Special Episode, Pt. 1: Near-Term Supply Chain Restructuring

Supply chain delays are on the minds of not only investors, policymakers and business owners, but the average consumer as well. How will recent challenges to supply chains be resolved in the near-term and will this create opportunity for investors?

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Michael Zezas Welcome to Thoughts on the Market. I'm Michael Zezas, head of public policy research and municipal strategy for Morgan Stanley.

Daniel Blake And I'm Daniel Blake, equity strategist covering Asia and emerging markets,

Michael Zezas And on part one of this special edition of the podcast. We'll be assessing the near-term restructuring of global supply chains and how this transition may impact investors. It's Tuesday, January 11th at 9 a.m. in New York.

Daniel Blake And it's 10:00 p.m. in Hong Kong.

Michael Zezas So, Daniel, we recently collaborated on a report, "Global Supply Chains, Repair, Restructuring and investment Implications." In it, we take a look at the story for supply chains over the short, medium and long term. Now, obviously supply chains are on the minds of not only investors and policymakers, but the average consumer as well. So I think the best place to start is, how did we get here?

Daniel Blake Thanks, Mike. What we're seeing actually is a surge in demand for goods, particularly coming out of the US economy. As we're seeing accommodation of a record stimulus program post-World War Two, combined with a share in spending that has shifted from services towards goods that has been unprecedented. For example, to put this in context, we're seeing U.S. consumer spending on goods increased by 40% in the two years between October 2019, pre-COVID, to October 2021. And that compares with 28% increase that we saw in the entire 11 years following the financial crisis. And so what we're seeing is a sharp fall in services being more than made up for with an increase in spending on goods. And that's put enormous stress on supply chains, production levels, capacity of transportation. And in conjunction with the surge in demand that was seen, we've also seen some acute difficulties emerge in parts of supply chains impacted by COVID. For example, in South Southeast Asia, we've seen semiconductor fabrication, we've seen assembly, and we're seeing components being impacted by staffing issues as a result of COVID health precautions. And this has all been made worse by the uncertainty about sourcing products and lead times. So what we're seeing is manufacturers, we're seeing suppliers, distributors and the and the end corporates that are facing the consumer, putting in additional orders, whether that component is in short supply or not. And so that's increased the stress in the system and created uncertainty about where underlying demand sits

Daniel Blake And so, Mike, amidst this uncertainty, policymakers have really taken note of the issues, not least because of the inflation that's been generated. What reactions are you seeing from the administration, from Congress and from the Fed?

Michael Zezas This is obviously unprecedented volatility in the behavior of the American consumer. And so not surprisingly, in the U.S., policymakers don't have the types of tools immediately at their disposal to deal with this. So you've actually seen the administration pull the levers that they can, but they're relatively limited. They've made certain moneys available, for example, for overtime work for port workers and transportation workers to help speed along the process of inventory accumulating at different ports of entry in the US. But there aren't really any comprehensive tools beyond that that are being used.

Michael Zezas Daniel, what about policymakers in Asia and emerging markets? How are they reacting?

Daniel Blake Yeah. In the short run, we're seeing a combination of tightening of monetary policy. For example, over 70% of emerging markets have been hiking rates by the fourth quarter of 2021. But we're also seeing competition for investment in global supply chains as they are being diversified by OEMs and as we're seeing some restructuring taking place. So we're seeing overall this competition happening across the value chain from battery materials like lithium and nickel in markets like Indonesia all the way through to leading edge 3D semiconductor manufacturing, where companies in Japan are partnering with industry leader Taiwan Semiconductor Manufacturing Corporation to try to pursue leading edge technology. So we are seeing this competition being a key feature of medium term trends.

Michael Zezas So, Daniel, clearly a challenge in the near term to supply chains in the economy. What's our view on how this resolves itself?

Daniel Blake Yeah, we have identified in conjunction with the global research team the most acute choke points, the primary choke points. And the short answer is we are seeing improvement in these in these areas. For example, in semiconductors, manufacturing capacity in in the backend foundry that was seen in Southeast Asia, we are seeing production come back in towards full capacity. And so we are seeing a real easing in the most acute bottlenecks. That should be good news for overall production levels and the most severe shortages. But at the same time, we do have some more persistent challenges, including rising costs and delays in transportation, as it will take some investment and multiple years likely to resolve the issues that we're seeing in labor shortages in areas like US trucking, in port capacity, intermodal capacity in the US. And as we see some persistent areas of demand really pushing for more investment, for example, in EV materials and the battery supply chain.

Michael Zezas OK, so the most acute stresses we see resolving in the near term, and that's one of the reason, for example, our economists expect that inflation pressures will start to ease this quarter and into next. And as a consequence, the Fed will hike rates this year, but not necessarily according to the more aggressive schedule that they previously laid out. Daniel, what do you think are some of the more micro investment implications, sectoral investment implications, that we should pay attention to here?

Daniel Blake Yeah, we are tracking very closely these key bottleneck segments in the global economy because we have seen companies producing those products have been sharp outperformers. And the challenge is obviously recognizing where these shortages will persist and where we see sustained pricing power. We do see that in some areas the semiconductors are continuing, we are still seeing investment channels in EV materials being a key source of demand. But on the flip side, we're also seeing an outlook for a reprieve in supply chains. As we mentioned some of the more acute challenges, for example, in auto production that may actually be a negative for some major semi companies, as they've benefited from these stronger margins. And so as that pricing pressure diminishes, we think investor consensus is somewhat too optimistic on this shortage and backlog persisting longer into 2022. In terms of implications, then that should be more of a positive for volume league players, for example, auto parts makers that have been held up in terms of their shipments as a result of shortages in other parts of the value chain. And the longer term, another favored investment theme coming out of the report is the likely strength of the US capex cycle in response to these challenges that we're seeing for supply chains.

Michael Zezas Thanks for listening. We'll be back in your feed soon with part two of my conversation with Daniel Blake on the restructuring of global supply chains. As a reminder, if you enjoy Thoughts on the Market, please make sure to rate and review us on. The Apple Podcasts app. It helps more people find the show.