Supply-chain bottlenecks resulting from the lockdowns imposed during the pandemic have fueled U.S. inflation, but they point toward a new cycle of investing opportunities, according to Marko Papic, chief strategist at alternative asset manager Clocktower Group.
It’s not just the loss of the “just-in-time” inventory that “we’ve all enjoyed,” Papic told MarketWatch in an interview. Two other “epochal events,” the trade war between the U.S. and China and the “green revolution” have all contributed to the supply chain mess.
Before the pandemic, the trade war sparked a shift in production out of China into countries in southeast Asia such as Vietnam, a “nascent evolution of the supply chain” that suddenly was strained as factories shut down due to COVID-19, Papic explained. Making matters worse, China, “the manufacturing heartland of the planet,” has recently cut power for many industrial users amid rising energy costs and a move away from coal to cut carbon emissions, he said.
Strengthening stretched supply chains will require capital expenditure, opening a new cycle of investing opportunities in “capex companies” that serve producers, according to Papic.
“You don’t want to buy the producer who will be stretched thin as they try to disentangle their extremely sophisticated and fine-tuned, just-in-time inventories that worked for them for the past 20 years,” he said. “You want to invest in the companies that do the capex for the producers.”
Buying shares of companies that make equipment or assembly-line robots are ways of gaining exposure to the capex cycle, as those are the types of businesses that could benefit from increased capital investment in manufacturing and production, according to Papic. Companies that make “very sophisticated machines” for semiconductor producers were an area of opportunity even before the pandemic, because of the trade war between the world’s two largest economies, he said.
In his view, supply chain disruptions won’t be quickly resolved, particularly amid elevated demand for goods as the global economy recovers from the pandemic. “In a cycle where you have to spend a lot of money to fix these problems,” he said sectors such as materials, energy and industrials should benefit.
“Those are going to be the sectors that are going to win this cycle,” he said. “All the sectors we kind of forgot about” because technology has “just swallowed the world in a capex-less cycle.”
Delays in the supply chain and strong demand for goods as economies have recovered from the pandemic have resulted in price increases and concern among some investors that higher inflation may last longer than expected.
Michael Cembalest, chairman of market and investment strategy for J.P. Morgan Asset & Wealth Management, told MarketWatch that the next two to three months are going to be “critical” with respect to the wave of COVID cases and shortages in semiconductors and labor.
His takeaway from a recent CEO event with mid-sized private businesses was that their “biggest issues” by far were related to the supply of goods and labor. “They just couldn’t get their stuff on time and they can’t hire people,” Cembalest said.
“We are concerned that sticky inflation and supply-chain constraints will weigh on the ’22 earnings outlook, Citigroup analysts said in a Sept. 28 Citi Research report focused on small and mid-cap
companies. “We have to consider that supply chains are facing both cyclical and structural issues.”
Supply chains are dynamic, with problems tending to show up suddenly, rather than gradually, according to Papic.
If they were stretched solely due to the pandemic, Papic said he would agree with the Federal Reserve that the disruptions are transitory. But the trade war had already created a “kink” in the supply-chain system for just-in-time inventories, he said, while policy makers want to move away from fossil fuels toward renewable energy in the “greatest paradigm shift in the world.”
“The odds that this is transitory, I think are low,” Papic said. “The big macro takeaway from here is that inflation is here to stay.”