One wedged ship and a few timely reminders
“Having already been buffeted by two big shocks in the last 10 years, the global economy's highly interconnected wiring is suffering a third because of the COVID-19 pandemic. Globalization thus faces a three-strikes-and-out situation that could well result in a gradual but rather prolonged delinking of trade and investment.”
– Mohammad El-Erian, Chief Economic adviser at Allianz. May 2020.
As trade has globalised, supply chains have become increasingly interconnected and complex, companies have shifted to a “just in time” inventory approach and countries have become increasingly interdependent. COVID-19 exposed this.
In the face of shortages in medication, medical supplies, personal protection equipment and countless other goods, there was much talk about how fragility had been bred over the past decades. Therefore, late last year there was an expectation that CEO’s in 2021 would move towards strengthening and creating redundancies in their supply chains.
However, we have recently seen that this vulnerability remains, which we remain mindful of when positioning client portfolios.
A fishbone stuck in the windpipe of global commerce
The Ever Given, a Taiwanese ship, ran aground in the Suez canal on Thursday morning. An apt analogy was drawn by the Telegraph who likened it to “a 200,000 tonne fishbone stuck in the windpipe of global commerce”.
The grounded ship has put a halt to commerce through the canal, a key international trade route. The route facilitates Northbound traffic of oil from the Arabian Gulf to Western and Southbound traffic of goods and services to North America, Far East and Southern Asia.
Consequently, an estimated $12.5 billion worth of cargo is expected to be held in limbo as salvage experts attempt a naval Heimlich Manoeuvre on the key trade route.
While the blockage is expected to be cleared within days, it provided a timely reminder to us of the fragility that has been bred over the past decades as supply chains have lengthened and trade has globalised.
Above: The Ever Given lodged in the Suez Canal
Vaccine diplomacy in 2021
As the Ever Green sat lodged in the Suez Canal, on Thursday the European Commission proposed a curb on vaccine exports outside of Europe for a period of six weeks.
There simply may not be enough vaccines delivered in time.
Faced with vaccine shortages, emergency legislation was enacted, making it more difficult for local vaccine manufacturers (predominantly AstraZeneca) to export vaccines from member countries abroad.
Similarly, Chinese produced vaccines from Sinopharm and Sinovac have become crucial to countries without domestic manufacturing capability such as Brazil, Indonesia and the Philippines. In Brazil, vaccine deals questionably coincided with an easing of its opposition to Huawei’s involvement in auctions for its 5G wireless network.
Prior to COVID-19, the installed capacity for vaccine manufacturing existed in a select group of countries, who predominantly produced vaccines for paediatric use. The sudden need for hundreds of millions of COVID vaccines has meant several countries without manufacturing capability have fallen by the way side.
In a time of crisis, we are seeing the consequences of the fragility bred over the past decades.
The scramble for semi-conductors
General Motors, Honda, Ford, Toyota, Fiat Chrysler, Volkswagen. All six auto manufacturers have shut factories or reduced production this year due to a shortage of semi-conductors.
Semiconductors are the chips that are the lifeblood of our televisions, laptops and gaming consoles.
As consumer demand unexpectedly rebounded late last year, a significant supply shortfall was created. This, coupled with a “just in time” approach to manufacturing has led to a shortage that has stunted automotive and electronic industries and could take “a couple of years” to ease, according to Intel’s CEO Pat Gelsinger.
The semi-conductor supply chain is notoriously complex and interconnected, with the production of a single computer chip often passing through international borders 70 or more times and requiring more than 1,000 steps before reaching an end customer (Source: Accenture and Global Semi-conductor Alliance).
Recognising this, Intel has committed to spending $20 bn to building two major factories in Arizona. Reducing fragility is also a national security imperative, with the Biden administration signing an executive action that will begin a 100-day review, which is likely to prompt additional government support.
We continue to see co-operation between private sectors and governments in this fashion to re-shore and shore up domestic supply chains.
Wine, lobsters and tariffs
This vulnerability is not only limited to supply. There are examples where industries face significant fragility as a result of concentration in demand and the weaponization of trade.
We have seen this at home, with tariffs placed on Australian goods such as barley, wheat, lobster, wine, thermal coal and timber putting many of these industries under significant pressure.
As highlighted in the chart below, goods targeted are those where Australia has been dependent on exports to China and where China has had a low dependency on imports:
Source: Macquarie Insights
The impact that the closing of our borders has had on the education sector provides another example of this.
This is therefore another form of fragility we are cognisant of.
Positioning and final thoughts
It is true that many of these fragilities has been exposed by “left tail risks” - events unlikely to happen but with the potential for large losses if they do, the biggest of all being COVID.
Yet in today’s world, we are beginning to see the impact of climate change, national security is taking greater precedence and geopolitical tension is rising.
This was evident in President Joe Biden’s first White House press conference overnight which highlighted that we are engaged in “a battle between the utility of democracies in the 21st century and autocracies.”
Faced with these challenges, this fragility is something the world is paying greater attention to. We feel investors should do the same.
We feel the potential for disruptions that result may add to inflationary pressures in the near term. Likewise any longer term shift towards reshoring and duplication of supply chains may have an inflationary impact.
As we have mentioned, our portfolio is positioned for the possibility of higher inflation in the future.
These considerations have also seen us avoid investments with a high degree of trade or geopolitical risk. Conversely, we have looked to provide the portfolio with a positive exposure to some of these dynamics.
As we have previously written, investments in Lynas Rare Earths and Hastings Technology Metals have benefited from government support in establishing domestic rare earths supply chains.
We also see our investment in Viva Energy benefiting from efforts to maintain domestic fuel supply and refining capability.
Furthermore, our portfolio holds a modest exposure to gold, which is sought as a safe haven in periods of high uncertainty.
The fragility that has been bred over the past decades continues to be something we remain conscious of when constructing portfolios.