Pinch Points

Friday Reflection | April 30, 2021

Among the more surreal chapters of the pandemic was the toilet paper shortage in the spring of 2020. Shelves were barren as people stockpiled in the early days of the lockdown, and hot tips were shared among friends on where to find this elusive staple. This episode revealed more than just irrational desperation; it also highlighted shifting consumption patterns as life moved from offices to homes, and the delicate balance of supply and demand.

Since last spring, the shortages of toilet paper have been resolved and the US economy has made substantial strides toward recovery. The Bureau of Economic Analysis reported that GDP grew at a 6.4% annualized rate in the first quarter and unemployment claims hit a new pandemic-era low at 553,000 this week.¹ Combine those data points with vaccination progress, Biden’s economic proposals, and a strong start to the year for stocks, and it begins to look like the economy is in great shape.

The truth is that the ripple effects of the pandemic are still being felt in many ways, as the global supply chain cannot adapt quickly enough to the changing landscape of consumer preferences and business spending. Years of underinvestment and just-in-time inventory management have left industries unprepared for rapid surges in demand. This dynamic has caused pinch points to arise across the spectrum of manufacturing components, from a basic commodity such as lumber to a complex manufactured product such as microprocessors

Lumber prices have tripled since June 2020, soaring to more than $1,300 per 1,000 board feet.² The price of lumber is not something the average person thinks about, but the knock-on effects are being felt by consumers across the country. Why have prices increased so dramatically? The answer can be boiled down to shocks that shifted supply lower while demand soared higher, creating scarcity. These imbalances will be resolved over time, but for now, markets are rationing scarce quantities through higher prices.

On the demand side, the shift higher is a direct result of the pandemic-induced migration from offices to homes. This sparked the need for more space, which translated into home improvements, additions of outdoor living areas, new furniture purchases, and skyrocketing demand for new homes as at least some employees could live further from cities and physical offices. Meeting this new demand is a lumber intensive process.

On the supply side, understanding the shift requires zooming out for perspective (a concept we talked about in last week’s commentary – A Dash of Perspective). Following the 2008 housing bust, sawmills and other wood product manufacturers cut their production capacity and forecasted permanently lower demand. Productive capacity has been rebuilt somewhat since those initial cuts, but in March was still 11% below the 2006 peak.³ The problem for sawmills, homebuilders, and homebuyers is that the recent ‘lost decade’ for housing ended so abruptly. Americans have bought an average of 79,000 new single-family homes each month since last July, up roughly 50% from the pre-pandemic average — and the pace seems to be accelerating.⁴ This sudden increase left sawmills with little time to build new facilities and has meant higher prices for homebuyers and remodelers.

At first glance, an advanced microprocessor and a piece of wood couldn’t be more different, but the challenges facing their supply chains are surprisingly similar. The boom and bust cycle for these computer chips was a decade before the housing crisis, during the dot-com era rise and fall in the late 1990s. Production decreased following the crash and ultimately shifted overseas. As demand recovered in recent years, foreign suppliers expanded operations in response. But like American sawmills, they were similarly unprepared to handle the surge in demand for chips during the pandemic.

On the demand side, homebound consumers increased purchases of phones, TVs, laptops, tablets, exercise equipment, and cars and trucks – all of which require microprocessors. Businesses similarly increased their need for new computers, phones, and specialty devices to facilitate the transition to remote work. The infusion of cash from stimulus checks and PPP loans accelerated this buying and distorted the balance of supply and demand. Like the lumber shortage, this has meant delays. One primary example is the impact on automakers, with Ford, Volkswagen, Tesla, and others announcing that various production lines will be halted and deliveries will be delayed until this imbalance is resolved.⁵

On the supply side, production was focused on the most advanced (and most profitable) chips needed for 5G expansion and data centers. The meant industry-wide underinvestment in more basic production capacity for the chips that are ubiquitous in cars, computer monitors, and simple electronic appliances. Due to the specialization of these chips, one plant cannot be easily adapted to create a different kind of chip. This creates a challenge for the industry: determining whether this shift in demand is a lasting change, and warrants the significant investment to expand or build a new plant. It typically takes two years to build and equip a semiconductor fabrication plant, which can cost billions of dollars. Once built, it still takes three months to make a basic chip – and longer for the advanced ones.⁶

Ultimately, both the lumber shortage and the chip shortage will be resolved with some combination of lower demand and higher supply. The question is how will different industries judge the longer term value of short-term capacity investment, and how long will it take to resolve the imbalance.

For clients and consumers, this may mean waiting before installing that new deck or delaying a remodel until lumber prices normalize, expected to be next year. Patience will be required as deliveries of electric vehicles and new laptops will be slower. For businesses, investment takes time and they don’t want to get burned if the current demand proves to be short-lived.

In individual industries and the broad market, boom and bust are part of the normal business cycle. So is recovery. These cycles exist in the cadence of our clients’ lives as well, and adjustments are made as circumstances, relationships, and financial priorities shift over time. In the current moment, we are in some ways more acclimated to change and to the unexpected; nonetheless, stability has a lot of value. Our firm’s motto is “Invest in Living” – and we continue to advocate an intentional approach to balancing action and patience as these cycles unfold.

¹ Gross Domestic Product, First Quarter 2021 (Advance Estimate). Bureau of Economic Analysis

² Lumber’s Unusual Price Surge Inspires TikTok Videos and Sticker Shock Bloomberg

³ Industrial Production and Capacity Utilization. Federal Reserve Data

⁴ The Lumber and Chip Shortages Have the Same Root Cause: Underinvestment Barron’s

⁵ Global Chip Shortage Set to Worsen for Car Makers Wall Street Journal

⁶ Why the Chip Shortage Is So Hard to Overcome. Wall Street Journal