy in the world, fluid labor markets bursting with unemployed workers eager for employment, and even shockingly low corporate interest rates. As an added potential catalyst, the policies advocated by GOP candidates for president, including likely-nominee Mitt Romney, are very pro-manufacturing, with almost universal calls for lower corporate tax rates. The stage is truly set for domestic manufacturing to lead our eventual economic recovery and regain its lost market share both internationally and as a percentage of US GDP.

As an investor, the task is now to profit from this trend. Thankfully, the momentum of public thought says that manufacturing is doomed, with investors looking for the next big thing focusing on tech and all things "green," leaving many cheap names in the US manufacturing space. The biggest names currently have P/Es less than 14: GE (GE), Caterpillar (CAT), and United Technologies (UTX), among others, and the automakers GM (GM), Ford (F), with P/Es less than 7, are also poised to benefit. There are also ETFs for the space, with the IShares Dow Jones US Industrial (IYJ) also an excellent choice. If you are bearish about the global economy at large in the near term, a view I am very sympathetic to, I would suggest a pair trade long IYJ and short IPN, which tracks international industrials.

All of the factors described above should cause domestic manufacturing to outperform its international counterparts, especially in Europe and China, regardless of the direction of the macro-economy, so this is an excellent way to capture the nature of the trade while mitigating the macro-risk. Regardless of how it fits into your portfolios asset allocation and risk profile, adding a dash of US manufacturing is, in my humble opinion, a worthwhile long term trade.

Source: U.S. Manufacturing Set To Outperform: How To Profit