The Big Idea
Chipping away at supply bottlenecks
Stephen Stanley | September 24, 2021
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Many parts of the economy have had to deal with supply bottlenecks since the early days of pandemic. One of the most prominent has been in the motor vehicle industry where chips have been in short supply since last year. The situation was supposed to be alleviated in short order, but that has not happened. The problems have lingered, keeping production restrained and taking a substantial toll on auto sales. This has led to a noticeable drag on consumer spending in recent months and promises to remain an issue until assembly lines get back to normal.
When Covid led to lockdowns in the economy in early 2020, expectations for activity were dire. Many believed that the economy would plunge and stay weak for a long time. Automakers certainly took such a view. They shut their assembly plants, slashed production plans and canceled orders from suppliers.
Semiconductor producers, among others, were left high and dry when automakers reneged on the usual flow of orders. Fortunately, chipmakers saw demand boom from makers of a number of other products including home electronics and computers. As a result, they were able to maintain a decent level of activity without much help from their auto industry customers.
As it turns out, the economy in general and consumer demand for cars and trucks in particular bounced back much quicker and more forcefully than expected. After public health concerns closed assembly plants for almost two months, automakers tried to rapidly ramp auto output but were stymied by parts shortages and public health constraints. In particular, they have spent over a year with insufficient computer chips to crank out cars and trucks at a pace commensurate with demand.
There are two issues with the supply of auto-related chips. First, though I have never seen this stated explicitly, I suspect that chipmakers shuffled automakers to the back of the line in terms of their production priorities. In essence, the attitude was that if you mistreat us by abruptly canceling orders when we needed you most, then we have plenty of other customers that merit greater attention.
Second, there have been a series of mishaps in the semiconductor industry. A plant in Japan dedicated in largely to auto-related chips suffered a fire early this year that took it offline for several months. More recently, Covid outbreaks in Asia this summer forced several chip plants to close altogether or curtail output based on public health restrictions.
Motor vehicle production
For the last year or so, automakers’ production schedules have shown a consistent theme. Depressed output for a few months, followed by a quick return to a more normal pace within a quarter or so. Then, a month or two later, when the next update to production schedules is released, the recovery is pushed out, as supply bottlenecks—chip shortages—prove to be more persistent than projected. That cycle has been repeated at least half a dozen times over the past year. The projections for the fourth quarter show that the pattern remains in place (Exhibit 1).
Exhibit 1: Motor vehicle production (industry estimates for Sep-Dec 2021)
On a seasonally-adjusted basis, unit production has been stuck in a range of about 8 million to 9 million units annualized, down from around 11 million in 2019. Of course, plans call for output to get back to roughly 2019 levels in the fourth quarter, but recent guidance from domestic automakers suggest that the chip shortages will not be resolved entirely until 2022, suggesting that the forward guidance on output may yet again prove overly optimistic.
Motor vehicle inventories
While production failed to fully recover, demand for autos surged once the lockdowns ended last spring. In fact, although fleet interest was lower than before the pandemic, retail customers wanted to buy significantly more vehicles, as households moved out of dense cities and into more spread-out locales like suburbs and avoided public transit.
Soon, auto dealers saw their lots thin out. Motor vehicle inventories have dwindled to a level not seen in decades (Exhibit 2).
Exhibit 2: Motor Vehicle Inventories
Motor vehicle sales
As noted above, motor vehicle sales surprisingly snapped back in the months after the lockdowns, even with fleet sales down substantially. By the end of last year, auto sales were running roughly on par with the pre-pandemic pace. In fact, for a month or two this spring, sales ran above the 2019 pace, peaking above an 18 million clip in April.
Exhibit 3: Light Motor Vehicle Sales
However, by late in the spring, the plunging levels of inventories began to eat into sales, as dealers simply did not have product to move. Unit sales have fallen substantially for four straight months since the April peak, reaching a 13-million-unit pace in August, the worst monthly result in 10 years aside from the months last year during the lockdowns (Exhibit 3).
The swoon in motor vehicle sales has had a significant impact on overall consumer spending in recent months. In May, spending excluding motor vehicles rose by 0.4 percentage points more than the overall figure, while the gap was two tenths in June, about 15 p in July, and based on my forecast may have been about two tenths again in August. The travails of the motor vehicle sector have contributed heavily—along with the impact of the Delta variant on certain services categories—to the moderation in real consumer spending in the past few months and may continue to do so in the near future, until production finally does pick up in reality as opposed to scheduled upticks that have repeatedly not materialized. When that happy day arrives, it will provide a stiff tailwind to consumer spending gains until unit sales fully reflect robust demand.
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