Contrary to what many central bankers and economists expect, “supply chain disruptions” are still ubiquitous. Indeed, a quick glance at delivery times, inventories and freight costs shows that supply chain disruptions are getting worse rather than less. That could put an end, at least temporarily, to the equity rally, has written Jeroen Blokland, multi-asset specialist and founder of the research platform True Insights, in his first weekly contribution to Fondsnieuws, Investment Officer Luxembourg’s sister publication.
Disruptions in the supply chain lead to longer delivery times and lower stocks. The longer waiting time for chips is probably the most important, as chips are used in just about every device. That may be nice for chip manufacturers, but not for the 169 industries that are directly affected by the shortages, according to Goldman Sachs.
In New York state, a record number of business owners have reported an increase in current delivery time from the previous month for five consecutive months. Do not underestimate the cumulative effect of this statistic. In the United Kingdom, companies are reporting the lowest amount of inventory relative to sales since 1983. This is certainly also due to all the skirmishes surrounding Brexit, but in other countries we also see extraordinary statistics.
The result: higher prices
Scarce goods are becoming more expensive. And we can see that almost everywhere. German import prices are 15 per cent higher than a year ago, the biggest increase since 1981. We know by now that Covid-19 strongly influences the year-on-year changes of many macro figures, but also compared to the 2019 level, German import prices are 10% higher.
US producer prices have risen almost 8 per cent compared to last year. Excluding the volatile components of energy and food, the increase is 6.2 per cent, the highest level in almost 13 years. And it is not just commodity prices that are skyrocketing. Ocean shipping now costs nearly USD10,000 per 40-foot container, more than five times the average price of the past decade.
Rally risk 1: lower production and sales
There are a number of ways in which supply chain disruptions can (under)break the equity rally. The first is quite simple: if there are shortages of chips and base materials, production must be cut. And that is exactly what quite a few companies are doing. Toyota, for example, produced 40 per cent fewer cars than planned worldwide in September. It is not much different at other car manufacturers. The chart below shows that as a result of lower production, US car stocks have fallen to an all-time low. In Germany, where the car sector has a major weight in the economy, industrial production is again falling.
Production cuts are no fun at all. But it is especially unpleasant when the price-to-turnover ratio of listed companies is sky-high, as it is now. With such high priced-in sales expectations, a price reaction is real if those expectations are not met.
Rally risk 2: Lower profit margins
The second and third way in which shortages can turn around stock market sentiment is through higher prices. Someone has to pay them. If companies do, it will be at the expense of profitability, which is currently at record levels. It has to, because even after the historically rapid recovery in corporate profits, equities remain on the expensive side. Again, if high expectations are not met, valuation may be a reason that sentiment turns.
Rally risk 3: A more aggressive Federal Reserve
If, as is currently the case, companies continue to be able to pass on higher costs to consumers, a greater risk is likely. After all, inflation will remain high, something the market certainly does not assume now. Investors have massively embraced the “inflation is temporary” theme. Higher prices also mean less disposable income. And this at a time when consumer spending, after mega government handouts to mitigate the impact of the Covid-19 outbreak, is likely to be declining anyway.
If “inflation is temporary” does not hold true, it is likely to cause the Fed to move as well. During his Jackson Hole speech, Chairman Jerome Powell kept insisting that the high inflation currently on the cards was short-lived. If this proves not to be the case, the Fed will have no choice but to intervene more aggressively in order to avoid ending up “behind the curve”. And then we would have the ball rolling in the stock market.
Concluding
In summary, I think investors underestimate the likelihood that supply chain disruptions will lead to a sharp downward revision of growth forecasts and a stock market correction. Of course, this does not mean that this will happen. The company figures show that so far the impact has not been too great. Many companies also expect to catch up when the deficits subside quickly. But based on the latest reports, that remains to be seen.
Jeroen Blokland is founder of True Insights, a new platform that offers independent research that enables clients to construct well-diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. He will make a weekly contribution to Fondsnieuws on Thursdays and may be published in Investment Officer Luxembourg in English. This is his first contribution.