The Ever Given, one of largest container ships in the world, runs aground and blocks the vital oil-importing pathway of the Suez Canal. Semiconductor chip demand outweighs supply forcing all automakers to drastically cut production. A cyberattack on Colonial Pipeline, one of the largest petroleum suppliers on the East Coast, resulted in the shut down of their entire operations, impacting gasoline availability for weeks.
And these three major shocks to various supply chains have occurred just as the global economies are striving to recover from the pandemic’s financial impacts. Investors must ask whether these supply shocks can delay or possibly derail the pending economic recovery?
In order to understand the magnitude of these disruptions upon the economy and the market it is important for investors to understand the different causes of supply chain problems. The first type of disruption is accident or weather related. Accidents, such as the Suez blockage, occur periodically and randomly. Severe weather issues, such as the recent freeze in Texas, have outsized impact. The lack of necessary infrastructure required to deal with otherwise abnormal conditions exaggerates the length and degree of the disruption.
While accidents and freak weather are impossible to predict, they are usually corrected relatively quickly as emergency resources overwhelm the problem.
Some disruptions are inventory based. These are the result of excessive demand for a product overrunning the available supply, as in the current semiconductor shortage. Eventually, due to increased sales incentives, companies will expand production to meet the heightened demand, and the inventory shortfall will be resolved.
Savvy market observers may anticipate the surge in consumer demand; however, due to the necessary increase in investment and capital expenditures, these supply chain shocks can last for some time.
Cyberattacks are a relatively new phenomenon. They may be mercenary in nature, strategically implemented by unfriendly governments, or acts of terrorism. As global economies have grown exponentially with the constant advancements of computerization, this tethering and reliance of our financial, industrial and consumer sectors to ever-expanding technology and operating systems has left many industries exposed.
Besides data breaches and theft, hackers have now shown that they can attack and disrupt the important energy grid. While the Colonial Pipeline hack halted gasoline supplies to many states in the South and East Coast, a successful attack upon the country’s electricity sources would be vastly problematic, to say the least. Unfortunately, it looks like malicious and man-made supply chain interruptions will be a frequent and constant problem.
A final type of supply disruption is currently not an issue, but investors should be aware of its potential. A lack of labor will create issues similar to the inventory-based problem. A reduced labor force makes certain products scarce: the decline in manufacturing shrinks inventories, thereby causing problems even without excessive demand. Recent data from both the US and China indicate a steady decline in population. However, technology has and will hopefully continue to make up for these labor force shrinkages.
These different supply chain disruptions all negatively impact the economy. They are at best difficult if not impossible to predict or strategize against. However, after some time and an abundance of resources directed at each situation, the actual impacts are temporary. Once addressed, market forces and economic activity basically return to the prior conditions with little consequence besides headline risk and a potential increase in fear. However, it is these headlines and fear that pose a threat to the recovery.
Consumer expectations help set inflation. When fears of extended product shortages pervade investors’ psyches, these demand surges result in higher prices. If a supply chain disruption becomes prolonged, this cycle can become a self-fulfilling prophecy, fueling increased inflationary expectations and forcing interest rates higher. And while the Federal Reserve will continue to maintain historically low rates, the Law of Diminishing Returns lessens their influence on real interest rates (see our “Can The Fed Save T.I.N.A.).
Actual threats to the economic recovery are not produced by any of these supply chain pauses. While impactful in the short-term, they produce insignificant adverse effects to the economy or market in the long-term. However, it is investor perception of these events that may prompt interest rates to drift higher. Investors should be aware of this potential risk to the recovery, especially at current valuations