Key Risks As Earnings Season Approaches
I doubt seriously that anyone needs to have the risks enumerated for them again, but I suppose another recap of key themes can be justified if it's contextualized via the onset of earnings season.
I've warned on the potential for "gale-force" macro headwinds. I think that's an accurate characterization (i.e., not just hyperbole for hyperbole's sake) when it comes to, for example, a severe slowdown in China and the prospect of consumer retrenchment stateside. But most of the known hurdles seem m
Reshoring also implies substituting capital for labor as well. Think about labor shortages. Walk into many supermarkets in the US today and you will see self check out lanes. You will also see much more software/AI replacing labor at the up and down the skill scale. If a company does this than some of the cheap labor give up from reshoring will be saved by lower shipping costs and lower labor factor inputs. This also implies lower unit labor costs in the US as more tech and other capital goods are substituted for labor in the reshoring process.
… which seems like win win win, as long as we find a way to redistribute wealth…
27% increase in EPS — and that’s down from 2Q? I’ve said it before and will say it again: profit maximization is killing democratic capitalism.
Well, remember the comp. These aren’t sequential growth rates. Think about what was going on during Q2 last year.
My rather jaundiced view at the moment is more focused on duration rather than degree. When I first saw lumber collapsing after it’s Covid gyrations, I took it as an indication that supply chains were getting back to normal and (for example) that homebuilders were about to see margin improvement. Wrong. That depends on the complexity of supply chains. Lumber getting from a Canadian forest to a Lennar development in Dallas has a relatively trivial supply chain so it’s logical that lumber’s price reversion was “quick”. But a Samsung dishwasher heading for that same development has a horrendous chain stretching from Australian iron ore through semiconductors and global shipping and it’s still getting worse because the automakers are in crisis, etc. The fact that iron ore is starting to drop because of China is nice, but check back in a year or so to see if dishwasher supplies and pricing in US stores are back to normal. And good luck to those homebuilders and their margins (not to mention the Fed’s “transient” thesis).
In my mind, the issue for stocks isn’t that earnings will start horribly missing (degree), it’s that we’re just starting to appreciate how surprisingly long that earnings headwinds could last (duration). To the extent non-trivial reshoring, or even supply chain re-optimization, is actually occurring, then the associated, and rather opaque, earnings hit is decoupled from Covid and coupled instead to complexity. Covid cases can go to 0 tomorrow and it could still feel like eons before we’ve untangled dishwashers, figuratively speaking.
All value chains are complex in modern industry. Even a box of cereal requires farmers to grow the grain (and sugar), a firm to process the grain, a firm that makes boxes and another, perhaps, for the liners. Then there are the truckers that haul the grain, others that haul the many processed inputs, and finally truckers to haul the cereal itself. Cereal is a lousy product to haul, btw, because it is bulky and not very valuable with a high volume-to-weight ratio, making per-box trucking costs high. Then there is a huge shortage of drivers, causing rising wages, and oil is up, and that’s just cereal. For foreign products/inputs, container prices have quadrupled, making cheap clothing, for example, much more expensive, especially when delays are factored in. Ports are short of labor and drivers/trucks to haul the containers are also in short supply.
Virtually all business decisions involve tradeoffs. Globalization, off-shoring, just-in-time, labor and materials substitutions, etc, are all ways to cut costs, reduce required investments in fixed assets and inventory, hopefully leading to increased profits. When all these strategies are working perfectly we see those profits climb. However, any disruption in the complex chains supporting these strategies produces a Keystone Cop sort of crash where each of the steps is held up and starts crashing into the steps in front. What is happening is that our processes suffer from what system theoreticians know as a lack of “requisite variety.” Variety in resources combats the effects of disruption. Safety stocks of extra inventory, diversification of suppliers and other such practices buffer firms from disruptions. Of course, each safety step costs money and firms have gradually striped away these precautions to increase profits. Now we will all pay the price and if one takes into account the idea of striking a better balance between minimalism and safety from external shocks, I suspect price increases will not just be “transitory” as we move to create supporting variety,and remake our value chains. Notice how Toyota, an original just-in-time proponent, has bested GM in the most recent quarter because it increased its stock of critical microchips and was able to build and sell more cars than its rival.
BTW, H, this was a very good piece.