Dude, Where’s My Stuff?

FEMALE VOICE:  This podcast has been prepared exclusively for institutional, wholesale, professional clients and qualified investors only as defined by local laws and regulations.  Please read other important information which can be found on the link at the end of the podcast episode

MR. MICHAEL CEMBALEST:  Good morning everybody.  This is the late September Eye on the Market podcast.  I’m recording this from a CEO event in Ennis, Montana.  It’s very beautiful here, but it’s not highly vaccinated.  All the CEOs are telling me more or less the same thing.  They intend to hire more people.  It’s very difficult to find people.  The COVID situation is making the challenges even greater.  And they’re all experiencing pretty substantial delays in the supplier delivery lays with respect to manufactured goods.  And this week’s Eye on the Market gets into this whole supply chain mess.  And one of the fascinating things about this is the attribution of these problems to the shipping cost discrepancies between eastbound and westbound freight.

So let me get into that a little bit, and this is on page two of the piece.  There was a surge in goods consumption in the United States when COVID hit, as everybody started building out home offices and doing home improvement projects, and overall just increasing their goods spending and drastically cutting back on their services spending.  So all of a sudden, global trade volume started to pick up just at the time that COVID was beginning to negatively impact all the workers and the supply chains in the U.S. and Asia.  

And then the shipping thing started to kick in a few months ago, and this is kind of remarkable in an odd and unfortunately very concerning way economically.  There has been a giant surge in freight rates for container ships between Shanghai, from Shanghai to Los Angeles that hasn’t been matched by an increase of freight rates from Los Angeles back to Shanghai.  So what has that done, is create this weird economic incentive for container ship owners to move them back to China empty to accelerate the receipt of the eastbound freight rates, instead of waiting for U.S. goods to be loaded up so they can earn the westbound freight rates as well.  And so based on the latest data we’re seeing, the westbound freight rates from Los Angeles to Shanghai are below $2,000 or 40-ft. box.  The eastbound ones are above 12,000.  So I can see why that’s happening.  

And we actually have a chart in here showing this giant increase in the container ships that are being, returning to Asia empty are now dwarfing the ones that are actually loaded.  This is messing up the supply chain in a lot of understandable ways, because as U.S. goods that were destined for export don’t leave the ports, they sit there and railcars and manufacturing sites and warehouses and dock areas are occupying the space that all of those containers ships waiting to unload into the U.S., they don’t have the space to do that.  So that’s one big aspect of the supply chain disruptions that have to do with these enormous shipping cost discrepancies.

And the other one, of course, is the semiconductor issue.  We talked about this a little bit last time, but just to go over a little bit of again, these chip shortages are related to the older and simpler 200-mm wafers, but they’re used in everything, cars, computers, laptops, refrigerators, washing machines.  These are the things that soared in terms of demand during the pandemic as people built out home offices, and the impact on auto manufacturers is kind of remarkable.  We have a chart in here that looks at the surge in manufacturer inventories and the collapse in dealer inventories as they’re waiting for the chips to come in to complete those vehicles and get them out for sale.

There’s limited economic incentive for people to build these new plants because the margins are so low, and there’s only a handful of new ones planned for 2022.  The good news is that there’s a few billion dollars being invested to expand capacity in the existing plants, in which case the semiconductor squeeze should start to ease a little bit by Q2 of next year.  And auto manufacturers are also discussing some long-term contracts with these tier two semiconductor suppliers that might incent them to build out some new capacity kind of the way an LNG export facility works.  It’s very hard to finance a multibillion dollar LNG export facility unless you’ve got pre-committed investment grade long-term contracts to help finance construction.  And increasingly, we might see that required to get new semiconductor capacity built.

And for all the clients that have always mentioned to me over the years their concerns about the political and economic problems associated with the rise of autonomous vehicles and lots of unemployed and angry truckers, I always tell them they’ve got it backwards.  The U.S. has had a trucker shortage for the last few years, and it’s projected to get much worse.  And so what’s happened here is that COVID has worsened some of the vulnerabilities in the U.S. supply chain, just as global goods trading is surging and people want more stuff instead of services.

So how does this get resolved?  This is one of the topics we spent a lot of time here on at this CEO gathering.  Well, the world is going to need more containers which carry more than 90% of the world’s traded goods, right.  So the world needs more of these containers.  Who comes to the rescue here?  Unsurprisingly, the Chinese get the benefit.  The Chinese companies affiliated with the Chinese government make up, I think 95% of the world’s container production market, and they’ve ramped up production. We’re also going to need more container ships in service.  Those are rising obviously more slowly.  They take time to build.  Who is going to benefit there?  China, the world’s largest ship builder.  I think they got 45% of all new shipbuilding orders in 2019.  Here are some more examples of how China continues to reap some unforeseen benefits from this COVID pandemic.

But more containers and container ships aren’t going to solve the problems in the West unless some of the other supply chain issues are resolved as well that have to do with labor, and that’s probably going to require an end to extraordinary housing and income support measures and a lot less concern about COVID.  So far, most of the analyses that we’ve seen don’t show a big differential in job growth between states that terminated the employment subsidies and those that didn’t.  That may have to do with the fact that it hasn’t happened yet but it’s going to; it may have to do with the fact that the Delta variant is a bigger issue.  We don’t know yet.  

That said, most of the forecasts we see call for around one-and-a-half to two million new jobs by the end of the year, due to some combination of expiring unemployment benefits and school reopening and less concerns about COVID.  So we’ll see.  And then on the foreclosure moratorium, those programs are also scheduled to end this fall.  Foreclosures collapsed once the moratorium was put in place, and so that’s also ending.  

And so the bottom line is that U.S. and European housing and income policies may have to normalize before labor supplies do.  When you look, we have a chart in here that looks at G7 manufacturing wages rising at some incredibly rapid clip at a time when unemployment rates are still this high.  And then one last comment here.  It is interesting that some of the people that are arguing for endless extension of the COVID unemployment benefits are also arguing for the largest amount of new Congressional spending, like 3.5 trillion.  

Without circling how all of that Congressional spending, what it might do to labor shortages, where are all these new workers supposed to come from, and how might that impact inflation and Fed policy?  In August, around half of all small business owners said they had job openings that they already couldn’t fill, which is the highest level on record, and that’s before people are suggesting $3.5 trillion worth of new Congressional spending.  

So on the COVID side, the concerns may dissipate in the next few months.  We had a client webcast in August where we laid out our vision for the fall that was heavily influenced by research we’ve done, conversations that we had with epidemiologists and chief medical officers at the vaccine companies.  And what we laid out was okay, this is going to be a terrible fall in the U.S.  And so far it is.  The latest infection and hospitalization mortality data in the hot spot states, mostly in the Southeast, are terrible.  The U.S. has the highest reported mortality rate in the world in the southeastern United States.

But we also thought that, given the high degree of Delta-contagiousness, a combination of vaccination and acquired immunity would drive down these pandemic measures substantially by, let’s call it November.  It looks like we’re still on track there.  We’ve got a chart in here showing a pretty sharp rollover in infections and hospitalizations in the Southeast.  Mortality is still rising, and it is a terrible rate and all the things you read about the ICU are true, but given the lag times between infection, hospitalization, and mortality, you would expect the death situation to get a lot better in the next few weeks as well.

The biggest look to this outlook is the fading immunity of vaccinated people.  We just don’t have enough information on this yet.  We’ll know more over the next few months how this plays out.  It is clear that the booster shots in Israel are driving antibody levels up substantially.  And for all the people concerned about Pfizer’s very modest efficacy gap versus Modena, the booster shots in Israel are showing that the efficacy numbers for Pfizer go back well above 90%, which is where the Moderna numbers are.  So if you’re concerned about that gap, go get a booster shot.

The developing world situation is a little more nuanced.  First of all, infections and mortality are declining.  This is mostly the result of the exhaustion of the lambda and gamma variants in Latin America and the delta variant in Asia.  A lot of these countries have very high COVID stringency requirements, more so than, even more so than countries in the U.S. and Europe.  That said, they don’t appear to be the epicenter of supply chain problems, because when we look at the data on manufacturing delivery time delays, the data is much worse for the Euro zone and the U.S. than it is for India, China, South Korea, and Brazil.  We know that in places like Malaysia that there are some issues around semiconductors and other stuff, but most of the supply chain issues appeared to be developed market problems, and that’s why some combination of reduced COVID concern and income and policy, income and housing support policy normalization are going to be required to resolve this.

So when does that happen?  I think both of those things happen over the next few months, and we start to see an easing of supply chains in Q1 of next year, although I will say that based on the CEOs in attendance at this event, they were more thinking Q3 and Q4 of next year.  So we’ll see how that plays out, and we’ll update you in the future as to whether they were right or I was right.  Anyway, thanks for listening, and we’ll talk to you next time, bye.

FEMALE VOICE:  Michael Cembalest’s Eye on the Market offers a unique perspective on the economy, current events, markets, and investment portfolios, and is a production of JP Morgan Asset and Wealth Management.  Michael Cembalest is the Chairman of Market and Investment Strategy for JP Morgan Asset Management and is one of our most renowned and provocative speakers.  For more information, please subscribe to the Eye on the Market by contacting your JP Morgan representative.  If you’d like to hear more, please explore episodes on iTunes or on our website.

This podcast is intended for informational purposes only and is a communication on behalf of JP Morgan Institutional Investments Incorporated.  Views may not be suitable for all investors and are not intended as personal investment advice or a solicitation or recommendation.  Outlooks and past performance are never guarantees of future results.  This is not investment research.