‘It’s Come To This’: Beyond The Great Supply Chain Crisis

If rates are losing the plot due to the impossibility of mapping the interplay between inflation, growth and monetary policy in an unprecedented macro environment, equity investors may be looking ahead to a time when the fog lifts.

Or if they aren’t, they should be, according to Goldman.

“Rapidly shifting outlooks for inflation and interest rates mean most equity investors should focus on identifying trends that will remain after ‘transitory’ dynamics have passed,” the bank’s David Kostin wrote, in his latest.

We’re now pondering the applicability of the “transitory” characterization to any and all pandemic-related distortions, not just inflation. And that makes sense. After all, macro volatility is the result of various shocks and shifts associated with COVID, and that macro volatility is now propagating into front-end rates as traders guess at the ramifications for policy.

During the Trump years, economists often emphasized the impossibility of rolling back decades of globalization. Deliberately severing supply chains and purposefully upending established trade relationships was fraught with peril, both economic and political.

But the trade war played well on the campaign trail, where it was congealed into nebulous catchphrases which obscured the risks. Essentially, Trump argued that the worst-case scenario had already played out, as evidenced by hollowed out US factories and the decline of the blue collar middle class.

Even if you’re inclined to believe Trump was right in his diagnosis, correctly diagnosing a disease doesn’t necessarily mean the doctor will identify the correct treatment. And it certainly doesn’t preclude deleterious side effects even when the proper treatment is identified and prescribed.

Now, in 2021, we’re getting a taste of what rapid deglobalization actually entails, courtesy of the pandemic. In short: This is why so many people, not all of them partisans, warned against the haphazard dismantling of globalization. It’s disruptive, inflationary and conducive to supply chain crises not easily resolved.

Because the current predicament is the result of a natural disaster as opposed to policies deliberately implemented (conspiracy theories notwithstanding), resolution is forthcoming. Or so we hope, anyway. And that’s what equity investors should look ahead to.

“Although the likely impact of supply chain issues on 2022 earnings remains unclear, eventual supply chain normalization seems inevitable,” Goldman’s Kostin said, in the same noted cited above. “As a result, incremental news-flow around the timing of that normalization will likely continue to generate volatile rotations within the equity market but should have little impact on investors with medium- to long-term investment horizons.”

He flagged “tentative signs” of improvement in supply chains and commodity prices, citing an index of container freight rates and “cautious optimism” in some equity-based measures, including the relative performance of a consumer goods basket and an index of stocks with China supply chains versus the broader market (figure below, from Goldman).

Really, though, everyone is flying blind as the bat which hosted the virus. Including and especially corporate management.

The ability to pass along rising costs to consumers is a recurring theme on Q3 earnings calls, and Goldman noted that stocks with high pricing power have outperformed those seen as more vulnerable to margin erosion by some 400bps over the past three weeks.

But “in contrast to the corporate consensus regarding raising prices, there appears to be no unanimity about when supply chains will normalize and input cost pressures will ease,” Kostin remarked.

A quick trip through the headlines is all you need to know that “tentative signs” and “cautious optimism” aside, the situation remains acute.

A lengthy article in The New York Times described the situation in Savannah, Georgia, at the US’s third-largest container port, for example.

“It has come to this in the Great Supply Chain Disruption: They are running out of places to put things at one of the largest ports in the United States,” Peter Goodman wrote. “As major ports contend with a staggering pileup of cargo, what once seemed like a temporary phenomenon — a traffic jam that would eventually dissipate — is increasingly viewed as a new reality that could require a substantial refashioning of the world’s shipping infrastructure.”

Maybe equity investors should, as Goldman suggested, look ahead. The trouble is, they may not like what they see.