We are now over two years into the pandemic and the world is still battling supply chain disruptions that are being amplified by the war in Ukraine and COVID-related lockdowns in China. Investment Director Catherine Yeung and Head of Asian Fixed Income & Hong Kong Investments Marty Dropkin gathered with Fidelity analysts and portfolio managers to assess the supply backdrop in some of the hardest-hit sectors. The contributors included Fixed Income Portfolio Manager Belinda Liao, Equity Analyst & Portfolio Manager Terence Tsai, Equity Analyst Charvi Pandey, and Equity Analyst & Portfolio Manager Ben Li.
From a broad macroeconomic viewpoint, the conversation touched on the transmission effects of supply disruptions on inflation. Liao contemplated the multiple elements that play a part in the production of everyday goods, such as commodities, energy and transportation. If there are interruptions at any stage, then specific prices will rise. Crucially, there are also the knock-on effects associated with human capital, where we’ve seen, for example, lower productivity due to a shortage of inventory. “We also have strong demand inflation on the back of unprecedented stimulus,” says Liao. Indeed, monetary policy tightening can partially resolve this side of the equation. “But a true solution to the inflation issue is to fix supply chain issues,” she adds.
All of this begs the question: why is inflation more significant in the West than in China and Asia? Liao responded by noting that domestic demand is generally weaker in Asia, and disruption is less severe because of proximity to suppliers. She observed that Asia may also be more self-sufficient in some major commodities like oil and gas. While in China, the government has more control over prices, especially those connected to energy use.
Location-specific COVID disruption in China
The issues stemming from lockdowns in Shanghai were also raised. Li commented on how the magnitude of the impact varies depending on where a company is located and what it produces. For instance, the manufacture of non-essential goods could be halted, whereas facilities considered vital should still be operating at some level. And aside from production suspension, Ben points out that “logistics disruption is another area of concern because local governments have introduced various measures that limit the mobility of workers, such as truck drivers.”
That said, though, businesses can take steps to mitigate supply chain issues and some firms are diversifying with offshore plants in places like Cambodia and Vietnam. A positive side-effect of this shift could be improved infrastructure in these locations coupled with labour force development.
Global ports caught up in the storm
Another significant piece of the supply chain puzzle is, quite literally, ship-shaped, with difficulties at various seaports across the world. “There are three major areas to look at: the first is the US, the second is in the Mediterranean and Black Sea region and the third is China,” says Pandey. For the US, congestion is primarily driven by legacy infrastructure issues, COVID-related factors and labour shortages. Whereas in Europe, the events in Ukraine are hampering the smooth transit of goods. Meanwhile, in China, because of rising COVID cases and associated lockdowns, the relationship between land logistics and water logistics is fractured. As a result, cargo clearance is a lot less seamless than before.
Drilling down further, investors are also asking whether some of the shipping issues are transitory or structural. Pandey explained that various components are currently in play. From a transitory perspective, the pandemic and working from home boosted demand for goods and services. And the supply of freight vessels was unable to keep pace. Turning to structural factors, as mentioned earlier, many ports in the West are ageing and haven’t been upgraded or automated, unlike facilities in Asia. Also, ships have become larger, and, as we saw last year, when a huge container vessel blocked the Suez Canal, if infrastructure doesn't keep pace with equipment, then the system can break down.
Pandey believes that “it will probably take three-to-five years” for some container ports to catch up, with some facilities in the West facing unionised workforces that could resist automation to protect jobs. She also observed that these problems will become irrelevant if demand falls and congestion eases.
The global chip shortage remains in focus
Another weak link in the chain, and one that has been with us for a while, is the global chip shortage. This began before the pandemic when the appetite for tech was already growing. It was then exacerbated by a desire for goods rather than services during the COVID lockdowns. “It takes time for supply to catch up with demand, which can be very fickle. So that's why we’ve seen shortages,” explains Tsai. However, demand and supply are starting to converge, which should remove some heat.
Looking ahead, Tsai added that China wants to become more self-sufficient in terms of semiconductor supply chains. Yet, the biggest challenge here is building out an ecosystem, especially as the US government has placed sanctions on a lot of the equipment required. Also, it is hard to replicate human talent, with Taiwan’s success in the semiconductor space built on cumulative experience established over many years.
Developing themes
We previously touched on the lack of human capital being a bottleneck in supply chains. As such, many companies are investing heavily in automation, with Yeung mentioning the “staggering” work that’s taking place in markets like South Korea and Taiwan. We are also witnessing a growing emphasis on renewable energy, given that events in Eastern Europe have disrupted global energy supplies.
