After a hiatus of several weeks, the weekend reading is back! Let us proceed with our ever-so-interesting educational articles, as we confidently self-proclaim. This weekend, we wanted to briefly address the supply chain issue we’ve all been hearing about.
This topic deserves more of a thesis than a brief article. In fact, I very much want to explore this topic more deeply, because it’s actually a problem that has been lurking for years and years and years. Dare I say that much of it has to do with capitalism’s perpetual pursuit of extreme cost efficiency. I’m not knocking capitalism. I mean, without capitalism, MOR Wealth Management doesn’t have much of a purpose for all of you. However, extreme efficiency can introduce risk.
For example, parents of young children can increase the efficiency of their cash flow by not paying for life insurance. But if the household wage earner dies, that leaves their dependents in pretty bad shape.
We can also explore the same effect with an investment portfolio. Traditionally, though not always, bonds carry less risk than stocks. But 100% of any kind of asset, even one with lower volatility, is usually riskier than “some” level of diversification. We show a graph representing that concept below.
Assume the vertical axis represents investment return, and the horizontal axis represents risk. Even though Asset A has lower return, and is generally accepted to have lower risk, “putting all of your eggs in one basket” begins to nullify the risk mitigation of the safer asset.
But I’ve digressed. We’re talking about the supply chain. The analogy is nonetheless relevant because, as is the case with the supply chain, “excessive” efficiency comes with a cost. In regards to the supply chain, the efficiency I’m referring to is the attempt to have as little inventory in storage as possible.
For decades, suppliers, stores, and distribution centers have used data collection and behavioral analysis to anticipate exactly the amount of supply needed to accommodate expected sales. Any amount of product left sitting on the shelves costs money to store. Ideally, as soon as stock arrives at a store or distribution center, it is purchased and leaves. Excess stock requires space to store, and storage space costs money. Eliminating the storage space saves money and increases profit. Companies like Amazon have nailed this down to a surgical science - as long as the system has no disruption! However, even the smallest disruption in supply can cause a domino-like breakdown and potential catastrophic damage. What we really need, throughout all industries, is for companies to simply carry excess supply.
From a thirty-thousand-foot view, that’s why the supply chain breakdown has occurred. It’s a little frustrating that corporations benefit from this extreme efficiency, but consumers have to share in the pain when the system breaks down. But I’m starting to digress again, so let’s get back to the point and explore where we are in this crisis, and what the effects could be going forward. I’m going to steal some snippets from our good friend and financial analyst Jim McAlister regarding port congestion and shipping costs. But bear with me- I promise it’s not too complicated.
For the most part, business for corporate America is strong, and the post-pandemic rebound continues with a few disruptions related to the spread of new variants. But the most common theme we’ve heard discussed in the calls we’ve participated in relates to the supply chain and the negative impact it is having on earnings and how it could continue well into 2022. And it’s not just us. According to FactSet, 342 of the S&P 500 companies made some sort of reference to the supply chain in their quarterly earnings calls. That is at a 10-year high, and it highlights how much of an issue this has become in creating bottlenecks for the economy and corporate earnings. The supply chain is critical, as it can result in demand destruction as consumers choose not to wait around to make a purchase. It can also result in higher costs. Both of these factors put and likely will continue to put downward pressure on earnings in the near term.
More recently, we have heard that some of these bottlenecks in the supply chain are easing ever so modestly. Several large auto manufacturers have indicated that they are now able to increase production thanks to that easing. Semiconductor availability is also improving, with lead times across the industry showing signs of decline. Outside of a select few high-demand products, retailers claim to be in good shape with inventory for the holiday season. While those anecdotes are encouraging, we also like to look to the data for confirmation. There are a variety of different ways to do so, but there are a few key factors we focus on more than others.
Port congestion. The first has to do with the number of ships that are waiting to gain entry into the U.S. ports where most of the supply chain constraints exist. According to a recent report from Wells Fargo, the seven-day moving average count of ships anchored at the L.A./Long Beach ports dropped to a low of just under 50 vessels from a high of more than 80 just a few weeks back. On its surface, that is a huge improvement and a very encouraging sign that bottlenecks are easing. But there are some differences in the data based on how a ship’s status is classified. Another report from American Shipper that accounts for ships that are not technically anchored but are “loitering or steaming offshore” bounces the full count all the way up to 90 boats. So, while there are some indications of improvement, the data remains mixed.
Shipping costs. Another indicator that we watch to gauge how tight the supply chain looks is the price that shippers are charging for the transport of single containers. This price immediately captures the status of supply and demand. The higher price can mean both more activity and a lack of demand due to port congestion. The Freightos Baltic Index measuring global container costs peaked back in September at about $11,100 right around the end of the third quarter. Rates then slipped to as low as $9,202 back in mid-November, which would indicate that the tightness in the supply chain was starting to ease. But in the past several weeks, prices have moved higher and now sit at $9,550. So, pricing has definitely eased from the peaks this fall, but it is still well above the $3,450 rate from the start of 2021.
The Good News
While companies spent a lot of time discussing tightness in the supply chain and the negative impact that might have on earnings over the next several quarters, the good news is that we are starting to see some signs of improvement. With port congestion easing and shipping costs moderating to some degree, the worst of the supply chain issues may very well be behind us. If that is the case, then it should at least provide some degree of stabilization in the near term.
There are still a lot of moving parts around a supply chain that is still struggling mightily to get its feet under it as we recover from what was hopefully the peaks of this pandemic back in late 2020 and early 2021. As we have seen in the past several quarters, if there are any breakdowns in this nascent recovery, including shutdowns related to new COVID strains, it could have negative ripple effects across the globe.
Hmm, maybe this was more of a thesis than a brief article. Well, whatever we call it, I hope it sheds some light on the issue.
With Hanukkah behind us and Christmas in front of us, now seems like a good time to wish everyone a wonderful holiday season.
Have a lovely weekend,
Matthew Ramer, AIF®
Principal, Financial Advisor
MOR Wealth Management, LLC
1801 Market Street, Suite 2435
Philadelphia, PA 19103
P: 267.930-8301 | c: 215-694-4784 | f: 267.284.4847 |
601 21st Street, Suite 300
Vero Beach, FL 32960
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