Echo Boom

During a recent meeting with 15 business owners, we discussed how their businesses are doing, what their biggest problems are and how they feel about the future. Almost everyone there was saying that business is great, or would be, if they could find supplies, get them to their businesses and find the labor to turn them into products. They all admit that sales would be significantly higher if supply chain issues weren’t a problem and if they could find all the workers they need. So what happens when they do? BOOM, another post-pandemic rally in future economic growth! An echo, if you will, of the boom we saw between the third quarter of 2020 and second quarter of 2021. Perhaps that is what stock investors are counting on.

Supply Chain and Labor

I won’t beat the supply-chain disruption issue, as my colleague Kelsey Ellsworth did a great job covering that last week. However, let me add a couple of thoughts, using Polaris as a case in point.

Polaris, the Minnesota-based popular maker of ATVs, UTVs, snowmobiles and motorcycles reported earnings this week. The CEO stated that substantial supply-chain disruption hampered revenue growth and noted that dealer inventories are down 60% to 80% from the same level in the third quarter of 2019 due to those disruptions. On a positive note, he indicated that customer pre-orders are at all-time highs. (I can vouch for the interest. During a recent motorcycle trip through the Black River State Forest, I saw hundreds of UTV/ATVs, apparently now the snowmobilers’ summer activity of choice.) These customer orders will most likely turn into sales, which will create another boon for Polaris when supply chain issues clear next year.

Consumers have three things going for them:

• Cash. Consumer savings rates have remained elevated now for almost two years. Money market funds have over $4 trillion in balances.
• Income. We also know that wage inflation has been on the rise, currently above 4% year-over-year. In leisure and hospitality wage growth is over 10%. Income growth will continue to rise because there are more jobs, over 13 million, than there are people to fill them today. 
• And jobs. The unemployment rate has declined from over 10% at the pandemic peak to less than 5%. It appears that job growth has slowed, but that is likely because companies like Polaris can’t use more workers until the supply chain clears. Which means we haven’t seen the low in the unemployment rate.

When consumer strength meets a clearing supply chain

So, what happens to economic growth when consumers have strong balance sheets, growing income and a decent job market? They buy durable goods like ATVs and snowmobiles. Therefore, while Polaris’ supply-chain issues caused their revenue to be flat over the same quarter a year ago, projections for this time next year are significantly higher.

The stock was punished for the revenue and earnings news. It is down 18% since a week ago. However, it still remains 300% higher than its’ April 2020 pandemic low (which admittedly was after a 60% pandemic decline.)

The supply-chain issues are real, and so is the inflation they are causing. Below is a graph from Polaris’ most recent earnings presentation. This chart shows that the increase in input costs for its manufacturing is five times higher than what Polaris expected back in January of this year.

That increase amounts to over $300 million in higher costs. However…and here is what we think is different…those consumer fundamentals I mentioned earlier and high consumer demand for Polaris’ products means that Polaris will likely be able to share those costs with consumers and protect their profit margins. Margins are currently higher than they were during the period from 2017 to 2019.

Toward an echo boom

Are supply chain and inflation issues real? Absolutely. Will wage inflation cause the cost of labor to be higher? Definitely. Will these things abate as we begin to see the post-pandemic issues associated with a global economic restart recede? Yes. And what will be left is an economic growth rate in 2022 higher than the lowered forecasts we’re seeing now. As a result, we believe that 2022 may actually be an echo boom given the unusual issues associated with the global pandemic recovery.

ABOUT THE AUTHOR

Brian Andrew

Chief Investment Officer | Johnson Financial Group

As Chief Investment Officer, Brian Andrew leads Johnson Financial Group's investment strategy to provide consistent, actionable investment solutions for our clients.