Trade skirmishes are bringing into focus the increasingly fragile, highly integrated global supply chains that form a complex network of production across the globe.  And US-based companies appear to be responding to the uncertainty.  For instance, Hasbro is accelerating plans to shift its production away from China in favor of Vietnam and India, reducing US goods produced in China to 50% from 75% currently.  Li & Fung, the world’s largest supplier of consumer goods has suggested that Chinese sourcing will fall to less than 50% this year.

How did companies become so vulnerable — the business management equivalent of “putting all of your eggs in one basket”?  Even the well-regarded operational genius, Tim Cook of Apple, has tied most of his companies’ production capacity to China.  It’s not quite as bad as it seems.  The fact is that most forward-thinking companies have been moving production out of China for years, not because of political realities, but for one simple economic fact – as more and more Chinese are entering the middle class, China is no longer the lowest-cost manufacturer in the world.  The latest political spat between the US and China has only accelerated this trend.

Still, there are some things like rare earth mining, production and processing that largely can’t be moved outside of China, especially if the Chinese government “weaponizes” such raw and finished materials like it did to Japan in 2010.  Curiously, Japan is now taking a page out of China’s playbook in its skirmish with South Korea, withholding three chemicals essential for memory chips and phone displays, areas in which South Korea produces most of the world’s supply.  Many in the tech sector believe that this mini-war between our two allies has the potential to be even more disruptive in the short-run to supply chains for smartphones, computers and other electronics than the trade war with China.  And yet, this skirmish is barely being discussed in the media.

While most companies are not moving away from China completely, Chinese manufacturers are getting worried, and desperate.  And this may prove very beneficial for European and Japanese consumer brands.  Faced with billions in infrastructure investment sitting idle, they are cutting prices to attract non-US companies.  And capacity in other places are filling up fast – Li & Fung says that Vietnam is completely full and not a current option for US companies looking to make a shift.  These alternative, mostly Asian, manufacturing hubs lack the scale to completely substitute for Chinese capacity.

Companies are beginning to adapt, some with the help of technology.  For instance, virtual factories are being designed and utilized by the likes of Unilever.  In addition to providing a platform for identifying operational efficiencies and testing new production processes, this technology also allows production to be shifted among production facilities to more efficiently allocate capacity across the globe.  In addition, more and more companies are keeping production local, as close as possible to the ultimate consumer.  With the likes of Amazon and Walmart pushing for one-day and even same day shipping as their eventual goal, proximity matters, especially with respect to transportation and energy costs.

How far this de-globalization process goes depends, in part, on how long these trade disagreements last.  We believe one thing seems certain, some of the changes will not be reversed even if trade agreements are secured – in some ways, there will be no going back.

 

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The views presented herein are those of Validus Growth Investors, LLC (“Validus”) as of July 2019 and are provided for informational purposes only.  There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend might begin.  The information is based on the economic and market conditions as of this date.  The information is not intended as a discussion of the merits of a particular offering and should not assume that any discussion or information provided herein serves as the receipt of, or as a substitute for personalized investment advice from Validus or any other investment professional. 

This material is provided for informational purposes only and does not constitute a solicitation.  The material is not intended to be relied upon as a forecast, research or investment advice and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.  There is no guarantee that any forecasts made will come to pass.