Little Lumber and Costly Chips: Inside The ‘Stuff’ Economy’s Pinch

Timber! Well, lumber to be precise. That is what businesses are in short supply of, along with semiconductors, copper and steel. With supply down and prices up, pundits globally are increasingly worried that the recovery from lockdowns is at risk. Demand may be hopping, but they warn that is no help if factories and builders can’t make enough gadgets and structures to meet it. We agree there are some challenges ahead, but a little perspective is in order. While this may present some headwinds to select areas of the economy, it seems overstated as a macroeconomic headwind. It is also well-known to stocks, sapping surprise power.

Yes, it is true that if businesses can’t make things, people can’t buy them. Since the US calculates GDP by adding up all transactions in the public and private sector, when people can’t buy stuff, it detracts from growth.^[i] That is well-known math. But the keyword there is stuff. The US economy actually isn’t heavy on stuff—services accounts for the lion’s share of economic activity. In 2019, the last full year before lockdowns skewed the picture, sales of (or investment in) physical objects totaled 33.6% of GDP.^[ii] That includes consumer spending on goods, residential real estate investment, commercial real estate investment and business investment in equipment—all things that, to varying degrees, might incorporate lumber, steel, copper or computer chips. Even last year, when goods consumption rose as GDP fell, the “stuff economy” was only 34.9% of GDP.^[iii] So right off the bat, just one-third of GDP, give or take, is directly vulnerable to shortages.

Then too, “shortage” is not synonymous with “none.” Semiconductor foundries are still running flat-out, especially now that the Renesas plant shut down by a fire last month in Japan is back online. It should be at full capacity in July, according to the company’s estimates. Blast furnaces, copper mines and saw mills are also chugging away. Now, current capacity isn’t enough to satisfy demand, but that doesn’t mean production of physical goods and structures grinds to a halt. Instead, it means producers compete for a limited supply. Purchasing managers will have their work cut out for them as they navigate price increases and negotiate with vendors—vendors who are trying to juggle an entire roster of demanding clients. That means, for the time being, there will be winners and losers at the industry and company levels.

While the cause of these winners and losers is new, it isn’t at all unusual for some segments of the economy to zig while others zag. Manufacturing output fell in 2016, but GDP grew. Oil production fell -49.8% (in value terms, not volume) in 2015 and 2016 combined, but—yes—GDP grew. Pockets of strength more than offset pockets of weakness. That is how it usually works in a strong economy. We also think it is likely to work that way this time around, given services’ size and relative insulation from these supply issues.

As for markets, we think stocks generally look about 3 – 30 months ahead. Supply issues will plague some industries at the closer end of that window, but that isn’t new news. The semiconductor shortage has dotted headlines for months now. Lumber and metals shortages (and accompanying price spikes) are a bit newer, but markets deal with developments like this very efficiently. They also know how this story generally goes: Shortages drive prices up, high prices incentivize new production, and supply eventually rises to meet demand. This doesn’t happen overnight, but markets are good at anticipating the process. In the semiconductor world it has already started, with key manufacturers in the US and Taiwan announcing plans to build new foundries—which should be online in two years or so. New sawmills take about that long to come online, too.

Mines take significantly longer, about 5 – 7 years, but we already have compelling evidence that prolonged copper shortages don’t prevent growth. The last big shortage occurred in the early 2000s, when China started a long infrastructure frenzy. GDP soared there and globally, and the Metals & Mining boom propelled Australia, Brazil and others for years. We aren’t arguing another such supercycle is in store now, as that is too long-term of a forecast. But it does again show that one business’s problem is another company’s opportunity, and the net result can be positive.

Keep in mind, also, that low production isn’t the only reason supply is down. The US imports most of these materials and components—some from Canada, some from South America, some from overseas. A lot of Canadian lumber comes on trucks, and truck drivers are in short supply. Lumber, metals and chips coming from Australia and East Asia come on container ships, which face huge traffic jams at US ports right now due to the combination of high volume and short staffing, which stems from social distancing requirements. Those factors should ease relatively quickly, helping supply move faster and probably easing the shortage somewhat.

In our view, the main lessons here are threefold. One, think like markets and look forward—look to the full range of that 3 – 30 window and consider carefully whether things are likely to be materially worse than everyone expects. Two, remember: Markets are efficient discounters of widely known information. This story dots headlines everywhere globally, suggesting its power to sway stocks is falling as we type. Three, diversify across sectors and geographic regions so that you benefit from the winners in this saga, like large Materials and Tech firms. Leave the fretting over the near-term losers to the headlines.