Earlier today, Morgan Stanley showed that more than inflation, more than concerns about the historic labor crisis, definitely more than covid, one thing has preoccupied the minds of most management teams this quarter: "supply chain issues", a topic which has seen an explosion of mentions on Q3 earnings calls.
But while by now everyone is aware that the global supply-chain shock is truly historic and getting worse by the day, with used car prices rising sharply again and over 30 million tons of cargo waiting outside US ports ahead of the holiday season, few have considered what realistically could normalize these frayed supply chains.
To address this topic, in a research report published overnight, Goldman's economists assessed the three key drivers of supply chain normalization and their most likely timing:
- improved chip supply driven by post-Delta factory restarts (4Q21) and eventually by expanded production capacity (2H22 and 2023);
- improved US labor supply (4Q21 and 1H22); and
- the wind-down of US port congestion (2H22).
And speaking of used car prices, in the first 15 days of October, the Manheim used vehicle index surged 8.3% due to yet another global supply shock: this time due to Delta-variant factory shutdowns in Southeast Asia and elsewhere.
Here, in a rare mea culpa, the Goldman economists admit that while previously they had expected improved microchip availability by 1H22 on the back of normalizing Japanese automotive shipments (post-factory fire) and a US supply response, with these catalysts now behind us — the Naka factory in Japan resumed normal shipments activity in July and US semiconductor plant hours jumped to 73 hours per week in the first half of the year vs. 46 in 2019 — Goldman now expects a "more extended timeline."
So with that demonstration of how thoroughly unpredictable the non-linear cascading consequences of such s diffuse, global phenomenon as international production pathways and supply chains are, Goldman proceeds to assess the three key drivers of supply chain normalization listed above, their likely timing, and the key indicators to track progress.
We start by reviewing one unique aspect of the global semiconductor industry that sets it apart from most other manufacturing and services industries of today’s economy: outside of Southeast Asian plant shutdowns, both output and capacity utilization have already returned to quite elevated levels.
So while the supply of dress shirts and haircuts is likely to rise sharply if demand returns, higher utilization of existing semiconductor capacity is not a viable path toward resolving the chip shortage.
Additionally, much needed moderation in US and global goods demand has alleviated (and will continue to alleviate) goods-sector imbalances. As shown in the left panel of the next chart, real retail spending has already normalized in major foreign economies. And while it picked back up domestically in August and September, US goods consumption has nonetheless declined by 5% since March.
That said, from the perspective of the key bottlenecks contributing to inflation, demand for consumer electronics, business tech, and other semiconductor-intensive products has remained elevated—both globally and in the US (right chart above). Furthermore, one should hardly expect the increased digitization of society and consumer preferences to reverse post-pandemic: Goldman's equity analysts forecast demand for semiconductor-intensive consumer goods to remain strong in 2022 (smartphones +4% after +12% in 2021, autos +5% after +6%, PCs -12% after +28% cumulatively in 2020 and 2021).
So returning to supply constraints, here is a summary of the three key resolution channels in turn (global chip production, US labor supply, reduced port congestion).
Channel 1, Step 1: Improved Chip Supply from East Asia Reboot
Goldman's expected timeline: 4Q21
Key indicators to watch:
- Effective Lockdown Indices (ELI) particularly in Malaysia, Vietnam, Mainland China, and Taiwan
- East Asian industrial production and exports of semiconductors, electrical components, and consumer electronics
- Automaker commentary on near-term chip availability
- China industrial policy, with respect to power cuts and the Delta variant
- Early- and mid-month trade reports (Japan, Taiwan, and Korea)
As shown in the next chart, three supply shocks weighed heavily on auto production this year, starting in February with severe winter storms and power outages in the southern United States and followed by a March fire at the Renesas automotive chip factory in Naka, Japan. While the plant was fully rebuilt in Q2 and auto production was set to return to near-normal levels in Q3, the arrival of the Delta variant and “zero covid” policies in some East Asian economies combined to produce another sharp drop in US semiconductor supply. The red line in the same exhibit shows the mid-year stepdown in automotive semiconductor units imported from key East Asian suppliers (data derived from granular Census trade records that include unit counts).
Looking ahead, there are several key drivers for optimism, starting with the vaccination-led drop in infection rates (chart below, left and center). As a result, lockdown severity is also now approaching pre-Delta levels in both Malaysia and Vietnam (right panel).
Going forward, it's important to track the semiconductor output and trade statistics of these key suppliers, as well as closely watch Chinese output and export data to monitor possible disruptions to chip or consumer goods supplies, for example related to power cuts or covid restrictions. For example, imports of integrated circuits from Vietnam and semiconductor devices and diodes from Malaysia declined 34% year-on-year in August, but Chinese production has so far remained firm.
These developments coupled with better near-term production commentary from General Motors and Toyota, would argue for some microchip relief in Q4, and Goldman estimates the removal of this supply bottleneck could return US auto production to or near the 10-11mn SAAR range achieved in late 2020 (vs. 7.8mn in September and 8.6mn in Q3).
Increases beyond that pace would likely require additional supply improvements, in part because today’s smart cars utilize more and more automotive systems with microchips and in part because of the continued mix shift towards SUVs and electric vehicles (EVs), both of which are relatively chip-intensive. The next chart plots the ratio of global automotive semiconductor shipments to global vehicle production (both on a unit basis.) The secular increase in chip intensity continued in 2021 and suggests demand for automotive semiconductors will continue to rise even with flattish unit vehicle demand.
Channel 1, Step 2: Improved Chip Supply from New Capacity
Goldman's expected timeline: 2H22, with a more normal environment in 2023
Key indicators to watch:
- Global semiconductor shipments, particularly automotive: Microcontroller Units
- (MCUs), power semiconductor, analog devices
- GS equity research forecasts for semiconductor capacity growth
- 2022 auto production forecasts (GS equity research, IHS)
- US industrial production of computers, communication equipment, and semiconductors
- Foreign production and US imports of auto and consumer electronics
A key step towards easing supply constraints and lowering core goods prices is the build out of global microchip production capacity. But despite the dramatic impact of the chip shortages on US economic output and consumer prices, automotive semiconductor capex only rose back above the 2019 pace in Q3
And with 2-3 quarter lags between equipment capex and chip production—and several-year lead times for new foundries—the rise in capex to above-normal levels in Q4 may not meaningfully boost chip supply until the second half of next year.
Reasons for the slow and restrained capex response include the long lead times and high fixed costs of new foundries and the likelihood that downstream industries will shift production away from the semis currently in short supply—many of which are older generation products to begin with. High industry concentration is another factor contributing to restrained capital deployment in the face of very strong near-term demand.
With Goldman analysts tracking capacity growth of just 5-10% per year in 2021-22 among the semiconductor industries that supply the auto and consumer electronics sectors, and with consumer demand for these products also likely growing at that horizon and given the rising semiconductor content of motor vehicles, Goldman expects chip supply to remain constrained through at least mid-2022. This reduces the scope for automakers to sustain above-normal production, and restock heavily depleted vehicle inventories. Accordingly, Goldman also expects auto dealer inventories to remain very low through mid-2022.
Channel 2: Improved US Labor Supply
Goldman's expected timeline: Q421 and 1H22
Key indicators to watch:
- Payrolls, particularly manufacturing and transportation
- JOLTS, particularly manufacturing and transportation
- Industrial production of consumer goods, excluding autos and high tech
- Supplier deliveries components of ISMs and regional Fed surveys
- Labor force participation rate
Labor shortages are another important bottleneck, but labor supply constraints are expected to ease substantially in coming months for several reasons. First, the September expiration of unemployment insurance benefits will boost Q4 job growth by around 1.0 million according to Goldman economists. Second, workers who have left their jobs because of child care concerns to return to work now that schools have reopened. Third, virus concerns will continue to fade as vaccinations increase further and infection rates fall—this would encourage some of the 2-3 million individuals staying away from the workplace because of health concerns to return to the job market.
Taken together, Goldman expects total employment to increase by about 4mn workers by end-2022, a 2.7% boost to non-farm payroll employment. As shown in Exhibit 11, labor demand in these industries is 5.1% and 0.9% above pre-pandemic levels in transportation and manufacturing, respectively. With job openings and wages at new highs for factory and transportation jobs, these labor shortages should ease gradually as the sectors draw workers from lower-paid services industries
Channel 3: Unwind of Port Congestion
Expected timeline: 1H22
Key indicators to watch:
- Transportation payrolls, particularly in the marine cargo handling, support activities for transportation, couriers and messengers, and warehousing and storage sectors
- Ships at anchor and inbound container traffic at US ports
- Shipments component of the Cass Freight Index
- US ex-auto manufacturing production
- US imports of cars and consumer goods
- Real retail inventories, excluding autos
Shipping delays and port congestion are also important bottlenecks for seaborne consumer products like furniture and sporting goods—semiconductors and high-value electronics generally arrive via airfreight.
Stranded cargo at the Port of Los Angeles has surged to record highs (left panel of Exhibit 12) due to elevated trade volume—container inflows into US ports are 25% above pre-pandemic levels (see right panel)—and ongoing shortages of transportation-sector labor.
We don’t expect significant near-term capacity growth in the goods shipping sector because bottlenecks currently constrain multiple modes of transportation. For example, if ports increased their capacity but the truck-driver shortage is not resolved, total shipping times could remain little changed. Moreover, to the extent transportation companies view shipping demand as temporarily elevated, they are unlikely to boost capacity meaningfully in the near-term.
We instead see two other drivers behind an expected easing in shipping and transportation constraints in the first half of 2022. First, demand is seasonally weaker in the fall and winter, bottoming out in February after the Chinese New Year when it is typically about 15-20% below August levels. If port throughput maintains the August not-seasonally-adjusted pace, the seasonal moderation in demand would help clear the backlog. Second, and as discussed in more detail here and in Exhibit 3, we expect US import volumes to normalize somewhat due to waning fiscal stimulus and a consumer rotation back toward services consumption.
Inflation and Fed Implications
As an aside, since any delays in supply chain normalization means higher prices, Goldman has once again boosted its sequential inflation assumptions for Q4 and early 2022 to reflect these continued upward price pressures, having done so already every month since April. The bank now forecasts year-on-year core PCE inflation of 4.3% at year-end, 3.0% in June 2022, and 2.15% in December 2022 (vs. 4.25%, 2.7% and 2.0% previously).
This slower resolution of supply constraints means that year-on-year inflation will be higher in the immediate aftermath of tapering than we had previously expected. While we expect inflation to be on a sharp downward trajectory at that point and to continue falling through the end of the year, this higher-for-longer path increases the risk of an earlier hike in 2022.