Supply Chains, Democracy, and Investing

From 'out of stock' to overstocked... The 'bullwhip effect' coming to a store near you... Continued COVID-19 confusion... Supply chains, democracy, and investing... Do investors care about democracy?... A big default in China... Lobbyists and authoritarian governments...

Get ready for some huge post-holiday sales...

In coming weeks, the global supply chain – the network of production and distribution that's the backbone of the world economy – is going to be under the microscope again... but not for the reasons we've gotten used to lately.

For months, weak links in the global supply chain have resulted in shortages of cereal, computers, couches, cars, and almost everything else. I (Kim Iskyan) have written about it here in the Digest, most extensively in September, when my furniture was stuck in the middle of the Atlantic.

As well as being a gigantic hassle, a disrupted supply chain is one of the main culprits behind escalating inflation, which happens when there's more demand than there is supply... whether it's a supply-and-demand imbalance of iPhone 13s, uranium, beef tenderloin, or anything else.

But at a certain point, the pendulum will swing back...

In fact, efforts to repair those weak links and unlock those bottlenecks – to unload 1,000-foot-long container ships in limbo at the Port of Los Angeles, to ramp up microchip production in Taiwan, to get people back to work making sneakers in Vietnam – are bearing fruit... sending the pendulum back in the other direction.

And as supply starts to match up with the continued high demand, we will begin to see something resembling normal...

Of course, we need to consider the pendulum's momentum taking things too far.

Because what happens next is called the 'bullwhip effect'...

That's when shortages turn into surpluses, when "out of stock" turns into "inventory reduction sale"... It's when your local Best Buy ‒ the next-to-last stop of the supply chain ‒ orders too many PlayStation 5s out of the fear of not being able to meet demand...

And the factory in China ‒ the beginning of the supply chain ‒ ramps up too much and does not cut production until it's too late... Soon, your local Best Buy is slashing prices to move the PlayStations off the shelves.

In other words, it's the supply-chain-management equivalent of your brain not getting the message from your stomach that you've had enough pasta... so you keep feeding on the fettuccine until you've had too much.

And it might already be happening, as the Financial Times explained recently...

Having spent months making excuses about stock shortages to American consumers, [retailers] are now trying to lure them back into the store or on to the website with promises of extended sales, discounts, and faster deliveries. But it seems the buying public are no longer so interested.

So goods such as furniture, appliances, and building materials, once impossible to find, are piling up in warehouses and stores.

Since September, monthly manufacturing data from IHS Markit's Purchasing Managers' Index ("PMI") has shown strong improvement throughout much of Asia, led by Vietnam and Malaysia... That means that output throughout that region – home to four of the world's six biggest manufacturing countries – is rebounding.

But meanwhile, last month the U.S. manufacturing sector posted a sharp slowdown in new orders... And the inventory index of the Chicago PMI, a barometer of business activity, rose sharply to its highest level since late 2018.

In other words... the global economy is going to get a stomachache.

Post-holiday sales are only one positive side effect for shoppers...

And what's good for consumers is also good for (lower) inflation... When the too-much-money-chasing-too-few-goods inflationary equation reverses, prices drop, and inflation falls.

If that's the case, then the inflation number for November – slated to be announced tomorrow – may wind up being the high-water mark... Estimates have it coming in around 6.7%.

What's more, as we wrote on Monday, the Federal Reserve recently admitted that inflation is no longer "transitory"...

That has been the Fed's preferred term to describe inflation in the U.S., which has risen from an annual rate of 1.4% in January to 6.2% in October. "Transitory" suggested that as the economy moves past pandemic-induced supply shortages and as demand fueled by COVID-19 stimulus cash dissipates, recent price increases would gradually disappear.

But in testimony before the Senate Banking Committee on Tuesday, Chair Jerome Powell said that it's time to "retire" the usage of the term. Inflation ‒ the Fed has finally realized ‒ is not temporary.

Powell said higher inflation will likely last into the middle of 2022. Here in the Digest, we've been warning about higher inflation – and doubting its transitory nature – for months.

However... there's a chance that the Fed's better-late-than-never recognition that higher inflation is sticking around could be a contrarian signal... That is, it's a sign that inflation is close to peaking within the next few months.

Markets have mostly shrugged off the latest chapter of the coronavirus...

With news last month of the COVID-19 Omicron variant – and the prospect of a new chapter of the pandemic – share prices fell sharply.

But over the past few days, we've learned that the Omicron variant is not as bad as we thought it might be... And more good news is that there may already be an effective antibody treatment in the works.

As a result, this week, U.S. markets have mostly made up for last week's losses.

Of course, there's still a lot we don't know about the Omicron variant which is now in 57 countries. And some nations are bringing back travel and other restrictions... For example, British Prime Minister Boris Johnson yesterday announced renewed work-from-home and mask-wearing mandates.

But so far, the signs are mostly positive...

Meanwhile, China's one-time biggest real estate conglomerate is back in the headlines...

In September, we wrote about China Evergrande (EGRNF), which owns more than 1,300 developments throughout China, with assets worth – on paper, at least – $350 billion. The company generated $73.5 billion in revenue last year... It's a huge company.

But at the time, Evergrande, with $300 billion in outstanding debt – more than twice what AT&T, the most heavily indebted American company, owes – was on the verge of default.

China's central bank injected $14 billion into the country's financial system to head off the possible tsunami-sized ripple effects – in both financial and real estate markets – of such a large company going bust.

As this story emerged, the Chinese government said it wouldn't bail out Evergrande... Since then, the company has staved off default by making bond payments just at the final hour... until this week ‒ when the grace period ended for an $82.5 million bond coupon payment that the company failed to make.

As a result, credit-ratings agency Fitch Ratings slapped the "default" label on Evergrande – the first time the developer has been formally branded with the scarlet letter of bond markets.

As the Financial Times reported today...

[Fitch's] announcement marked the most significant moment yet in the developer's marathon liquidity crisis that has spread to other businesses across the country's vast real estate sector and fueled global concerns about the potential impact on China's economy.

The Chinese central bank released liquidity into the country's economy earlier this week, in part to ease market concerns over Evergrande. Government representatives also took seats on a new risk-management committee at Evergrande, indicating that the Chinese government will carefully manage the failure of the company to reduce market risks.

While it's on the radar of markets today, Evergrande's default doesn't look like it's going to boil over into a full-blown market crisis...

Shifting gears, the White House is focusing on global democracy...

But do investors care?

Today and tomorrow, President Joe Biden is hosting a first-ever virtual "Summit for Democracy" with the heads of state of some 100 countries... The aim of the meeting is to develop strategies to fight corruption, defend against authoritarianism, and promote human rights...

Promoting democracy is an important ingredient of the Biden White House's foreign policy. What's more, democracy around the world has taken a setback in recent years.

The Economist Intelligence Unit's ("EIU") Democracy Index measures how democratic countries around the world are by assessing a range of parameters like political participation, the electoral process, and civil liberties...

In the latest iteration, the global average democracy score hit an all-time low since the survey began in 2006.

As the EIU explained...

Across the world in 2020, citizens experienced the biggest rollback of individual freedoms ever undertaken by governments during peacetime (and perhaps even in wartime).

For those keeping score at home, the U.S. – the birthplace of modern democracy – ranked 25th out of 167 total countries, earning the distinction of a "flawed democracy"... below "full democracy" club members South Korea, Germany, Uruguay, and Taiwan.

But democracy doesn't seem to matter to investors...

Environmental, social, and governance ("ESG") investing – that is, filtering stocks for what's good for the earth, people, and society – is an investment trend that's gaining real permanence.

As of late last year, ESG investing accounted for nearly one-third of all money professionally managed in the U.S. – including hedge funds, mutual funds, and pension funds... that's around $17 trillion.

You'd think that democracy would be central to the mission of ESG. Without a sound, rule-of-law government – far more likely with a democratic government – ESG is, to some degree, pointless.

But as the British emerging-markets brokerage firm Tellimer explains...

Most investors demonstrably do not care much about democracy.

If they did, the Chinese stock market – the world's second largest – would be shunned...

After all, China's authoritarian government is far from democratic... as is also the case with many emerging and frontier markets.

And if democracy was something investors factored into investment decisions, many of them would not hold Meta Platforms (FB), the former Facebook, in their portfolios.

A growing body of evidence suggests that the social media platform facilitates the spread of misinformation – and worse... Just yesterday, a group of Rohingya refugees in Myanmar sued the company for $150 billion, accusing Facebook of facilitating genocide in the Asian country.

Then there are companies that spend hundreds of millions of dollars lobbying the U.S. government... To many people, the degree to which lobbying – and the massive amount of campaign dollars that go along with it – influences public policy is a threat to democracy because it circumvents the will of the people.

Among the biggest offenders: Amazon (AMZN), which last year spent $18.7 million, and Meta Platforms... and the pharmaceuticals and health-products industry, which in 2020 spent $306.23 million trying to influence U.S. government policy... One way to slow these actions, say, followers of ESG investing, would be not to buy their stock.

Of course, not everyone sees it that way...

To many financially minded people, ESG investing is like trying to make money with one hand tied behind your back... A lot of people don't have any qualms about investing in arms makers, defense contractors, tobacco companies, or fossil-fuel producers – some of the biggest offenders in the ESG world...

It's difficult enough to make money in markets – but investing while having your values as a determining factor makes it tougher.

And even for those who do commit to ESG investing, factoring in a country's commitment to democracy is probably an unreasonable constraint. It would be too limiting, they'd say...

New 52-week highs (as of 12/8/21): Apple (AAPL), AbbVie (ABBV), Brown & Brown (BRO), Richemont (CFRUY), Cintas (CTAS), Quest Diagnostics (DGX), Eagle Materials (EXP), Hershey (HSY), Invitation Homes (INVH), IQVIA (IQV), iShares U.S. Home Construction Fund (ITB), Lennar (LEN), Lam Research (LRCX), Lynas Rare Earths (LYSDY), Martin Marietta Materials (MLM), NVR (NVR), Invesco S&P 500 BuyWrite Fund (PBP), Procter & Gamble (PG), Sprott (SII), Teradyne (TER), and Trex (TREX).

In today's mailbag, a subscriber praises our colleague Dr. David "Doc" Eifrig for the most recent issue of his Retirement Millionaire newsletter. (If you're a subscriber, you can get the full report right here.) Plus, frequent Digest contributor Dan Ferris answers one reader's questions about the next market crash. Send your thoughts, comments, and observations to feedback@stansberryresearch.com.

"The December issue [of Retirement Millionaire] is very informative. It has given me a much better understanding of what is going on in our financial world in our country. You have also helped reinforce my leanings as to what I wanted to do to adjust my portfolio.

"Thank you, [Doc]. You are the best. Wishing you and your family a very happy and healthy new year." – Paid-up subscriber Bernie C.

"Thank you, Dan. I was beginning to think I was the only one that thought that putting my hard-earned money into non-existent land was a ridiculous concept.

"I have to wonder what has happened to common sense. Are people so greedy that they will jump into the most insane concepts in order to make a dollar? I agree that if it's virtual it can disappear because it's no longer 'cool' and they have moved on to the next 'hot' concept.

"If I'm investing in real estate, I want to see it in the 'real' world where it can have real-world practical applications. People seem to think that escaping reality is going to make life better. Learn to deal with, and live in, the real world." – Paid-up subscriber J.W.

"Hi Dan, like you, I know I can't predict the future. I agree that signs of a market top are all around us today, and that holding significant cash, gold, and some bitcoin is prudent preparation for what's to come. I also agree that holding the value stocks you recommend is the place to be right now.

"Lately, the market went wobbly. I thought, 'Gee, maybe I should sell some stock now and build more cash.' [But then] I went through my current holdings – most of which I acquired on your recommendation – and I thought, 'Wait a minute, all of these stocks currently are gushing cash flow, with consistent margins, strong balance sheets, excellent shareholder rewards, and return on equity. Do I really want to unload any of these stocks now?'

"I decided to stand pat. And guess what? The market came back quite a bit.

"All this makes me want to ask: Should prepared investors plan to stand pat as the market crashes? Or should they plan to do something once the deluge begins? What are the signs that we have a good plan?

"Finally, you should know that I subscribe to a number of financial newsletters, and I sometimes think that when the deluge comes, I might cancel a bunch of them. But the last to go will be Extreme Value.

"Thanks so much for all you have done for us." – Paid-up subscriber Hank C.

Dan Ferris comment: Hank, thanks for the kind words. Hearing from subscribers like you is truly one of the best parts of this job. And of course, I'm grateful that you're an Extreme Value subscriber.

It's also great to hear that you already seem to be prepared for a wide range of potential outcomes. As you know, that's what I believe folks must do at any time.

The simple fact is that none of us can predict the future. But by learning to analyze the stocks you're holding and make your own educated decisions, you're ahead of most folks. That's great.

And frankly, it shows you already have the best answer for your own questions...

Yes, investors should be prepared to stand pat when the market crashes. And yes, they should plan to do something once the deluge begins.

I realize that's probably not the answer you're looking for. But truthfully, by doing what I suggest all the time – holding a truly diversified portfolio with four basic elements (stocks and bonds, plenty of cash, gold and silver, and a little bitcoin) – you should be ready for almost anything.

And then, when the market crashes, you must remember another critical rule... Leave your emotions at the door.

That's the hardest thing for us to do as humans. They can spiral out of control when things start getting crazy... And that can be catastrophic for both your health and wealth.

But that's why we always have a plan in place ahead of time... You should be using trailing stops or other risk-management tools. Stick to them. Don't choose to ignore them when they matter most – in a market meltdown.

And of course, when the next market crash occurs, we should be able to find incredible value opportunities all over the place. So make sure you're ready with all your cash.

That sounds like a good plan to me.

Kim Iskyan
Ashton, Maryland
December 9, 2021