September 20, 2022

The Trade Mess Is Improved, But Don’t Get Too Comfortable

While the armadas of container ships waiting for berths have shrunk, other problems lurk for cargo transport.

Reported by Larry Light

Art by Irina Selaru

Whew. The supply-chain tie-ups are getting unsnarled. Instead of 100 freighters parked at sea off the California coast and waiting for docking space, the count now is around 10. Container rental rates, which shot up to an average monthly $10,361 in late 2021, have fallen by almost half. A national railroad strike seems to be resolved, with union membership approval expected.

Trouble is, some underlying problems persist. Chief among them: a shortage of ocean-going containers to meet needs and stubborn inventory excesses. For asset allocators, the implication for their investments is obvious.

The logistics bottlenecks were the most prominent early culprit for the higher inflation rates that began bedeviling the U.S. and the rest of the world last year. But with those easing, a still-buoyant economy, higher wage pressures, lower Chinese output, the Russia-Ukraine war and escalated food and energy prices get the inflation attention.

The availability and cost of goods is a strong influence on the economy. Inventories are still high, due to big retailer ordering in the 2021 bounce back from the pandemic-induced recession the year before. This leaves less room to store goods.

The ultimate fix for lingering supply-chain woes, not to mention inflation, likely would come if the long-expected recession hits. In the event of an economic downturn, says Pushkar Mukewar, CEO of trade finance firm Drip Capital, “demand will come down.” And hence the supply jam-ups would end, the thinking goes. Retail sales stayed strong through August, up 9.3% from the year-ago period, the U.S. Census Bureau reported. Another factor is that consumers’ focus seems to be shifting back to services, which would lighten logistics woes.

The Shippers’ Dilemma

For the ocean shipping industry, the last couple of years have been a mixed blessing. This business, whose nine top players are all foreign, has recorded extraordinarily robust earnings during the supply imbroglio. Nonetheless, its stock performance has suffered lately amid public vilification and a new federal law designed to regulate the shipping outfits more tightly.

Container rates, while off their recent highs, are still far above pre-COVID levels, at $5,986—almost four times the January 2020 price. “Pricing is loosening up,” observes Scott Harrison, portfolio manager at Argent Capital Management, who follows the industry. “But it’s still way up.”

That’s where the mixed blessing comes in. The world’s largest shipping company, Denmark’s A.P. Moller Maersk, saw its stock skyrocket to $18 in January, from $4 in early 2020. Since then, it has slipped to $10. Profits, however, have kept mounting. In this year’s second quarter, earnings per share reached $7.18; that’s quite a leap from 5 cents in 2020’s first three months.

The Ocean Shipping Reform Act, which President Joe Biden signed in June, gives new powers to the Federal Maritime Commission, a body that regulates seaborne freight traffic into the U.S. Biden labeled high shipping rates a “rip-off.” Other critics have called the shippers an oligopoly.

As the world’s largest importer, and also a major exporter, the U.S. is ipso facto an important presence in international trade. The legislation beefs up the commission’s ability to enforce edicts and makes it easier for American shipping customers to file complaints against the cargo industry. The agency is writing new rules for the business, due at year-end. Some say the law, even before its full implementation, has already had an effect in widening the availability of containers on the West Coast.

The shipping industry, for its part, believes the new law goes too far and could harm global trade. Its trade group, the World Shipping Council, released a statement condemning attempts to “demonize ocean carriers by deploying ‘us versus them’ rhetoric.” The number of leading shipping companies shows that the business has plenty of competition, the statement argues. And the high profits, after years of small financial surpluses, are being plowed back into infrastructure to ensure servicing of higher trade volumes in the future, it adds.

The supply fracas is wide-ranging. Today’s overflowing shipments and crammed warehouses have spawned an unhappy situation for U.S. trucking companies. They complain that the shipping firms force them to house empty containers because there’s no room in shipyards. As the U.S. imports more than it exports, no one is eager to claim unused containers on American soil.

Trucks handled twice the amount of imports by weight in 2019 (the last year available) than did rail. That said, the railroads have a similar excess empty container plight. Union Pacific and BNSF Railway last month limited container shipments from Southern California to their Chicago-area freight hubs.

What Else Could Go Wrong?

While the consensus is for an international economic slowdown, if not a downright slump, few strategists expect the globalization trend to reverse itself. But they suspect the pace will slow. The World Trade Organization expects global trade volume to expand 3.0% in 2022, a retreat from its previous projection of 4.7%, and 3.4% in 2023. True, a reshoring movement is afoot in the U.S. to bring home certain types of manufacturing—such as chip-making—but its limitations are considerable.

The primary obstacles are high American labor costs and the amount of time involved to create new manufacturing capacity. “It takes years to build a fab [a semiconductor factory] in the U.S.,” says Chris Shipley, chief investment strategist for North America at Northern Trust Asset Management.

Beyond that looms the prospect of geopolitical turmoil, warns John Kartsonas, managing partner at Breakwave Advisors, which sponsors an exchange-traded fund covering dry goods shipping (nonperishable stuff on the order of iron ore). He points to the Ukraine conflict, which is harming Western Europe due to Russia’s crimping supply of natural gas, among other reasons.

Moreover, the possibility exists that China could make good on its desire to annex Taiwan, by force if necessary. If the U.S. and much of the world deemed China a pariah state and blocked its immense trading effort, severe international consequences could ensue.

Atop all that are acts of nature and plain old accidents, “like the container ship that blocked the Suez Canal,” Kartsonas says. The Ever Given, a massive vessel carrying 18,300 containers, was wedged in the key waterway for six days in March 2021. An estimated 369 ships sat idle until the passage was cleared.

The pandemic demonstrated powerfully that shipping needs to flow steadily. “A stop-start environment doesn’t work,” says NTAM’s Shipley. There’s a reason logistical networks are called supply chains. They need to be durable.