VIPs
- Skilled workers are in short supply; Richmond Fed’s manufacturing index’s gauge of skills availability fell to -17 in August from -16 in July, the lowest on record
- Manufacturers in the Richmond Federal Reserve District are experiencing vendor lead times that have spiked to a record high
- Major restocking tends to coincide with the economy emerging from recession; that makes the current inventory build unusual, in a bad way
- Fear is driving companies to overbuild inventories; transportation bottlenecks and worries over future higher-priced input costs are the two main catalysts
- July wholesale inventories rose by 0.7%, more than triple expectations and are up a strong 5.2% this year
- Inventories will boost third quarter GDP, but the consequences of an artificial, fear-induced supply boost will lead to a nasty payback
King Kahekili knew a thing or two about engendering loyalty. One of Hawaii’s last independent kings in the 1700s, Kahekili used cliff diving to test his wannabe warriors’ mettle. Alpha tendencies being what they are, in time, the ancient proving ground gave way to competitions that drew avid spectators. Primitive no more, this sport of precision enjoys worldwide recognition under the World High Diving Federation. Devoted fans continue to be mesmerized.
Chances are that manufacturers in the Richmond Federal Reserve District are less than enthralled with the delay times they’re dealing with. Securing the requisite supplies to keep facilities up and running in the central Atlantic region including Ohio, Kentucky, Tennessee and northern Georgia has never been as taxing as it is today.
Part of the challenge comes down to the story we can repeat in our sleep – the dearth of skilled workers. One indicator within the Richmond Fed’s manufacturing index that gauges the availability of skills needed fell to -17 in August, down from -16 in July and the lowest on record.
What we’re witnessing in vendor lead times is not natural. We can’t write “spikes of this magnitude” as what we’re seeing is unprecedented. Past surges have been concurrent with economic recoveries, reversals of deep dives that take place as firms slash inventories to protect their margins in recession. What follows, which we’ve depicted on a four-quarter cumulative basis to smooth out the noise, is an inventory rebuild which flows straight through to GDP growth.
The missing piece of the puzzle at the moment is recession, as in we’re not in one which begs the question: Why are firms rebuilding stocks as if we we’re exiting an economic contraction?
In one word, fear. Firms don’t need what they’re buying to satisfy underlying demand, they’re buying for the same reason many investors are plunking money into stocks – fear of missing out, that ‘FOMO’ acronym bubble-vision cheerleaders trot out with remarkable frequency.
As is the case with stock market investors, firms fear prices tomorrow will be higher than they are today, so they buy ahead to safeguard future profit margins. Critically, this fear is fed by two toxic streams, not inflation alone. The trucking shortage, which some subscribers report is partly fabricated to boost margins (imagine that!), has also extended lead times as is apparent in the graph above (Richmond is not alone; it’s just the most recent to report.)
The damage being exacted is widespread reflecting how we’ve come to expect our every need arriving at our front doors…care of a delivery truck. The added need for truckers to support e-commerce has exacerbated the predicament of businesses that have traditionally relied on trucking to keep their operations up and running.
Take air conditioners as an example in this year that scientists predict will be the fourth hottest on record. In an August 23rd report on the HVAC industry, J.P. Morgan equity analysts noted that trucking shortages left thousands of Carrier units stranded in the second quarter, the shipping for which was postponed until the third quarter, something they’ve heard echoed by other mid-tier players. Some have “built some inventory to assure product availability.” Sound familiar?
Price increases of up to 6% are being rolled out as a result. So strained are supplies, one price increase isn’t cutting it. This from the JPM report: “Carrier recently took the highly unusual step of announcing a second midyear price increase, this one for September, reflecting increases in commodities and transportation costs, and this was followed by another one from Rheem beginning with units shipped in October.” Other industry players are considering following suit. (Now might be a good time to make sure your HVAC unit is in good working order.)
As an aside, any sticklers for details may note that inventories are not exactly rising; in fact, they’re going the opposite way, known as “down.” You could take our word for it that the trend is set to reverse, or better yet, consider higher frequency data than what we’ve graphed to smooth the series to not induce a headache as this last leg of the trading year kicks off.
In July, wholesale inventories rose by 0.7%, blowing past the 0.2% economists had penciled in. They’re up a strong 5.2% this year. Retail inventories both inclusive and net of autos also surprised to the upside. The payback from the second-quarter inventory drag is expected to be significant.
As flattering as inventories will be to third quarter GDP, it’s never a good thing when firms build artificial supply because they fear the consequences otherwise. Needing something but not wanting it will send the artificial supply right over a cliff and economists’ growth forecasts with it. The landing may leave unassuming investors awestruck, but not in a good way.