Scarcity is a prime mover in capitalist economies. The scarceness of a good drives price movements, substitution into alternatives and innovation to create workarounds. The unfettered pursuit of these responses allows for the smooth functioning of the economy and means that capitalist societies rarely face the line-up-in-a-queue shortages that have become the hallmark of more controlled economies.
Market-based responses to shortages are generally effective but they take time. Even capitalist economies can face shocks when changes to supply or demand are large or unexpected, as we saw last year with toilet paper and other household staples. Who would have ever thought we’d see queues and rationing at Coles and Woolies?
Fortunately, the great TP shortage of 2020 is now behind us… but now it’s the producers’ turn to feel the pinch. The economy is facing a second wave of pandemic related shortages, and this time it is manufacturers and service providers who are worried about “essential supplies.”
Companies are currently grappling with three supply shocks.
The first is labour. It seems paradoxical that at a time when many economies are facing the lowest level of employment in decades, employers can’t find the staff they need. If people aren’t working why are employers struggling to get staff? Globally, there are workers who prefer income from pandemic benefits to receiving a similar amount for going to work. One aspect of this is the health risk that many jobs pose. It’s fine for professionals, who have largely shifted seamlessly to “WFH” but hospitality, transport and manufacturing jobs are inherently “F2F”. As such, continuing to show up to work means taking on the risk of infection.
Here in Australia, employers additionally face the impact of closed borders. The international border has stemmed the inflow of overseas students and backpackers who are crucial to many industries. And the frequent closure of state borders has reduced mobility, which has led to an acute shortage of new entrants to the mining industry in West Australia. Some companies are now having to pay over AU$400,000 to relatively unskilled workers in order to keep mine production running. To secure staff others are now engaging fly-in, fly-out workers from New Zealand and Tasmania.
The second global shortage is integrated circuits. These “chips” are now ubiquitous across manufactured goods. No longer just found in laptops and mobile phones, they now power cars, household appliances, and manufacturing tools and sensors. Over the past decade ICs have become as essential to modern manufacturing supply chains as toilet paper is to households.
The latest generations of integrated circuits are incredibly difficult to make. The “fabs” (fabrication plants) that chips are manufactured in require huge licks of capital and can take years to bring on stream, so the global supply of ICs is inherently constrained. Layer on top of that a rebound in demand as corporates around the world attempt to ramp their finished goods production back up to pre-covid levels, plus a structural shift to the cloud, and a supply shock is the inevitable result.
The third shortage producers are grappling with is of other, lower-tech commodities such as lumber and steel. On the supply side, pandemic-related production inefficiencies and logistics bottlenecks are pinching. On the demand side, a similar bullwhip effect to the one seen in demand for chips is playing out. For example, government stimulus into the local home-building market is colliding with lower production and import levels resulting in shortages for such basic items as floor joists and masonry.
What are the implications of these shortages for investment markets?
At the macro level, these labour and input shocks are a headwind to economic growth. But with such a strong rebound underway, they may actually serve to smooth out the rebound, providing a tailwind to production that will persist into 2022 and 2023. A slower ramp up of production across many industries might dampen the bullwhip and the ups and downs it transmits to the broader economy.
For individual firms however the outcomes can be less benign. Corporates are mostly in a race to restore their earnings to pre-pandemic levels. Being unable to find staff or having to pay overs to get them – or being unable to source critical inputs makes this impossible.
And the pain is not being shared evenly. General Motors recently announced that it is restarting production at all its idled plants whereas BHP on the hand is facing impacts from a shortage of train drivers. In the main however it’s the smaller manufacturers and producers who appear to be bearing the brunt of these bottlenecks.
There’s a buying opportunity emerging, to the extent that these stocks sell off as Mr Market drives down share prices due to missed production targets and earnings disappointments. One of the big opportunities of 2020 was to buy the obvious “pandemic losers” of the consumer discretionary sector; 2021 may end up offering an opportunity to buy the second-order “pandemic losers” of the mining, industrial and manufacturing sectors.