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Supply Chain Disruption and De-globalisation

It’s been almost 2 years since the world got its first glimpse of COVID-19. A lot has happened since then, and plenty more is still unfolding.

In the early stages the world was coming to grips with the unfolding event and its consequences, most of which were lockdowns, public health orders and basically a halt on everything.

However months later, and even now, we’ve started seeing the second order consequences from the pandemic play out. They may not be as obvious, but that doesn’t mean they don’t have severe impacts.

In this 3 part series, we want to delve into some of the global issues that are coming to light due to the pandemic and what they can potentially mean for markets and stocks. Then, more importantly, we want to delve into how we as investors can best prepare ourselves given this environment and use tools to improve our decision making process.

With that being said, here’s 3 global issues that we want to discuss:

  1. Supply Chain Disruption and De-globalisation
  2. Decarbonisation and Climate Initiatives
  3. Money Printing, Asset Prices and Inflation.

All of these issues are unfolding right now, and over the longer term, they will play a significant part in the future of our economies.

First up, let’s talk about:

In today’s society, we have the potential to order goods from all over the world and receive them on our doorstep in a matter of days or weeks (Pre-Covid). Additionally, many of the goods we’re able to buy have been created from inputs and factories from all over the world. That is primarily thanks to Globalisation.

Globalisation is the process by which the world becomes increasingly interconnected as a result of massively increased trade, capital flows and cultural exchange. The process has been going on for hundreds of years, but in the last 50 years, it has accelerated enormously and got us to a stage of interconnectedness that was almost unimaginable a few decades ago.

Thanks to Covid, it has recently hit a bit of a bump. In fact, many are claiming “slowbalisation” or “de-globalisation” will more accurately reflect the global economy over the coming years thanks to COVID and government decisions around global trade. Globalisation had reportedly reached a peak around the late 2000’s.

We’ll cover de-globalisation in more depth shortly, but let’s first discuss how we got to where we are today.

In regards to manufacturing, this interconnectedness we achieved from globalisation resulted in the ability to move production facilities to countries with cheaper costs of doing business. As for supply chains, it resulted in the ability to source goods from all over the world, with more ease and at a cheaper cost than ever before.

Now, while this transition brought about huge benefits in terms of efficiencies, optionality and cost-saving, it also inadvertently brought about elements of

fragility.And fragility in systems is typically only discovered in times of stress.

The last 18 months have been quite “stressful” in that regard, and shockwaves from the pandemic disrupted almost every industry imaginable around the globe.Shortages, delays and price hikes have occurred in everything from food and lumber to computer chips, shipping containers, materials, resources, and even cars. Many of these issues are still ongoing.
While some of these delays were instigated from natural disasters (flooding, fires, etc), the primary reason for the shortages was vulnerabilities within global supply chains.The pandemic may have caused these shortages, BUT it’s not what made them possible.

Most manufacturing businesses employ a “Just-in-time” (JIT) model, which is part of a production system founded by Japanese car maker Toyota (TSE:7203) in the 1950’s. The process ultimately was designed for efficiency and to minimize holding excess inventory that can be costly to store. The idea is the manufacturer only receives the relevant materials when they have demand for their product. Therefore their products are built “just in time” rather than ahead of demand. It’s a pull system rather than a push system.

While many businesses saw the high-level benefits of this JIT model, they chose to ignore some of the finer details. And they were:

  1. Not all supply chains are created equal, and
  2. Eliminating excess inventory is not the same as eliminating ALL inventory.

Toyota’s supply chain benefits from the fact that many of their parts are sourced within Japan, which is a geographically small country and therefore less prone to disruption, and they do actually have spare inventory, to account for supply chain disruptions.

Toyota is one of the only car manufacturers unfazed by the global chip shortage since they required their chip suppliers to stockpile

2-6 months' worth of semiconductors for them since they knew (from the 2011 tsunami) that supply chain disruptions are an inevitable part of the manufacturing business. From then on, their supply chains had resilience.

Toyota has learned from past experience and updated its supply chains, and it now seems other big businesses are doing the same.

For example, we’ve already seen that the likes of

Intel (NASDAQ:INTC) are increasing their investment of in-house production capabilities to both reduce their reliance on suppliers of critical components and meet the demand of customers. We covered earlier this year Intel’s plans to spend $20bn on semiconductor plants in Arizona. This plan to increase their Foundry services division will allow other companies to source their production of chips from Intel, which considering it’s in Arizona, will increase the capacity of chip creation within the US and reduce reliance on international providers.

Intel will still utilize some of the creation of its chips to other areas around the world (to serve those local customers), but this expansion of a foundry business within the US (and in the future, Europe), is an example of businesses reducing potential obstacles within the supply chain (by having more suppliers located domestically rather than internationally).

As mentioned, COVID has simply brought to light many vulnerabilities that were already embedded within existing global supply chains.

While in-house production simply isn’t feasible or affordable for most regular sized businesses, it’s not unlikely that we’ll see two outcomes from this: an increase in localised and distributed manufacturing capabilities, and an increase in

supply chain visibility, efficiency and resilience.

The former is being helped along by government policies that encourage and incentivise internal production capabilities, while disincentivizing foreign goods by imposing tariffs on certain imports. These actions aim to reduce reliance on other countries, and increase independence, which is counter to the globalisation trend that was occuring.

It wouldn’t be unreasonable to expect some companies to address the vulnerabilities in their supply chain by increasing domestic production, stockpiling essential materials or diversifying their suppliers to include some more local manufacturers (similar to what Toyota has done previously).

The consequences of this change are both numerous and important, especially for us as investors. If we’re positioned within our portfolio to benefit from globalisation or trade openness, we might be at risk of betting against trends that seem likely to eventuate over the next few years.

However, with that in mind, we can then position our portfolio to be exposed to, and benefit from, some of these trends that we’re seeing play out.

Some areas that might benefit from this transition in the foreseeable future are:

  1. Supply chain management services,
  2. Domestic manufacturers,
  3. Industrial construction companies,
  4. 3D printing companies, and
  5. Companies offering warehouse or industrial space.

Figure 3: The U.S. Logistics industries earnings, revenue and market capitalization growth over the past 10 years - Simply Wall St Market Page (currently in Beta)

If you’d like to explore these industries in more detail, there’s a few things you can do:

  1. We've created a Dedicated Stock Screener for you to explore companies in your market that might benefit from this transition.
  2. Go wider and explore the broader sectors which also have exposure such as Transport or Capital Goods (remember to select your market).
  3. Or within those industries, you can investigate the likes of SPS Commerce (NASDAQ:SPSC) within the Supply Chain management industry, or Emerson Electric Co (NYSE:EMR) which is a manufacturing business in the US. They are by no means the only companies within these industries, but they’re a good place to start looking if you’re interested.

The issues around global supply chains and de-globalisation are only some of the big issues going on in the world today that could impact us as investors. While we can’t control them, nor should we try and predict them, it’s useful to be aware of them because that way our decision making can come from a more informed position.

Stay tuned for the next part in our 3 part series which will be focusing on another big global issue:

Decarbonisation and Climate Initiatives.

Invest Well,

Michael Paige

Simply Wall St