Commentary —

The Shortage of Everything

Scott Morrison

Scott Morrison

Founder & CIO


Is it us or does everything seem more expensive these days? From lumber to microchips to workers, there seems to be a supply crunch for many items on our shopping lists. CIO Scott Morrison details why we are paying more lately in his latest commentary.

It has been over 444 days since my last business trip, which ended on March 11th, 2020. On that day, I was scheduled to attend a dinner with the CEO of one of our investments, Intercontinental Exchange, in Boca Raton, which was cancelled due to COVID fears. Earlier that day, I met with the CFO and head of business development at Nextera Energy’s headquarters in Juno, Florida. That same evening, I nervously flew home from Fort Lauderdale’s airport where my half-full plane was mostly passengers returning after their latest cruise ship trips in the Caribbean. Thinking of my last head office visit to a town named Juno reminded me of the upcoming 77th anniversary of the D-Day landings — specifically those on codename “Juno” beach in Courseulles-sur-Mer, France. This is, of course, where many Canadian and allied soldiers, and innocent civilians, lost their lives or were injured during the invasion of Normandy in the final year of WWII. It is estimated that between 70-85 million people died over the course of the Second World War.

It is also now estimated that over 3.5 million lives have been lost globally due to COVID-19 and over 175 million have tested positive for the virus over the course of the pandemic. Countless millions of others have seen their personal, psychological and professional circumstances negatively impacted. Further anticipated as a fallout to the pandemic are various geopolitical tensions, which might reverberate for years to come. For instance, there are renewed efforts at finding a smoking gun in China’s Wuhan district. Not since the Spanish Flu outbreak of 1918-1919 have so many deaths been caused by a pandemic; and as a result, we predict unprecedented levels of finger pointing in the months and years to come. There are also tussles between countries over vaccine supplies and technology. We are watching carefully an area of pre-COVID tension in debt-levered countries like those in Southern Europe, which is explored in the below charts. Germany is emerging as the country whose population is most inclined to keep the EU together, after the United Kingdom officially withdrew late last year.

Citizen Support for the EU
Sources: Standard Eurobarometer, Barclays Research et al.
Votes for Italian Populist Parties
Sources: Standard Eurobarometer, Barclays, et al.
Previous Episodes Show that Pandemics Last for Multiple Years
Source: Maddison GDP tables, World Bank, WHO, CDC, ADB, CEIC, Haver Analytics, et al

As a result of COVID, central banks and governments have dedicated huge sums of money to the purpose of placating economic problems and now we at Wealhouse are watching for the unintended consequences of such unprecedented stimulus measures. Time will tell how many consumers, mesmerized by misinformation launched from social and traditional media platforms, will remain terrified and cling to virtual lives supported by home delivery. A recent article on Morningstar stated that, “research has shown that most employees prefer some form of flexibility in where they work. An upcoming survey of 9000 workers by Accenture PLC found 83% of respondents viewed a hybrid workplace as optimal.

“What Best Describes your WFH Schedule?”
Source: Evercore ISI Research

It is very important that investors do not presume our pre- and post-COVID worlds to be one and the same – remembering, for example, how major structural shifts resulted from the global financial crisis of 2008. Government spending levels as a percentage of GDP are at levels not seen since World War II and this is an economic tailwind that is NOT sustainable in our opinion. As vaccines roll out around the world, at very high numbers in the richest economies, we are set to see the biggest economic boom of our careers. This will cause spikes in earnings and free cash flow for many companies that have pricing power. This abundant growth will come at a cost to those without the “power of the buyer or supplier,” and we fully expect that some companies will experience difficulties passing on those extra costs and risk profit margins in the coming earnings reports.

Public Attitude Towards Deficits Over Time
(3M moving average)
Sources: Pew Research Center, et al

As I have reminded readers before, it is the job of central banks to allow easier access to money in difficult times and disallow it when things improve. We fully acknowledge, based on the U.S. Fed’s numerous comments around staying extraordinarily accommodative, that they will very likely leave the “punch bowl at the party” longer than previously seen. And considering that governments are “spiking” that punch bowl with a level of fiscal spending never seen during a time of peace, the world is sure to experience some very serious economic hangovers. Politicians will surely see the stands full at recent events such as the PGA Golf Championship, NHL playoffs, Indy 500, etc., and their willingness to vote for further stimulus initiatives will be diminished.

Debt as a % of GDP
Source: Federal Reserve, et al

It goes without saying that there are many continuing to struggle with their health, employment and financial outlooks, regardless of the seeming “Open Bar” policy of the U.S. central bank. Its efforts stem from a notion that the recovery from the 2008 financial crisis left too many behind and was too tepid in nature. As a result, President Biden and his ex-Central Bank Chief Janet Yellen are pouring more and more money into the economy. And as you can see in the chart below, this is a global phenomenon that many central banks are facilitating. Regardless, there will be a percentage of displaced workers from disrupted industries that will neither re-tool their skills nor pivot to other areas in need of labour.

Policy Measures Taken So Far
Source: Refinitiv, Credit Suisse research

During April we saw the following headline on CNBC, that summed up results perfectly: “April’s expected hiring boom goes bust as non-farm payroll gains falls well short of estimates.The article went on to say: “Hiring was a huge letdown in April, with non-farm payrolls increasing by a much less than expected 266,000 and the unemployment rate rose to 6.1% amid an escalating shortage of available workers.” Below you can see that some of the sectors most negatively affected by the pandemic are having trouble finding workers, just as consumers are eager to spend money as vaccinations roll out. We will carefully monitor this issue.

Job Openings Change DEC 2020 to MAR 2021 (in millions)
Source: Evercore ISI, US Bureau of Labor Statistics

Some are beginning to argue, as we have, that if the government insists on paying workers to stay home, it should come as no surprise when many decide to stay there. Laurence Summers, a famous former Democratic economic advisor to Bill Clinton and Barack Obama, recently stated to Coindesk,

We are seeing something very powerful in the heat of the labor market. I would not have expected the pervasiveness of job shortages while we have unemployment at these levels… I would not have expected that so many employers would be complaining that they’re not able to find workers. I would have thought that the best argument for being relatively optimistic about this – that this was all going to work out okay – was the suggestion that when extraordinary unemployment insurance benefits ran out in September, people would go back to work in large quantities and then the labor market would be able to absorb it. But the Administration insists on denying that argument and insists on denying that unemployment insurance has an important impact.”

The problem is most definitely real when such a high-profile Democrat criticizes his own party’s liberal policies.

Comments around shortages of workers concern us, as they come up more and more in conversations with management teams in our due diligence meetings. As well, we are hearing that an increasing number of workers are looking at retiring early. According to an article from Fox Business, Americans under 54 represented a higher percentage – 13% – of pre-retirees, or people who are likely to retire within five years, in 2020 than they had in years past, according to March survey results of 60,000 households from market research company Hearts and Wallets, even as more U.S. households hope to work as long as health permits.

We have spoken for years about the secular deflationary forces caused by higher and higher levels of debt, an aging population that looks to save more money for retirement, and the productivity and deflationary impacts of disruptive technologies. I have toured many industrial plants over the course of my career that are able to replace workers with automation technologies from robotic manufacturers. I have toured Japan and Germany – two rapidly aging populations requiring automation solutions for their domestic leading companies. Self-serve checkouts in grocery stores and pharmacies reflect the impact of automation similar to that seen in the advent of Automatic Teller Machines (ATMs). Only time will determine the level of continued growth in this area, which would allow companies to stay ahead of a looming uptick in labour costs.

Based on our recent conversations with companies, the trends of early retirement and disincentive to work are potentially very disturbing for medium-term wage inflation. We have always said that we would not worry about inflation as long it stays away from the labour costs of our companies, as labour is such a large cost component of many businesses. Moving forward, we anticipate hearing about significant wage increases and signing bonuses to fill empty positions. We also anticipate hearing that more and more companies will offer temporary workers full-time positions. This will be an important indicator to monitor, since doing so will decrease a company’s ability to manage economic uncertainty and cyclicality.

There is no doubt that consumers and businesses should ready themselves for a year-over-year inflation shock, ready to hit in the near-term. By now we are all aware of rising prices in lumber, copper, natural gas, corn, soybean, chicken, coffee, steel, etc. Since two-thirds of the economy is consumer-driven, consumer confidence levels should begin to fall as they see wage increases struggle to keep up with the triple- and double-digit price increases of some commodities. These are mentioned above or illustrated below.

Lumber Prices
Source: Random Lengths, Bloomberg, Evercore ISI Research
Copper – LME Prices
Source: Bloomberg, Evercore ISI Research

As an individual homeowner and consumer, my family has benefitted from the increase in our home’s value. Although we are sounding cautionary alarms around inflation and potential impact on margins for companies without pricing power, it cannot be denied that the majority of consumers are seeing major lifts in personal net worth if they own a home. This will have a positive effect on future consumer spending. As you can see in the charts below, house prices are up very nicely versus previous years.

Monthly Median Existing Home Prices – NAR
(Note: Most recent data point represents the y/y change in median sale price for the week ended 5/9/21, per Redfin)
Source: NAR, Redfin, Evercore ISI Research
Weekly Median Existing Home Prices – Redfin
Source: Redfin, Evercore ISI Research

As so many of us were forced to stay home over the last year, we saw massive spikes in demand for laptops, video game consoles, large screen TV’s, new appliances and automobiles so we could avoid public transportation. However, these items depend increasingly on high amounts of semi-conductor content. This increased demand for semis caught the industry flat-footed, as a result of long lead times and distant supply chain sources. As a result, used car prices are spiking as auto companies cannot source semi-conductor components to build new cars. This is evident in the Manheim U.S. Used Vehicle Value Index, below.

Used Car Prices Spiking due to Shortages of New Car Supply
Source: Bloomberg

The shortage of semi-conductors is an example of a potential future inflationary pressure that might not be transitory. Tensions between China and Taiwan have caught our eye. I remember visiting the Forbidden Palace Museum in Beijing and noted how its collection of antiquities was far less impressive than the historic Chinese antiquities I saw years later at the National Museum Palace in Taipei, Taiwan. I questioned at that time the possibility that mainland China might take them back one day. Since then, Taiwan has become one of the most important manufacturers of advanced semiconductors in the world. As more and more of our lives become impacted by the use of semiconductors, we are slowly seeing an effort by countries to bring home this and other important components of the supply chain. This onshoring trend we believe has legs and will result in higher costs to produce many goods for consumers and businesses. This is one reason why we remain bullish on certain semiconductor equipment makers. Ultimately, we live in a world where China does not want to be dependent on American-centric technology and the U.S. does not want China to catch it technologically. Only time will tell who wins this technological war that may stop at nothing to achieve its respective objectives.

Again, we remind readers that we have exited a COVID recession with the lowest interest rates in financial history, and with the largest levels of debt in human history. We are not trying to be negative since we are about to witness the biggest pent-up consumer spending spree in consumption history, but this could get very tricky if inflationary pressures remain elevated longer than anticipated. Again, this is why I diversify my family’s money into my colleagues’ funds, Amplus Credit Income Fund and Lions Bay Fund, because of their unique hedging capabilities. Voyager Fund, our long-only small- and mid-cap fund, was indeed up a strong +6.67% during April, but it would be irresponsible of me to encourage investors to extrapolate those returns. As government and central bank accommodations peak, we will likely see more uncertain economic parameters cause market volatility.

Changes in Margin Debt Levels tend to Follow Changes in S&P 500 Index Levels
Source: FINRA, Evercore ISI Research

We believe that economists will continue to be surprised since so many economic variables are operating at extreme levels. As a result, traditional correlations such as leading and lagging indicators are out of sorts versus historical cycles behavior. We are also balanced in our portfolios because it would be incredibly naive of us, as guardians of our clients’ capital, to assume that incapable politicians are intelligently allocating trillions of dollars of taxpayer capital. As mentioned above, we believe that inflation is likely rising more than expected. That has potential consequences for interest rates that have been in steady secular decline for 40 years. Therefore, it makes sense for us to own some businesses that have pricing power and assets that will cost more and more to replace in value. For example, we still like balancing the portfolio with shipping companies that will help fill the world’s shelves; low-cost commodity businesses with supply constraints; and real estate businesses that can drive rents and trade below replacement values—which as I type this are inflating. We are excited to see some of our favourite secular growers with proprietary technologies and quality franchises experiencing multiple contraction.

Panorama

Panorama

Panorama Fund strives to maximize capital appreciation by investing only in securities that we believe offer above-average returns on a risk-adjusted basis. The fund employs a variety of strategies including investments in equity, bonds, currencies, commodities, and publicly traded real estate. The fund also makes prudent use of derivatives to generate yield and enhance or protect our positions.

As Wealhouse Capital’s flagship fund, Panorama takes advantage of market inefficiencies across different geographies, industries, market capitalizations and asset classes to build a balanced portfolio. We actively analyse different risk factors in the markets to better diversify and safeguard our clients’ capital.

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