Weekly Reading 4/22/2022

Architecture’s Impact on Music by David Byrne.

China locked down Shanghai, a city of over 25 million people for COVID on March 27th. There are a few read-throughs on this.

• This looks like an extreme over reaction. When a country is managed in a top-down manner with no respect for personal liberties, there is no debate. COVID-zero is the official policy and so the state will do whatever it takes to achieve zero cases of COVID.
  • New cases are over 20k per day. China has acknowledged 3 deaths. “A release from the city health commission said the victims were aged between 89 and 91 and unvaccinated.”
  • “Monday’s deaths were also the first Covid-linked fatalities to be officially acknowledged by authorities in the entire country since March 2020.”
  • Yea sure. Whatever you say, Chairman Xi. China’s chart below looks normal compared to the global chart.





• Locking down a city of 25 million to prevent the deaths of several non-vaccinated nonagenarians does not make sense. But why do we assume that an autocratic, communist regime is logical?
• Everything I’ve seen and read suggests that most of China’s pain is self-inflicted rather than being directly caused by the virus.
  • People are ordered to shelter-in-place but do not have enough food.
  • Draconian quarantine rules are splitting up families and compounding the malaise.
  • Evidence is emerging that the Shanghai population is becoming increasingly frustrated with these restrictions.
• If you’re a foreign investor looking to locate a new factory, is China where you want to locate your investment? 4-5 years ago, the answer to this question might have been ‘yes,’ now, I’m not so sure. China’s Common Prosperity and Zero COVID policies could be causing irreparable harm to its reputation. This also comes at a difficult time for China as the country backs Russia’s unpopular invasion of Ukraine.

Libertarian rants aside, this Shanghai lockdown will have a profound follow-on impact to global supply chains. “It’s probably worse than Wuhan”

• There are now signs that Shanghai’s lockdown is easing. For example, the WSJ reported today that Tesla’s production facility there is ramping up to full production in the coming days. But I think the damage is done.
• Logistics weren’t a mess when Wuhan locked down in 2020- now they are. Also, when Wuhan locked down, the rest of the world did too. Now, that’s not the case!
• Assuming Shanghai opens back up right now, supply chain difficulties (like a delayed-fuse bomb) will still hit in a few months. This also lines up with what logistics companies like JB Hunt (JBHT included below) are experiencing.

REMINDER: DISCUSSION OF A SECURITY DOES NOT CONSTITUTE A RECOMMENDATION TO BUY. Please see bottom of the page for full disclosures.

Earning season continues. Company-specific news aside, earnings also provide meaningful economic datapoints. Last week we looked at JP Morgan’s numbers. This week, JB Hunt (JBHT) reporting earnings. JB Hunt is one of the largest trucking companies in the US so its operations are closely tied to general economic activity. It’s estimated that about 70% of all consumer goods are moved by truck in the US. JBHT 1Q22 transcript excerpts below.

Similar to JP Morgan, JB Hunt’s message is a bit mixed. Demand and pricing are very strong and JBHT’s commentary is generally upbeat. Even in the face of higher fuel prices, JBHT is doing fine and is able to pass along pricing increases. Businesses are more focused on getting products onto shelves rather than getting the lowest price transportation. To me, this suggests upward pressure on inflation. It sounds like JBHT is well positioned but more inflation is not a positive economic data point.

The other datapoint that is worrisome is the looming threat of additional supply chain issues. Thanks to COVID-related shut-downs in China and also labor shortages (at ports and throughout the economy) JBHT is expecting supply chain issues to get much worse as the year progresses. With < a href="https://www.scmp.com/business/china-business/article/3174800/tesla-saic-and-other-shanghai-manufacturers-get-slow-start?module=live&pgtype=homepage" target="_blank">Shanghai struggling to emerge from its draconian lockdown, the market will have to wait and see to get better visibility into supply chain issues.

We’ve discussed a few times the different components of CPI calculations. Rather than using normal housing prices, CPI uses the ‘Owner’s equivalent rent of residences’ to estimate shelter expenditures. Rents tend to trail housing prices. Housing prices increase immediately but it takes time for leases to roll over and reprice. The result is that CPI utilizes a lagging datapoint to calculate CPI.

To simplify CPI:

Next, let’s consider housing prices. New home prices are up 25% since COVID-19, compounding at 7.5% a year. In the last year alone, housing prices increased 10%. CPI’s calculation of shelter costs has increased 10% since COVID-19, compounding at 3.2% a year. This includes 5% in the last year (included in the table above).

So shelter costs (as CPI calculates them) have some catching up to do!

If housing prices stopped increasing today, rents still have about 13% to go before catching up. That’s a big IF! Remember, the US under-built housing for a decade. All-else equal, just this increase in rent means 4% inflation. But all else is NOT equal. Spiking energy costs are likely to impact other categories and put upward pressure on inflation. Labor (not captured directly by CPI) is extremely tight. This is illustrated by the Producers Price Index (PPI) which is increasing in the double-digits. Producers will either take a major hit on margin or more likely pass these price increases along to consumers.

How is this gold only up 10% in the past year?!