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Investing

Are supply chain and inventory shortages a threat to GDP?

Despite growing concerns, current challenges are unlikely to require significant downward revisions to GDP expectations over the next few years.


 

Global disruptions, strong demand

Overall, these disruptions have been more acute than we expected, driven primarily by robust demand. Our supply chain gauge shows that pressures around delivery times, inventory sentiment and shipping costs have all increased year-to-date. It seems that consumers are experiencing a lack of inventory and expanded wait times for everything from cars to couches, to golf clubs, just to name a few.

 

Supply chain pressures have spiked across the board year-to-date

Source: J.P. Morgan Private Bank, Bloomberg Finance L.P., as of 8/20/2021

 

Given this restricted supply, some market commentators have suggested that growth expectations must come down based on the views that it is hard to generate output without inventory to sell, or that prices will increase so much that future demand will decline. While we see modest downside risk to our global GDP outlook (mostly on the back of COVID-19 worries and potential policy missteps), we don’t expect supply shortages alone to require significant downward revisions.
 

1. It is important to level set on the math surrounding GDP. From where we stand today, it’s not a high hurdle for 2021 U.S. GDP growth to come in above 6% (our base case). Consider that 2020 real GDP was $18.38 trillion for the full year, while real GDP for the first half of 2021 was already $19.36 trillion. The implication is that even in the unlikely case that GDP growth is flat for the rest of 2021, it would still increase around 5% for the year. Add in the sizable catchup growth that remains to be had in the service sector, where real spending is still 3.3% below end 2019 levels, and it seems unlikely that GDP will significantly stagnate for the second half of the year. Of course, the dominant risk to this view—and to service sector spending specifically—is the Delta variant. But so far, the variant does not appear to be having major impacts on mobility. It is also encouraging that vaccine adoption appears to be picking up again in recent weeks.

2. Despite mounting year-to-date supply chain pressures, inflation has not restricted growth. Plus, these fears seem overblown. In fact, the only area where inflation has held back growth is in the auto sector, where it has significantly outpaced real spending over the past six months. Real spending everywhere else this year has vastly trumped inflation. While auto production bottlenecks remain an issue, they are likely more micro than macro in nature and appear to be easing at the margin, with a promising rebound in July industrial production data.

 

No sign of demand destruction (ex motor vehicles)

Source: J.P. Morgan Private Bank, Bloomberg Finance L.P., as of 8/20/2021

 

3. Inventories are moving from a headwind to tailwind on GDP. In GDP accounting, inventory changes boost GDP when rising, and subtract from GDP when falling. Inventory depletions so far this year have subtracted nearly two percentage points off GDP. Here’s a simple way to look at it: Headline GDP in the first half of 2021 averaged 6.4%, but GDP excluding inventories averaged 8.4%. The best proxy for real underlying demand, which excludes inventories, trade and government spending (Real Final Sales to Private Domestic Purchasers), grew nearly 11%! 

 

Real GDP understates the strong domestic demand in the first half of 2021

Source: J.P. Morgan Private Bank, Bloomberg Finance L.P., as of 8/20/2021

 

Inventories are falling because sales have been incredibly robust, resulting in record low inventories-to-sales ratios. Even excluding the auto sector, sales have far outpaced inventories over the past 12 months. Companies simply have not been able to produce goods fast enough to maintain normal levels of inventories to sales. To make matters worse, the shift to just-in-time (JIT) inventories over the past 25 years meant companies were already running very lean, leaving them vulnerable to the worst supply shock this economy has seen in recent history.

 

Inventories haven’t kept up with robust sales

Source: J.P. Morgan Private Bank, Bloomberg Finance L.P., as of 8/20/2021

 

U.S. retail (ex motor vehicle) days inventory

Source: J.P. Morgan Private Bank, Bloomberg Finance L.P., as of 8/20/2021

 

Rebuilding inventories to levels more consistent with current sales volumes would boost GDP by about one percentage point over the next 12 to 18 months, and it is possible this replenishing might be even more robust than we are expecting. For example, companies could decide to hold even more inventory than they did in the decade leading up to COVID-19 as a buffer for future shocks. However, this may end up being more of a 2022 story, as building up inventories in the next few months may prove difficult, given that supply chain disruptions remain acute and seasonal demand for goods is strong, thanks to back-to-school and holiday shopping. Still, that just takes GDP growth from 2021 and moves it to 2022, rather than destroying output.

 

What does this mean for companies?

Looking ahead, companies are likely to focus on supply chain resiliency and boosting inventories and sourcing diversity. They may also begin to onshore production back to the United States to maintain greater supply chain control. That should be a growth tailwind as firms look to boost inventories above pre-COVID-19 levels and increase capital expenditures (capex) to meet current robust demand. While corporate spending last cycle was lackluster, it appears that both the manufacturing and innovation technology fronts may enjoy strong growth in the current cycle. We have written extensively about our view on productivity increasing this cycle, which is further supported by a capex acceleration.

Semiconductors are a great example of this low inventory and capex link. The pandemic highlighted chip supply chain structural vulnerabilities, and there has been a shift toward self-reliance in production in the name of national security. As a result, the United States is planning to invest billions of dollars to subsidize chipmakers moving production from Asia back to the United States.

 

Investment implications: Industrials

Previously, we have discussed our view that industrials should benefit from a robust economic recovery that remains firmly intact and supported by pent-up savings/demand, capacity to borrow, and a high likelihood of additional fiscal spending focused on infrastructure in the United States and abroad. The need to rebuild inventories only furthers this case, given that restocking tends to favor the industrial side of the equity market as demand picks up across the supply chain. In fact, our research shows that after periods of declining real private inventories (from the GDP accounts), industrials have tended to outperform the S&P 500.

 

Industrials tend to outperform after inventories bottom

Source: J.P. Morgan Private Bank, Bloomberg Finance L.P., as of 8/20/2021

 

We can help

Please speak with your J.P. Morgan team about how our economic views and the impending rebuild of U.S. corporate inventories might inform your financial goals.

 

IMPORTANT INFORMATION

All market and economic data as of August 2021 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

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