Splitsville

Splitsville.  Stocks had a mixed close yesterday as racy tech stocks and conservative value stocks went their separate ways due to irreconcilable differences. Manufacturing PMIs missed their targets, but investors found a silver lining in the numbers.

N O T E W O R T H Y

Please hold.  It has been out there, traders are discussing it, economists have been waxing philosophical about it, and it has finally come home to roost.  I am, of course, referring to supply shortages.  Last year, 2020, was an interesting one indeed.  Aside from the obvious stuff which has been covered here in this note and just about everywhere else in the media, some very interesting anomalies appeared last year. Before I get into those, let’s cover something obvious in order to set the stage.  Crude oil is a necessary basic commodity in a whole host of products, most notable diesel, gasoline, and jet fuel.  Last year when the pandemic struck, the entire world went into one type of lockdown or another.  The common theme was less air travel, less ocean-based travel, and less automotive traffic. As one might guess, that meant less demand for jet fuel, diesel fuel, and gasoline.  Though the energy industry is more efficient than it is often given credit for, it still takes time for drillers, distributers, distillers, and shippers to slow down the production process when demand slows.  The steep drop in demand for distillates caused a large buildup of excess supply.  You may recall last year when the industry virtually ran out of storage due to excess supply. The result was crude oil future prices going negative last April. All of this was due to basic supply and demand economics. Decreased demand and increased supply meant sinking prices.  I started with energy because it was all over the news last year and it is a clear example of basic micro economics.  There were some interesting contrasts that might have escaped mainstream media coverage last year, but you will surely not be surprised.  Last year as demand for oil dropped drastically there was a notable uptick in home buying.  I won’t get into what might have caused it, but suffice it to say that historically low mortgage rates were certainly a factor.  High demand for existing and new homes spurred a homebuilding boom.  Lots of different raw materials go into building a home with the most obvious being lumber.  Last year’s boom caused prices of lumber to skyrocket to all-time highs.  When I say “skyrocket” I mean something on the order of +288% from January 2020 to present.  If we look back to the onset of the last recession which resulted in a housing bust, lumber prices have climbed by +571% to date.  The increased cost of lumber has caused new home prices to rise and outright supply shortages have left many already purchased homes unbuilt.  The supply shortage is not only caused by increased demand but also due to an industry caught on its heels. Suppliers have been slow to grow in the post Great Recession years as the housing market was essentially moving sideways.  The rapid rise in demand that took place last year was simply unexpected.  The industry does not even have the capacity to ramp up production quickly as it takes time to not only collect the raw materials, you know, chop down trees, but also to mill the trees into usable product like studs, plywood, and moldings. Turning our sights to a more familiar industry we are seeing a similar problem.  Semiconductors are in virtually everything we use these days.  Sure, they are in our computers and smartphones, but they are also in electric toothbrushes, coffee machines, television sets, exercise equipment, wash machines, and cars.  You see where this is going? Once again, I will start with the obvious.  During last year’s lockdowns, demand for televisions, home office computers, game consoles, and yes, exercise equipment sky rocketed.  Producers rushed to fill the orders causing an increase in demand for the integrated circuits, or semiconductors, that made those smart products run. A little less obvious was a significant increase in automobile demand following a steep drop in the first quarter.  There a few interesting facts to note here. Since the drop that occurred during the last recession, total vehicle sales climbed by +104% to a peak in 2017 and then went sideways leading up to 2020. From January through May of last year, sales plummeted by -48% only to rebound by +115% as reported just yesterday.  As demand started to grow, manufacturers stepped up production only to realize that there were not enough semiconductors to complete production.  That has resulted in the manufacturing shutdowns that we have been reading about in recent months.  In the case of autos, increased demand for product drove production which was compounded by the fact that new cars have far more semiconductors than models produced just a few years back. More and more demand… for chips!  Similar to lumber, the semiconductor industry also had a manufacturing deficiency.   Many semiconductor companies have been cutting back on facilities investments in the past few years, relying more heavily on off-shore fabrication facilities. Manufacturers did not expect increase for products to ramp up so quickly.  They, like the lumber mills, were caught off guard. Adding capacity for a semiconductor supplier takes quite a bit more investment and time than a lumber mill, so despite their best efforts, meaningful changes are not going to come anytime soon.  What does this mean to us at a higher level. Yesterday’s manufacturing PMI showed slight monthly decreases resulting from supply chain slowdowns.  Taking it a step further, the ISM Prices Paid index, which is a component of its manufacturing PMI (prices paid for raw materials), showed a greater than expected monthly growth.  Increased demand and decreased supply means… you guessed it, higher prices.  For now those increases are being levied on the manufacturers, but it is just a matter of time before we see those increases on the store shelves and the show room floors. 

THE MARKETS

Stocks had a mixed close yesterday as weak economic numbers reflected that consumer demand is strong despite gummed up manufacturing supply chains.  The S&P500 rose by +0.27%, the Dow Jones Industrial Average added +0.70%, the Russell 2000 Index climbed by +0.49%, and the Nasdaq Composite Index slipped by -0.48%.  Bonds gained and 10-year treasury yields slipped by -3 basis points to 1.59%.

NXT UP

– Factory Orders (March) are expected to have climbed by +1.3% in contrast to February’s -0.80% drop.

– Durable Goods Orders (March) may reflect a +0.5% growth, in line with prior estimates.

– Fed speakers today include Daly and Kaplan.

– This morning, Louisiana Pacific, Bunge, DuPont, Zimmer Biomet, CVS, IDEXX Labs, Eaton, Sage Therapeutics, Marathon Petroleum, Martin Marietta Materials, Under Armour, Cummins, Virtu Financial, Apollo Global Management, ConocoPhilips, KKR, and Vulcan Materials beat, with the standout loser being Catalent.  After the bell, we will get numbers from Skillz, Lattice Semiconductor, Activision Blizzard, Devon Energy, Prudential, Host Hotels, Coursera, Zillow Group, RingCentral, PerkinElmer, Lyft, Match Group, and McAfee.