The great global supply-side crunch

Over the last year, across the world, supply lines have been dislocated. And Victor Hill believes that there is more of great import going on than just Covid and Brexit.

The year of the bottleneck

Across the globe, manufacturers are grappling with shipping delays, shortages of raw materials such as steel, timber and semiconductors, and labour shortages. Logistics delays and staff shortages are also in evidence in the service sector. Some headline-grabbing examples in the UK of late include: restaurant chain Nando’s running out of chicken; the pub chain Wetherspoon running out of beer; and the furniture giant IKEA running out of mattresses. These inventory outages were blamed on a shortage of lorry drivers slowing down deliveries just as demand spiked.

In the UK, the most recent IHS Markit PMI (Purchasing Managers’ Index), which analyses producer confidence, was a bullish 60.5 – anything above 50 suggests that business leaders expect their order books to grow. For example, companies such as JCB (private) are reportedly working at full capacity to meet demand. This could result in a boom in capital expenditure as manufacturers set out to boost production capacity. But factory input costs are running at about 10 percent higher than this time last year – indeed, steel prices have more than doubled.

In terms of the labour market, a record number of service companies are hiring staff – though they are having to raise salaries in order to fill vacancies. The UK recorded an exceptional 953,000 job vacancies in the three months to July. There were 1.7 million live job adverts in the UK in the last week of August.

Europe’s large automotive players such as VW (ETR:VOW) are also struggling to meet demand for new vehicles given similar input and labour bottlenecks. That is one reason why Eurozone inflation has just hit three percent – a 10-year high.

Where have all the lorry drivers gone?

The shortage of lorry drivers in the UK has been blamed on Brexit and the pandemic. Many lorry drivers working in the UK were apparently EU nationals – particularly from eastern Europe and the Baltic states. About 14,000 of these drivers returned home after Brexit. And we will recall that the UK’s formal departure from the EU on 1 January this year coincided with the height of the second wave of the pandemic.

Then many drivers were obliged to stay at home during this summer’s ‘pingdemic’ (when the NHS app pinged people who had been in contact with Covid sufferers, obliging them to self-isolate). However it seems that lorry drivers are not a very healthy bunch, anyway: according to the trade union Unite, the number of lorry drivers who have had their heavy goods vehicle (HGV) licenses refused or revoked on medical grounds has more than doubled in a decade.

The Road Haulage Association estimates that there is a shortfall of 100,000 HGV drivers in the UK. Last week, James Wroath, chief executive of logistics major Wincanton (LON:WIN), proposed that the training time for new drivers be reduced from 12 months to three. He also recommended that more women should be welcomed into the profession. Mr Wroath is among a growing chorus of business leaders who believe that UK immigration rules should be relaxed for lorry drivers, at least temporarily. Currently, driving an HGV is not categorised as a skilled occupation by the Home Office. Tony Danker, director-general of the CBI, suggested that HGV drivers − along with welders, butchers and bricklayers – should be added to the Home Office’s Shortage Occupation List.

Thus far, the UK government has resisted calls to relax immigration rules. But it has reduced limits on drivers’ hours and is working to clear a backlog of thousands of HGV tests. The UK haulage industry has been hamstrung for decades by low pay, poor conditions and an ageing workforce. But it is not unique in that respect. The EU is lacking around 400,000 drivers (45-60,000 in Germany alone).

Rather than seeing Brexit as an insurmountable problem, some manufacturers have responded by bringing vital parts of their supply chains in-house. David Nieper womenswear, based in Derbyshire, is now manufacturing much of its own fabric instead of buying it in from Europe.

Shipping problems

Before the pandemic struck, the cost of sending a container from China to Europe was $2,500. Currently, it is around $11,000. Spot container rates for the pivotal Shanghai-Rotterdam route have been surging for a year now and show no sign of retreating. In early August, the benchmark container rate for Shanghai-San Francisco/Los Angeles broke through the $20,000 mark. Reportedly, importers are also being hit by a barrage of new surcharges, including for insurance. What is going on?

It seems that, globally, there is a shortage of containers given that thousands of containers are in the wrong place due to dislocation caused by the pandemic, combined with surging demand as economies all over the world recover from lockdowns.

Global container shipping is an oligopoly dominated by just 10 major playersⁱ. The largest of these, Denmark’s AP Moller-Maersk (CPH: MAERSK-B) has posted two successive quarters of record profits. Its share price has more than doubled over 12 months – though that is modest when compared with the shares of Taiwanese shipper Yan Ming Marine Transport (TPE:2609), which have risen fourfold since the beginning of this year.

The ease with which the big shippers have been able to hike their prices, even though they normally enjoy long-term relationships with their major clients, has led to calls for tighter regulation of the shipping sector by competition authorities. Thus far, the European Commission has been silent on this issue.

On the other hand, some say that before the pandemic shipping costs were artificially cheap. In some cases, it was cheaper to put goods in a container and ship them than to store them in a warehouse. Hence sourcing goods from the Far East was often cheaper than sourcing them from home. It should not surprise us then that the number of new container ships on order and under construction has rocketed this year. That is excellent news for the likes of Japan’s Mitsubishi Heavy Industries (TYO:7011) and Italy’s Fincantieri (BIT:FCT). The latter’s share price is up by over 33 percent year to date.

It did not help that in March, a 1300-foot container ship got stuck in the Suez Canal, trapping hundreds of vessels behind it. The Ever Given finally arrived at Felixstowe on 3 August – four months late – with containers full of rotting fruit.

Skills shortages

Many employers are complaining that, even with increased salary offers, they cannot recruit suitably qualified people. The skills needed are in constant evolution, but anecdotally, many employers think there is an imperfect connection between the world of education and the world of work. New graduates do not always add immediate value in the workplace. And many are sceptical about the efficacy of traditional universities in the digital age.

The hospitality sector is particularly hard-pressed. I was unable to get a table in Brown’s restaurant in Cambridge a few weeks ago. Only two chefs out of five had turned up for work that day. But then Le Gavroche in London’s Mayfair has closed for lunch completely – much to the consternation of the local hedge-fund community. Some hotel chains such as Travelodge (owned by Whitbread (LON:WTB)) are responding with innovation by offering auto check-in (something pioneered by the Accor (EPA:AC) one-star F1 chain).

Labour shortages also persist − from the fields where vegetables are picked to the food- processing companies that use them as ingredients. The building trade is greatly afflicted by skills shortages, especially when it comes to the renovation of historic buildings. In June, Historic England announced that it had obtained a grant of over £4.3m to train apprentices in traditional building skills, including marquetry, joinery, lime-plastering, pargeting, roofing, lead-working, stonemasonry and flintknapping. Hopefully, newly skilled young craftsmen and craftswomen will help save some of the more than 5,000 buildings on historic England’s at-risk register.

Also, nightclubs are short of bouncers – with the result that they are, allegedly, turning to security firms which employ uninsured staff. Yet bouncers are the people who will police vaccine passports. There is also a shortage of GPs and care-home workers (almost 40 percent of London’s care-home workers identify as non-British). Even bin collections have been disrupted across nearly half of the councils in England and Wales by driver shortages. Recycling and waste-management firm FCC Environment (a subsidiary of the Spanish construction company Fomento) announced that it was trying to lure more drivers by offering flexible working conditions.

Unemployment in the UK is still low at around 4.8 percent (as compared with 5.4 percent in the US), having been cushioned throughout the pandemic by the government’s furlough scheme, which comes to an end on 30 September. At the moment, about one in 20 workers is still furloughed. Some economists think that the prolonged furlough scheme has hindered recruitment. But job vacancies stand at one third above pre-pandemic levels. Now employers must face the prospect of not just having to pay higher wages, but of having to pay higher employers’ national-insurance contributions on those wages too.

The loss of jobs in lower-paid sectors such as hospitality has served to push up average wages across the economy. Pay growth is now running at around five percent. Even so, a report by the Recruitment and Employment Confederation (REC) predicted that the economy will be plagued by labour shortages for years to come. Richard Walker, chief executive of Iceland (private), has warned that Christmas might have to be “cancelled” once again.

The fact is that the UK and other advanced countries, including the US, have become overly dependent on immigrant labour to perform basic-skill tasks. EU citizens make up one third of the population of Boston, Lincolnshire, which sits at the centre of a fertile agricultural region, according to the Daily Telegraph’s analysis of the EU Settlement Scheme. Around six million people have applied for permanent UK residence under this scheme – well above the 3.5-4.1 million anticipated by the Home Office. So, it would seem that there were even more EU workers in the UK than was thought.

Microchips

Back in May I wrote about the shortage of microprocessors and rare earth metals. Automotive production lines have come to a halt this year because there were not enough chips in stock.

This is not necessarily disastrous. Until recently there was a glut in microchips with prices falling rapidly. Some believe that this made the relationship between chip designers, hardware engineers and software developers a little too cosy. A shortage of microprocessors should challenge us to examine how resilient our supply lines are – and what would happen if China got control of Taiwan (virtually all of Apple’s chips are manufactured by TSMC (TPE:2330)). A dearth of chips will make equipment designers more sparing in how they use them, and spur software designers to create software which uses processing power more efficiently.

Inflation in the system

All this adds up to huge inflationary pressure. While the consensus among leading central banks is that we are experiencing a transitory bout of inflation, many manufacturers believe that we are only at the beginning of a period of pronounced and prolonged price inflation. Demand-pull inflation is being compounded by cost-push inflation as exemplified by energy prices. Gas-price futures hit an all-time high last week at 135 pence per thermⁱⁱ. That is partly due to voracious demand for liquified natural gas in Asia. And electricity prices pushed well above €100 per megawatt hour across much of Europe in August. I’ll be taking a look at Britain’s looming energy crunch soon.

In the US, the government is about to embark on a massive programme of infrastructure spending financed largely by borrowing; in the UK, another £36bn is to be pumped into the NHS and social care, financed largely by taxation. And yet both countries, as in Europe, are still printing money.

Inflationary pressures combined with rising demand for capital goods tend to be accompanied by a rise in corporate-bond yields. Therefore, bondholders should keep their portfolio duration short.

What is fundamentally going on here is not just the effects of the pandemic but a medium-term repricing of goods, services and labour as a result of deglobalisation. The era of globalisation which truly began with China’s admission to the World Trade Organisation in December 2001 is now over and the deflationary forces of globalisation are now in reverse. What I call the Primark effect – the sudden influx of abundant cheap and cheerful goods − is over. In time, there will be benefits to deglobalisation but the short-term impact, most notably inflation and supply-chain bottlenecks, will be painful.

Afterword: long-term demographics

The pandemic has pushed down birth rates across the globe. The fertility rate in Britain is thought to have plunged to just 1.6 children per woman in 2020. Last year also, deaths in the UK outnumbered births for the first time in more than 40 years and only the second time since 1900.

Morgan Stanley predicts that 70 percent of the world’s population will be below the replacement rate (the number of babies required to sustain the population) within five years. A declining population is a particular problem for highly indebted nations – there will be a slew of defaults. Moreover, men could outnumber women in a third of the world by 2100 according to BMJ Global Health, which will in turn depress fertility rates.

The coming inflection point in the global population, about which I wrote in April in these pages, will have huge economic consequences, including chronic labour shortages. That will accelerate robotisation in all advanced economies. Such supposedly low-skilled tasks as fruit-picking will be robotised soon – although it turns out that this is in fact quite a sophisticated activity and therefore difficult to replicate in a machine. I’ll have more to say about that in a forthcoming article.

PS

Election fever

The Russians elect a new parliament on 19 September (Mr Putin’s United Russia party has already won). Canada will have its federal election on 20 September. Germany goes to the polls in one of its most closely fought federal elections on 26 September. That will be an important day for Europe as a whole. I’m predicting a big surprise in at least one of these elections.

Listed companies cited in this article which merit further investigation:

• Wincanton (LON:WIN)
• AP Moller-Maersk (CPH: MAERSK-B)

i^ See: https://www.ship-technology.com/features/the-ten-biggest-shipping-companies-in-2020/

ii^ Equivalent to 100,000 British thermal units.