No Shortage of Souring Sentiment

Hear the one about supply chain bottlenecks knocking global growth, threatening the economic recovery from lockdowns? The IMF did—and ratcheted down its projection for developed-world growth this year from 5.6% to 5.2%. So did the people surveyed by Germany’s ZEW Institute, whose measure of German investor confidence slipped to its lowest level since COVID panic set in last year. And the US small business owners surveyed by the National Federation of Independent Business, whose sentiment measure fell again in September. And US CEOs surveyed by The Conference Board—their confidence level slipped almost -20% in Q3 on, you guessed it, supply issues. This all comes on the heels of The Conference Board’s broad US consumer confidence measure sinking to a seven-month low in August. Many pundits are treating these increasingly dour sentiment readings as portending to weak economic activity ahead in a self-fulfilling economic prophecy. We think that is a stretch. To us, these surveys and projections show the state of sentiment—and what markets have priced in—likely extending this bull market’s wall of worry in the process.

We do think it is fair to say everyone citing supply shortages as an economic headwind is on to something. While strong demand and overflowing order books are great, at the end of the day, output and spending are what show up in economic statistics. If businesses can’t get the supplies they need, they can’t make their widgets, and output drops. If they can’t get finished widgets to customers in a timely fashion, then sales likely drop. Both can weigh on industrial production, retail sales, GDP and other hard data.

Thing is, stocks don’t have a one-to-one relationship with any economic statistic. They don’t need growth to be fast or even particularly good. Just ok and not so bad are quite fine outcomes if expectations are low enough. This is because stocks move not on absolute reality, but the gap between reality and expectations. The lower expectations become, the easier it is for reality to beat them, even if reality is not so wonderful.

All these sentiment surveys, along with the IMF’s revised forecast, tell us the prevailing expectation globally is for supply chain problems to take a bite out of growth, slowing the recovery. In our view, it is quite fair to presume markets have priced in this viewpoint, as they deal efficiently with all widely known information. That includes opinions, fears and forecasts (which, frankly, are also opinions). What will drive stock prices over the foreseeable future, then, is how economic reality squares with expectations. If things go exactly as people fear, it likely won’t be a huge deal to stocks, as they will have already priced in that reality. If things go even a smidge better, that should generate a positive surprise.

Don’t discount the chances of that happening. Sentiment surveys aren’t predictive—they tell you how people feel today, which is generally a product of what they hear and read. People who hear endlessly that supply chain snarls are tying up the global economy will naturally tell surveyors they expect bottlenecks to be a big economic risk. Surveys both reflect and amplify headline sentiment, creating a negative feedback loop. Meanwhile, what gets less attention are the anecdotes about companies chartering their own ships, finding ways to transport goods across the sea without traditional containers, and cutting nonessential costs to preserve profits without raising prices. Incremental workarounds are often the seeds for incremental positive surprise.

Another key consideration that gets lost in most of the supply chain coverage: It doesn’t affect all industries equally. Software and digital services, for instance, are relatively insulated. So are growth stocks in general, which have much fatter gross profit margins than the market as a whole. Not only can they self-finance workarounds (as well as future growth), but they can also stomach cost pressures more easily than value companies operating on a shoestring. In our view, far from being a market-wide negative, supply chain issues are likely a big reason for growth stocks’ big outperformance since May.

If things go far worse than everyone anticipates, then it could prove problematic for stocks. We don’t dismiss that possibility, either. But markets move on probabilities, not possibilities, and shortages of components and raw materials have already prompted suppliers to ramp up, which suggests this issue should resolve sooner rather than later. That could change, but in our view, the most probable scenario is that supply shortages create winners and losers, not a bear market.