From a newsletter I receive. The Trump team isn't prepared for this:
“Just-In-Time”
We see a little understood new problem that is related to the Covid-19 (Corona) virus. Twenty-five years ago, most supply chains for corporate America were very different. Most companies had large warehouses with 30-60 days of inventory to sell. When it came to raw materials and parts, they generally had a 30-60 day supply of materials to build their products. If a hiccup came along, it could easily be ridden out until alternate supplies were located or the factory restarted.
Today the supply chain world is different. The parts and raw materials for next week’s production arrive the week before or in some cases the day before. This is called “just-in- time” supply chain delivery. The supply companies in some cases are given a two-hour window to deliver supplies for the next day to the factory or store. It is all super-efficient.
The just-in-time delivery system has several advantages. It is cheaper, you do not need to carry as much inventory, and your supplier carries the inventory. That inventory may be in a local warehouse or in China. Therefor the company needs less warehouse space thus saving more money. Best of all, since they carry very little inventory, they need less working capital to pay for it. This improves the balance sheet freeing up more cash to buy back company stock.
Shock
Then along comes the Covid-19 virus shutting down 80% of China’s manufacturing capacity. Not only are the factories shut down, but most of the air and water shipping out of China is shut down as well. Ships are trapped in Chinese harbors unable to leave. China’s economy shut down for three weeks will likely stay closed for several more weeks. This is likely to result in a supply-chain shock to Corporate America. We maintain very little inventory of critical items from China because our hyper-efficient supply chains were not designed for any interruption.
This is why we are starting to see some car factories shut down in Korea, Japan, and Europe-and soon in the United States as companies cannot source parts from their Chinese supply chains. As an example, Fiat Chrysler shut down a European factory because they could not get the radios for the Fiat550 that were stuck in China. Missing a critical part means, you cannot sell the finished product. In some cases, companies are able to source American made products as replacements. Over the next couple of weeks, we are likely to see additional factory shutdowns in the United States. In addition, we will see shortages of some products as well.
There has already been concern about a drug shortage in this country because 80% percent of the raw materials for pharmaceuticals made in the U.S. are produced in China. The FDA has halted drug inspections in China until the end of March and warned drug shortages are possible. The sectors most threatened are the technology, drug and auto sectors.
Rose Colored Glasses
Most Wall Street analysts are comparing Covid-19 to past viral outbreaks like SARS and MERS. This is very different because China’s economy is basically shutdown-likely for at least one month. In the other viral outbreaks, there was a week or so of shutdowns in a couple of areas. A better way to look at this is as a war or natural disaster that shuts down the country for a month or so. In that case, things take longer to recover to get back up to normal GDP levels.
The China supply shock is very real and underestimated by Wall Street. If China restarts Monday and gets back to full production next week, it should not be a problem. If China’s manufacturing and transportation sector remain crippled through March, expect to see plant shutdowns and product shortages in the United States. At a minimum, we expect to see a surge of earnings warnings from S&P 500 companies.
There have been stories of some companies in China rushing workers back to the factory; they were hit with the Corvid-19 virus and quarantined. The world is now recognizing it is more important to protect their citizens than meet profit goals.
Given the possibility of some shortages, it would be a good idea to make sure you have the essentials to last thirty days.
The Covid-19 virus is proving to be far more destructive to the world than the SARS outbreak of 2003. Going forward we want to watch to see if Covid-19 can be contained in China. Recent outbreaks in Japan, South Korea and Iran bear watching.
Thus far, the stock market has held up well in the face of the Covid-19 virus outbreak as investors flock to the safety of the United States and investors anticipate a quick recovery. Earnings warnings due to the virus are starting to happen. Thursday Proctor and Gamble (PG) warned they will not meet earnings estimates due to the China shutdown; there will be many more. This will pressure the S&P 500 stocks going forward.
If the Covid-19 virus were to come to the United States, we would be able to handle it. A concern would be that consumers choose to stay home and not shop, or investors on Wall Street all head for the exit at once. This could lead to a steep drop in the stock market. |
