Supply Chain Risk: A Unique Global Investment Thesis

vale_t/iStock Editorial via Getty Images Supply chain disruptions are heavily cited in the media and in firms’ conference rooms. The pandemic has laid bare the challenges. The semiconductor industry, owing to the COVID-19 pandemic, is often a standout of the challenge. The Inflation Reduction Act is loaded with funding for relevant industries as well. But I’m looking at supply chain investment cases. They are extensive. The macro environment is chock full of opportunities, but you have to know where to look and what to look for. While many focus on inflation’s impact, a different type of macro theme exists. To precede some of this analysis, commentary about the new legislation follows: About the Act, General Motors ( GM ) CEO Mary Bara (who I heard give the Duke University graduation keynote in May) says: “This bill will help drive further investments in American manufacturing and sustainable, scalable, and secure supply chains.” Bill Gates credits the policy with developing “a new era of American innovation.” Maybe. We’re already there. Much more on that later. Signals Most importantly, the legislation is a signal. The market has to sort out the business and financial case for long-term winners. This leads back to supply chains… Supply chain research has often centered on shock transmission, and how events like the earthquake in Japan or Thai floods in 2011 affect firms’ supply chains. However, missing from the equation are insights into how firms are affected by supply chain risk—quantified at the firm level—and how they respond. The research by an SMU Cox Finance Professor Ruidi Huang and coauthors reveals novel insights into the nature of supply chain risk. Huang and his co-authors analyze instances of supply chain mentions in earnings calls of publicly-traded firms’ transcripts, which speaks to “sentiment.” Secondly, they analyze risk and uncertainty associated with those supply chain mentions. A firm level measure reveals a lot of where the action is. For example, Apple ( AAPL ) has an extensive supply chain network globally. Huang notes: Apple has much more volatile supply chain issues compared to Microsoft ( MSFT ), with spikes in 2009 and 2018. Huang believes they correspond to issues in China in 2008 and issues with mineral mining in both years. When firms have lengthy discussions about supply chain, our measure tends to pick those up. Further, he adds, “But Microsoft is not without supply chain issues. The graph looks flat (one he references I asked for). But that’s because Apple’s supply chain risk is much more volatile and changes the scale for the whole picture. Microsoft’s supply chain risk is almost three times as high in 2020 than in 2018.” According to the analysis, supply chain risk appears to be heightened and sentiment becomes more negative in connection to events that are disruptive to global supply chains, such as the 2011 Great East Japan earthquake and the Thailand floods, the Sino-American trade war, and more recently with the COVID-19 outbreak. Supply chain risk (Ruidi Huang and coauthors) “Supply chain risk is not one sided,” the authors note. There are firms and periods with positive supply chain sentiment, with opportunities for outsourcing to reduce costs, and also of negative sentiment when concerns about bottlenecks and the reliability of the supply chain emerge. According to the research, manufacturing industries are the most sensitive to supply chain risk. So are others. In particular, the pandemic revealed a “flight to quality.” When faced with supply chain risk, the research finds that firms seek out leaders in their industry. The trend toward reshoring is a byproduct of supply chain risk. Semiconductors follow that line of thinking and are represented by iShares Semiconductor ( SOXX ), VanEck Semiconductor ( SMH ), and Invesco PHLX Semiconductor ( SOXQ ). The larger story however is the drive toward supply chain resiliency. That is driving capital in macro and micro ways. N.M. Arroyo (Jennifer Warren) Thesis building Now, how do you operationalize a supply chain thesis? There are many ways to skin this cat. Certain sectors are more relevant than others: High-tech, manufacturing, minerals, and machinery. We can drill into this by sector, for example, in “green” minerals, VanEck Green Metals ( GMET ) is a candidate. Or an individual firm such as MP Materials ( MP ) for rare earths fits a number of supply chain themes. SPDR S&P Metals and Mining ETF ( XME ) is relevant in a more macro thesis manner. (See my YouTube interview with Huang for more detail.) Jennifer Warren interviews Huang […]

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