December 2021 Market Update

2021 started with optimism and hope that we were finally turning a corner after COVID changed the world in 2020. This year has thrown more curve-balls into supply chains than anyone could have anticipated, and it is clear that the path to full recovery will be winding and complicated. With a focus on immediate emergencies, it can be difficult to find the time to keep up with recent developments. We have compiled the top concerns that our customers and partners are discussing, with added research to keep you up to date on the latest trends impacting supply chains.

Ocean freight is still a massive bottleneck, with waiting container ships just idling farther off US coasts.

Congestion at the largest US port of LA/Long Beach has increased even as aging containers waiting to be picked up by importers has decreased with the threat of daily storage fines. In past months the ports had noted aging containers that were offloaded but not picked up as a significant cause of delays, and the threat of fines has now pushed importers to pick up their containers. Even so, there are currently 96 ships waiting of LA/LB with 31 at berth in the port. Much of the recent news commentary has been around finally turning a corner at ports as congestion eases, but the facts are that the backlog of waiting ships has not decreased and port congestion in the US causes downstream effects for future sailings, making the issue slow to solve. Gene Seroka, Director of LA/Long Beach recently stated that, “Since we instituted a penalty for long-aging containers, the number of ships at anchor has decreased by more than 40% over a four-week period.” In our research, this analysis is misleading.

The reason port directors and politicians can say that congestion is easing is due to how “vessels at anchor” is typically calculated. The traditional calculation looks at any ships idling or anchored within 40 miles of a port to determine which are waiting to dock. US ports have a Safety and Air Quality Area (SAQA) 150 miles West and 50 miles North/South of the ports, and ships are now encouraged to wait for berths outside of this SAQA. This is coupled with a new system of allowing ships to reserve space at ports based on a “calculated time of arrival” rather than the previous system of first-come first-served. The effect is that many waiting cargo ships are in queues far off US shores based on their calculated time of arrival, but are still in line for a spot at the port. Rather than wait directly offshore to save their spot in line, ships can reserve space based on their CTA and wait further offshore. In our personal experience as an importer, the last month has brought more delays in-transit to the ports of NJ/NY by about 5-10 days, with premium market-rates for containers decreasing ~10-20% since this time last month.

In our assessment, the new policies do more to score political points than reduce congestion or increase throughput at ports, though they could prevent accidents at sea by spacing ships further apart.

Note the extreme right-hand side of the graph, the recent policies that just started in November reduced ships waiting within 40 miles of the port, but total ships waiting to dock has increased.

A new COVID Variant of Concern is troubling financial markets and offers the possibility of continued supply chain woes, depending on how countries respond.

For those of us who are tired of hearing the word “COVID”, the news about the Omicron Variant in late November was disappointing. The Omicron Variant of COVID has world leaders and scientists concerned for the global recovery, although there is still much to learn about the new variant. We do know that Omicron has the highest number of mutations that we have seen, and many of these mutations occur on the spike protein
 that lets the virus infect humans. In our November Update we noted that supply chains already stretched to their limit are susceptible to further disruption, and that this disruption could have outsized impacts. The response to this new variant could be such a disruption.

The graph above shows the high number of mutations on the spike protein compared to other variants

Why the concern about Omicron?

While Omicron is the 5th Variant of Concern since 2019, it has the most mutations of any variant so far and over 30 of these mutations affect the spoke protein that allows the virus to bind with human cells. Some of these mutations have effects which are understood to increase transmissibility and may reduce immune response; others have not been seen before, and the concern is that these new mutations could make vaccines less effective. First reported out of South Africa, Omicron likely originated in Europe and has so far been reported in at least 38 countries worldwide. Reports from South Africa show the Omicron Variant spreading twice as fast as Delta had, which could be devastating for health systems in countries with low vaccination rates. The good news is that so far Omicron appears to cause mild symptoms and vaccines are expected to reduce hospitalization in infected patients.

What is the risk for Supply Chains?

The risks for supply chains now mainly depend on countries` responses to this new variant, especially China. While other countries like Australia and New Zealand stepped back from their Zero-COVID policies, China still follows this strategy which in the past has caused entire cities to shut after just one positive case. Other countries are limiting cross-border travel and may impose lockdowns if infection rates rise. Another possibility is that another spike in cases could reduce consumer expenditure on dining, entertainment and travel and keep levels of consumer spending on physical goods elevated. This would make it more difficult to reduce bottlenecks and inflation.

Until we have more information on the effects of the new Omicron variant, the best course of action is not to panic but to follow new developments closely.

Power shortages in China are easing as the government has adjusted its policies on emission reductions.

Electricity shortages in China have eased a bit since the crisis peaked in September as the government allowed more mining of coal to supply powerplants. There is still electricity rationing in place, but the disruptive effect on supply chains has been diminishing.

What caused the energy crisis? Chinese emission targets for a green energy transition have reduced the production of coal in China, which forced prices higher. The government strictly controls electricity prices in China to keep them artificially low, and this means that coal burning power plants had two choices – continue production and operate at a loss or reduce output of electricity. At a time when global demand is rising for durable goods which China produces, this has caused a mismatch of incentives. In the past month the government has increased coal production and relaxed its emissions requirements after their previous policies caused widespread outages in September and October.

Labor shortages across the US are adding to higher prices and delays, with ports, truckers and warehouses struggling to attract and retain workers.

Labor shortages are still causing delays and raising costs with companies struggling to attract dock workers and truck drivers – the American Trucking Association estimates 80,000 more drivers are needed to meet demand. The US labor force is almost 5 million workers smaller than it was pre-pandemic, and the rate that workers are returning to the workforce is slowing in recent months. Many of the lost workers are from the leisure and hospitality industries, and while warehousing and transportation gained 50,000 jobs last month (~23% of the total) there is much more demand for workers. In addition to adding to the delays, the rise in wages offered to attract new workers is helping to push costs (and inflation) higher.

With the increased demand for their services, many US workers have been pushing for better working conditions and pay. In July of 2022 the negotiations between ports and the International Longshore and Warehouse Union will begin, and with additional bargaining power many are expecting the negotiations to be tense. The last time an agreement was reached in 2015, labor disruptions impacted port operations for months with productivity slowed by about 50%. The President of the ILWU recommended on a podcast that dockworkers save money heading into next year`s talks, stating, “There may be a battle in 2022… Be prepared.” Hopefully port congestion eases by July, but we will be keeping an eye on the news leading up to the negotiations.

The graph above shows the slowing growth of the labor force since August 2021

The Federal Reserve noted that inflation is lasting longer than they had expected, and will take action to fight inflation.

Since early 2021 the Federal Reserve, who is responsible for keeping unemployment and inflation low, has held the stance that inflation was “transitory” as the economy reopened from a once in a century pandemic. After 10 months of higher inflation with no end in sight, questions have been raised on how long “transitory” inflation may last. Last week the FED Chairman Jerome Powell testified to congress that, “the risks of higher inflation have moved up.” It is expected that the federal reserve will reduce bond-buying programs that were intended to boost the economy and raise interest rates sooner than previously expected to shift focus to fighting inflation.

All the issues in this update (high freight costs, Omicron, rising input costs for factories, labor shortages) lead to increased costs for businesses, some of which are passed on to consumers. With additional government spending on the horizon and a push toward a green energy transition, demand for industrial products and durable goods is likely to remain high in the coming years, leaving little time for supply chains to catch up.

Actual inflation now is almost 3 times as high as before the pandemic, and is expected to remain elevated for some time. August 2021 is the last month the Federal Reserve has released CPI data for.

Regarding fasteners, even extremely common items are still stocked out domestically. Companies needing immediate inventory replenishment may need to use substitute items.

Since April/May 2021 domestic stock levels of fasteners have been falling dramatically. Companies that realized they were low on fastener inventory began scrambling to buy any material they can find, leaving many top factories out of stock for months. Whereas there are normally many suppliers with available material many are now completely stocked out. Some common parts are out of stock across the country, forcing companies to use substitute items. The market has shifted to favor those who are able to plan and forecast. The situation is so tight that we regularly have calls now from our competitors looking for parts. Domestic manufacturers still have lead times extending 12-20 Weeks.

The most important takeaway is that companies that wait until the last minute to acquire parts are paying much more for immediately available material and will likely need to use substitute items. Planning your usage ahead of time is absolutely necessary with domestic stock levels so low.

We are entering 2022 with several challenges to supply chains, but the outlook is brighter.

Speaking with our customers and partners, the most common question is when things will return to normal. 2021 was more volatile than many had expected – As we entered the second year of a global pandemic new challenges arose that were not foreseen in 2020. (Think of port bottlenecks and inflation risks) Even with the various and serious issues we discussed throughout this update, the governments and businesses have learned how to operate through a pandemic and supply chains have become more resilient than they were pre-pandemic. We still urge all customers to review their inventory and demand visibility in their supply chains – the earlier a potential issue is discovered, the more options you will have to react and find a solution.

The port backlogs are likely going to ease over the coming months, and without additional huge shocks we are probably seeing the worst delays and highest prices now. Omicron does pose a risk, especially if the variant overwhelms health systems and causes lockdowns again. The path for COVID to become endemic will be rough, and we are likely to see additional variants and mutations in the coming years before it is as common as influenza. Even so, governments have learned to balance the need to protect lives and the need to maintain livelihoods much better than in early 2020. Inflation and labor shortages could both slow the recovery but are unlikely to get to crisis levels.

In summary, our view is that we are currently experiencing the worst of the COVID-related supply chain disruptions. While the challenges will continue well into 2022, the next focus will be how quickly the market can shift to a post-pandemic “new normal” and what this new normal will look like.

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