Supply Chain Woes

By Ben Ferris, CFA & Portfolio Manager

The recent bout of inflation in 2021 has spurred much discussion about the confluence of factors contributing to the broad rise in prices. In general, there are three factors at play: supply constraints, stimulus-induced demand, and easy monetary policy.

Supply chain bottlenecks have resulted from a shortage of workers in the US, a fleet of aging cargo ships that need to be fitted with cleaner propulsion systems, and COVID-19 control measures in Asia. The Delta variant has upended factory schedules abroad, where production capacity has been shuttered by 40-50% in Vietnam and nearly 25% in China.

Though the Delta variant has contributed to constraints on the supply side, strong consumer demand has also played a key role. US retail sales have increased 14% through the first nine months of 2021 over the same period in 2020. Consumers, many of whom sheltered in place last year, are now spending at an increased clip, largely due to built-up savings from an unprecedented amount of deficit spending by the federal government.

Over the past year, the federal government has run the biggest fiscal deficit since World War II, representing close to 20% of GDP. When the federal government runs a deficit, by definition, households and/ or corporations will run a surplus. As such, we have seen a record level of household savings and corporate profits. Income in the private sector now greatly exceeds the sum of consumption and net investment in real assets such as homes and capital equipment. But unless we maintain the deficit indefinitely, households and corporations are going to have to replace the fiscal spending on a go-forward basis. While it is true that an economic “recovery” is afoot, the increase in private spending is likely to simply replace federal support instead of adding real growth to the economy on a sustained basis.

The reason for the demand increase is somewhat irrelevant as it pertains to its impact on supply chains, however. Coming out of the depths of the pandemic, factories and supply chains couldn’t keep up with demand after being largely shut down for months. In the face of strong demand and shortages of key components, manufacturers are being forced into bidding wars to secure space on vessels. The Baltic Dry Index, a measure of the price of moving raw materials globally, has increased nearly 10-fold from the beginning of 2020.

What’s more, the ratio of inventory as a percentage of sales is at an all-time low. As a result, everything from lumber to new cars has been in short supply. For instance, Toyota, the largest vehicle manufacturer in the world, announced in September that it would cut production by 40% due to semiconductor shortages.

Tangentially, a falling labor participation rate and a shortage of truck-drivers has further caused problems getting imported goods from ports to downstream distributors. On a recent earnings call with investors, Costco CFO, Rich Galanti noted that “port delays are continuing to have an impact… the turnaround of a container hitting the US delivering its contents and being back at the US port to head back overseas has gone from approximately 25 days to 50 days.”

The Port of Los Angeles has reported a 30% uptick in incoming cargo during the first nine months of the year, and the Port of Charleston, SC seems to be breaking records every day. The issue has become so extreme that the White House is urging trade unions and California port operators to work 24/7 to help alleviate the strains.

Due to the bottlenecks, companies are reporting an unprecedented level of inflation. Nearly half of all companies in the S&P 500 cited “inflation” on earnings calls in the second quarter, up from an average of just 25% from 2016-2020.

Companies from Fastenal to Pepsi are making moves to offset input cost pressure by raising prices for consumers. The topic of whether the current rise in inflation is merely transitory is hotly debated and no one knows when the supply constraints will be alleviated. But what is clear is that prices are higher and inventory of some goods are low for the time being, so if you were hoping to get your hands on a 2022 Toyota Tundra Limited with the 437hp hybrid i-Force Max powertrain, you might want to visit your local dealer now to put a deposit on one because there won’t be many of them, especially if you had your eye on the one in Wind Chill Pearl!