The Scarcity Trade and Why it May Be Getting Started
We constantly hear about the supply chain. Yet, few mention the other chain that is formed when events lead to consequences.
That chain is getting stretched.
By the time this article is published, the Federal Reserve will have made its intentions known and the markets will have responded. Prior to the July Federal Open Market Committee (FOMC) meeting, the consensus was for quarter point increase in the fed funds rate. I agreed. As I always say, it’s more about what Fed Chair Jerome Powell says during the press conference.
Yet, even as the global economy slows (China’s housing market is in shambles, Europe is in a technical recession,) and U.S. consumer and producer prices have flattened out, recent money flows into stocks suggest the smart money is betting on scarcities of key commodities, specifically, housing, food, and petroleum products.
Without Supply There Is No Supply Chain
The term supply chain is often mischaracterized as it implies a seamless connection between items and asset classes. It also conjures up images of orderly widget lines making their way from factories to consumers.
Certainly, through the 1990s, up until the pandemic, this was a reasonable observation. Not so much now.
Some call the present period one of stagflation, i.e. stalled growth and simultaneous inflation. But that’s an inaccurate term which implies that there is some sort of invisible hand at work.
The hand that’s creating the supply crunch in key commodities isn’t invisible at all. The rising scarcity of key products is the result of the retrenchment of globalization. Governments, corporations, and the public are adapting to drastic changes in previous norms.
Still, scarcity is often about how production affects the level of supply, which is the actual amount of stuff that’s available now and how much of it will be available in the future, and the decisions that are being made by producers as influenced by the evolution of relationships among countries, regions, and localities.
If there is insufficient wheat and corn, whatever the cause, cattle may not get fed, bread may not get baked, and prices of whatever meat or bread is available, assuming it can be delivered, will rise.
Global adjustments create investment opportunities.
If home ownership becomes unattainable due to high mortgage rates and low supplies, those who can afford to own a home will pay a higher price and builders will build fewer homes to keep profits and margins in their favor.
If revenues and profits remain stable despite fewer sales, they are just as bankable.
On the other hand, those who own rental properties, especially if they keep rents at a reasonable rate, will benefit. In this case, the number of apartment complexes being built is on the rise and is not likely to slow anytime soon.
Finally, even if everyone owns an electric vehicle (EV), we’ll still need petroleum products since everything from Vaseline ointment to the plastics and materials used to make seats for EVs is petroleum based.
Let’s get granular.
Scarcity # 1: Housing
The housing shortage is ongoing. Familiar readers are aware of my bullish views on homebuilder stocks. But the dynamic is changing for homebuilders, as higher interest rates have finally put a damper on the intentions of even potential buyers in the luxury segment.
This is evident in the recent earnings reports of large-cap homebuilders whose revenues have risen moderately while their earnings have beaten lowered expectations. They are still making money, but less than what they made a year earlier.
Moreover, homebuilders, like a college basketball team which plays the four-corner offense to protect its lead, are keeping the number of new builds in balance with demand and putting their money into controlling land, paying dividends, and buying their own stocks back as they prepare for better times when the Fed lowers rates.
You can see by the price chart of the SPDR Homebuilders ETF (XHB) that long-term investors are nowhere near bailing out on the homebuilders. At the same time, it’s clear that this sector is due for a consolidation.
But there is still a housing shortage. And while owning a home may be out of many potential buyer’s budget, the residential rental market, and related real estate sub-markets, are once again coming to life.
You can see that in the price chart for the Nuveen Short-Term REIT ETF (NURE). This exchange-traded fund (ETF) provides exposure to U.S. real estate investment trusts (REITs) with short-term lease agreements. Specifically, these holdings are self-storage providers, commercial warehouses, and single family and multifamily homes.
While homebuilders are playing the stall game, the apartment and storage sectors are building out capacity and renting space at a healthy clip.
Scarcity #2: Agricultural Products
The El Nino weather pattern has delivered volatile weather, and a raging forest fire season, especially in Canada this spring and summer, with no signs of abatement. Indeed, the combination of intense heat and paroxysmal rainfall along with violent storms have wreaked havoc with crops and crop forecasts, especially for wheat. Orange juice and rice supplies are suddenly in flux.
Russia’s scrapping of the Ukraine grain deal, and increased aggression toward cargo ships in the Black Sea, has added to the uncertainty. This can be clearly seen in the rising action of the Van Eck’s Vectors Agribusiness ETF (MOO), which features companies such as grain producer Archer Daniels Midland (NYSE: ADM).
The real question when it comes to the agricultural market is whether we are amid an exaggerated, yet seasonally normal weather cycle, or if this is due to something longer lasting and structural.
Scarcity #3: Petroleum Products
Back in early May, 2023, I discussed the possibility that crude oil prices were about to rise as supplies were likely to be squeezed by producers.
Since then, crude oil prices (WTIC) have risen over $12 per barrel. OPEC+ and U.S. shale producers have been cutting production, while demand has remained stable, despite the consensus in the market that demand was about to falter as the global economy slowed.
Moreover, even as domestic oil production has been reduced, oil exploration abroad has increased, especially in Africa and South America. Producers are preparing for the next up cycle.
Oil service companies such as Transocean (NYSE: RIG) which offer support services to exploration and production companies have benefited.
The Van Eck Vectors Oil Service ETF (OIH) has been a great beneficiary of this boom in exploration. But it’s not alone as the iShares U.S. Oil Exploration & Production ETF (IEO), which I highlighted in my May article, has also moved decidedly higher.
All Chains Break
The supply side of daily life, such as housing, food, and petroleum products, are experiencing a supply squeeze. The other chain, the chain of events, is increasingly active.
Some of the squeeze is naturally influenced by weather. El Nino works on its own chaotic schedule.
On the other hand, slowly developing shortages in housing, gasoline, diesel fuel, fertilizer and specialty chemicals are at least partially influenced by a combination of government and boardroom decisions, geopolitical events (e.g., deglobalization), and higher interest rates.
Governments justify actions based on national security. Companies adjust based on profits.
If a country, has a monopoly on key industrial materials (China with rare earth minerals, Russia with uranium) it will use those levers to influence its policies, even to the point of war.
If inputs and labor are expensive, company boards can choose to pass costs to the consumer and/or reduce operational expenses by laying off employees and shutting down facilities. The net result is a reduction in supply of key products.
When nature exerts its chaotic influence, human actions will exacerbate the situation as national security and profit margins are squeezed.
Therefore, when the Federal Reserve makes its decision on 7/26/23 (likely another increase in the fed funds rate), cabinets and presidents will meet. Decisions will be made. And along with them, corporate boards will be faced with making crucial decisions about how to keep the lights on and the profits as good as possible.
The supply levers will once again be pulled.
As a result, a likely outcome will be a continuation of, or a possible acceleration of, current market patterns: tight supplies and either stable prices at the currently high levels, or another wave of price hikes.
All of which, barring something very dramatic from the Fed, translates to the likelihood of higher stock prices for the oil, housing, and agricultural products sectors.
Eventually, though, all chains break. Stay vigilant.
PS: Does all this uncertainty have you on edge? The key to mastering risk resides in what my colleague Jim Pearce calls “Mayhem Trades.”
Jim Pearce is chief investment strategist of our premium trading service, Mayhem Trader. Jim has developed an under-the-radar strategy to flip market mayhem into fast payouts. Want to learn more? Click here now.