Why We Warned About Supply Chain Issues Before the Headlines Did

Posted by Vident Financial on 1/11/22 1:53 PM

Supply chain disruption issues are very much in the news and in the public mind at the moment. One reasonably-good proxy for public attention is a Google Analytics feature that allows the user to track the relative frequency of various search terms over a certain time period. Here are the analytics for "supply chain”:

“Supply Chain” Google Search Trends

(Source: Google, December 2016 – December 2021)

Interest in the topic really spiked in September and October of this year. At the beginning of this year, interest in the topic was about average compared to the prior four years, and lower than at the worst of the pandemic shutdowns. This illustrates well how narratives about financial and economic topics tend to crest after the evidence for the topic can be seen in the data itself.

For example, as early as the fourth quarter of this year, there was a divergence between the growth rate of the overall economy (gold) and the supply chain (green):

Gross Output vs Gross Output minus GDP

Real Private Gross Output minus Real Private GDP Change
Gross Output Change

(Source: FRED, Q1 2005 – Q2 2021)

We described this in the first and second quarter reviews as "the supply chain struggling to keep up with demand." At the time, we identified it as both a supply chain issue and also a driver of inflation, in that a greater demand for goods without a greater supply of goods logically implies inflationary pressure. When we want to buy more stuff and the economy isn't producing enough stuff to keep up with our desires, the prices of goods and service gets bid upwards. But we’ve already written about our inflation outlook (spoiler: it’s another case where we think public perception might be exaggerating the reality).

If we take the data from the green line above, which is our estimate of supply chain activity, put it in bar chart form, and then align it chronologically with the monthly survey of purchasing managers, we see that those managers of supply chains registered concerns and also recovery roughly in sync with what it turned out was actually happening.

Change in Business Output vs PMI

(Source: FRED, January 2019 – November 2021)

One has to keep in mind that the data at the top half of the chart is based on data that has long delays between the time it describes and the time it is reported. In other words, information about what happened in the third quarter of this year was not available as of the time of this writing in mid-December. But on the other hand, the data represented by the lower half of the chart is available within two weeks from the end of the period covered. The data used to measure actual supply chain activity is both lower frequency (quarterly) and lagged, whereas the data regarding purchasing managers' optimism is higher frequency (monthly) and close to real time.

The purchasing managers index is kind of a 'mood ring' ("What This Supply Chain 'Mood Ring' Tells Us About the Recovery," Vident Financial blog, 2-19-21) for the supply chain and it was signaling problems well in advance of the newspaper headlines. It registered declines late in 2019, it registered recovery in the summer of 2020, it started to register concerns again last spring, and it bottomed out in June. Since then, it has shown signs of healing.

We are on the record when it comes to the reality of supply chain issues as early as our second quarter review (summarized in the article "Profits Got Unfrozen," Vident Financial blog, 8-17-21) when public attention had not yet been directed towards the issue. But given the past pattern in which public attention lagged behind the data reality, and given the latest data from the purchasing managers, it is reasonably likely that the current fear spike is late and overstates the magnitude of the problem. The Christmas buying season also likely made people hyper-aware of delays in delivery, causing the press to overstate the supply chain problem. Of course, if new strains of COVID trigger broad-based production disruptions, all bets are off.

Next, we'll consider inventory dynamics to get a better look inside the supply chain issues and get a clearer understanding of how supply chain disruptions can be real yet also to some degree exaggerated.

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