SUPPLY AND DEMAND IN 2021
As the global economy continues to emerge from the COVID 19 crisis, one of the ongoing issues impacting this recovery is the significant disruption to global supply chains. Combined with what some are calling “positive demand shock”, the impact on the economy and therefore on stock markets is significant and is something investors need to keep in mind for the foreseeable future. We’ll try and summarize the major issues below. Supply chain challenges have surfaced based on the fallout from the COVID crisis which started in March 2020, but didn’t become apparent until some point in 2021.
Layoffs, factories shutting down, orders cancelled, travel and mobility restrictions, and skilled labour shortages, all contributed to a shrinking supply of goods around the world once COVID hit.
Consumer spending slowed for a period of time as a natural response to COVID but in 2021 demand has roared back, creating bottlenecks in industries ill-prepared to increase capacity quickly. The Auto industry is a great example of this. Some have estimated lost sales for the automakers in 2021 will be in excess of $200 billion, based on lower than needed inventory levels, mainly from chip shortages.
According to the Adobe Digital Economy index, there were over $2 bln “Out of Stock” messages delivered to online shoppers in Oct 2021! This is an increase of 325% from pre-pandemic levels two years ago, as in clear evidence of supply chain issues at the retail level.
As we know from the headlines, there is a backlog of ships and containers at major ports around the world, a shortage of truck drivers to deliver the goods, and 71% of the S&P500 companies that had reported Q3 numbers at the end of Sept had noted supply chain issues as having a negative impact on earnings.
With supply and labour shortages, demand in many sectors has taken off as we pull out of COVID restrictions and resume a lot of “normal” activity. On the surface, this is a recipe for inflation. Restricted supply and higher prices typically spurs spending on increased production (think of new mines and factories being built) and higher prices typically temper demand back to the point where things are in balance again. This is one reason why many believe the current supply chain and hyper-demand issues are temporary and will sort themselves out. For example, companies such as UPS and FedEx are having difficulty hiring and retaining drivers while dealing with what one analyst called cramming 5 to7 years of expected e-commerce growth into the last 18 months. This phenomena is widespread across many industries. In this scenario, some inflation might be necessary to help us get back to a supply-demand equilibrium, which is why we believe Central Banks in Canada, the US, and around the world will be cautious to raise interest rates simply in response to what could be a transitory increase in inflation.
While COVID continues to pose a threat, there is a sense the worst is over and we are now better prepared to deal with outbreaks and new strains that may appear. So far, corporate earnings are still pretty healthy and companies have been able to grow their revenues and earnings by passing along price increases to their customers. If this trend continues and supply chain issues are resolved in the next year or so, there is no reason to believe that stock markets won’t continue to provide solid returns. There is a lot of pent up demand being unleashed and some spending is being re-directed back into service industries that were particularly hard hit and are now recovering - such as travel, hospitality and entertainment. These sectors are generally less exposed to supply chain disruptions, although rising fuel costs will have some impact on travel.
If above normal inflation persists, driven by a restricted supply-increased demand scenario, we can expect to see corporate profit margins suffer as many companies will not be able to pass along cost increases and their earnings will be hit, along with their stock price. Sectors particularly exposed to this risk are industrials, and consumer staples and discretionary names. Sectors that have done well in inflationary periods are energy, mining and materials as they are more able to pass along their price increases.
To wrap things up, lets look at the world’s most valuable company – APPLE – and summarize its recent supply chain issues. In early October, Apple acknowledged that it had reduced its expected 2021 iPhone sales numbers from 90 to 80 million units, due to a global shortage of semi-conductors. Apple probably has more leverage than any smart-phone company in the world over its supply chain, so you can imagine if they are having difficulty getting the parts needed to meet demand, the same thing is happening to all their competitors to an even larger degree. This could be good news for Apple from a long-term competitive perspective, as the opportunity to gain market share at the expense of others is greater than ever. Not surprisingly, Apple has been able to maintain revenues and profit margins throughout 2021, and its share price is still up 14% this year despite the expected reduced sales volumes of 11%+ on its best-selling product. That is pricing power, and is a good reason why Apple is such an attractive long term investment.
THE REYNOLDS SOBLE MOORE GROUP
