Timber! Well, lumber to be precise. Based on business surveys and media coverage we have seen, that is what businesses are reportedly in short supply of around the world, along with semiconductors, copper and steel. With supply down and prices up, financial commentators we follow globally are warning that the economic recovery from lockdowns is at risk. Demand may be heating up, but they warn that is no help if factories and builders can’t make enough gadgets and structures to meet it. We agree there are likely some challenges ahead, but we also think a little perspective is in order. Whilst this may present some headwinds to select areas of the economy, it seems overstated as an overall economic headwind. It is also well-known to equity markets, sapping surprise power, in our view.
Yes, it is true that if businesses can’t make things, people can’t buy them. Since the US and UK calculate gross domestic product by adding up all transactions in the public and private sector, when people can’t buy stuff, it detracts from growth.[i] (Gross domestic product, or GDP, is a government-produced estimate of economic output.) But the keyword there is stuff. Most developed world economies actually aren’t heavy on stuff—services accounts for the lion’s share of economic activity. In 2019, the last full year before lockdowns skewed the picture, sales of (or investment in) physical objects totaled 33.6% of US GDP.[ii] That includes consumer spending on goods, residential real estate investment, commercial real estate investment and business investment in equipment—all things that, to varying degrees, might incorporate lumber, steel, copper or computer chips. In the UK, the same categories generated a slightly larger share of GDP, 39.1%.[iii]
In our view, it is important to consider that shortage is not synonymous with none. Semiconductor foundries are still running day and night, and the Renesas plant shut down by a fire last month in Japan is back online. It should be at full capacity in July, according to the company’s estimates.[iv] Blast furnaces (which smelt iron ore to make steel), copper mines and saw mills are also chugging away. Now, all the reports we have seen indicate current capacity isn’t enough to satisfy demand, particularly in the US, but that doesn’t mean production of physical goods and structures grinds to a halt. Instead, it means producers likely compete for a limited supply. Purchasing managers will have their work cut out for them as they navigate price increases and negotiate with vendors—vendors who probably are trying to juggle an entire roster of demanding clients. That means, for the time being, there will likely be winners and losers at the industry and company levels. We are already seeing some short-term production stoppages amongst UK automakers who are awaiting new stocks of semiconductors.[v]
Whilst the cause of these winners and losers is new, recent history demonstrates it isn’t unusual for some segments of the economy to zig whilst others zag. US manufacturing output fell in 2016, but GDP grew.[vi] The UK experienced the same phenomenon in 2015.[vii] US oil production fell -49.8% (in value terms, not volume) in 2015 and 2016 combined, but—yes—GDP grew.[viii] Similarly, UK mining and quarrying output, which includes oil extraction, fell in 2014 and 2016, whilst UK GDP grew in both years.[ix] In all of these examples, pockets of strength more than offset pockets of weakness. Our research shows that is how it usually works in a strong economy. We also think it is likely to work that way this time around, given services’ size and relative insulation from these supply issues.
As for markets, we think equities generally look about 3 – 30 months ahead. Supply issues will probably plague some industries at the closer end of that window, but that isn’t new news. The semiconductor shortage has dotted headlines we have reviewed for months now. Lumber and metals shortages (and accompanying price spikes) are a bit newer, but our research shows markets deal with developments like this very efficiently. We think they also know how this story generally goes: Shortages drive prices up, high prices incentivise new production, and supply eventually rises to meet demand. This doesn’t happen overnight, but we think markets are good at anticipating the process. In the semiconductor world it has already started, with key manufacturers in the US and Taiwan announcing plans to build new foundries—which should be online in two years or so, based on prior construction projects’ timeline. New sawmills have typically taken about that long to come online, too.
Mines take significantly longer, about five to seven years, but we already have compelling evidence that prolonged copper shortages don’t prevent economic growth. The last big shortage occurred in the early 2000s, when China started a long period of infrastructure buildouts. GDP soared there and globally, and the Metals & Mining boom propelled Australia, Brazil and other resource-rich nations for years.[x] We aren’t arguing a similarly long metals boom is in store now, as we think the far future is unknowable. But we think this example does show that one business’s problem is another company’s opportunity, and the net result can be positive.
Keep in mind, also, that low production isn’t the only reported reason supply is down. The US imports most of these materials and components—some from Canada, some from South America, some from overseas. A lot of Canadian lumber comes on lorries, and hauliers are in short supply. Lumber, metals and chips coming from Australia and East Asia come on container ships, which reportedly face huge traffic jams at US ports right now due to the combination of high volume and short staffing, which stems from social distancing requirements. UK ports face similar delays, as has been reported widely. Yet with COVID vaccines rolling out and lockdowns beginning to ease, we think these factors should fade relatively quickly, likely helping supply move faster and probably easing the shortage somewhat.
In our view, the main lessons for investors here are threefold. One, we suggest investors seeking long-term growth think like markets and look forward—look to the full range of that 3 – 30 window and consider carefully whether things are likely to be materially worse than everyone expects. Two: We think markets are efficient discounters of widely known information. This story dots headlines everywhere globally, suggesting its power to sway equity markets is falling as we type. Three, it can be beneficial to diversify across sectors and geographic regions so that you have exposure to what we view as the likely winners in this saga, like large Materials and Tech firms. Leave the fretting over the near-term losers to the headlines.
[i] We are oversimplifying this a bit in order to illustrate the point more clearly.
[ii] Source: US BEA, as of 4/5/2021.
[iii] Source: FactSet, as of 5/5/2021.
[iv] “Renesas Says Normal Production at Fire-Hit Chip Plant to Take 100-120 Days,” Eimi Yamamitsu, Reuters, 29/3/2021.
[v] “The Chip Shortage Bringing Car Factories to a Standstill,” LaToya Harding, Yahoo! Finance, 29/4/2021.
[vi] See Note iii.
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