How to invest in the shortage economy


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Welcome to the shortage economy.

As we enter into the third year of the pandemic, COVID has truly turned the world upside down. More than a million Australians have contracted the virus and the impacts on the economy have been numerous and large. None so much as the shortage economy Australia finds itself in right now.

From an abundant western society with just in time logistics, we now face crippling shortages of labour, materials, shelf stock and essential services.

investing in shortage economy

It's most obvious in any supermarket you visit currently where stock levels skews are normally 98%, now we see sold out fruit and veg, pharmaceuticals and the old pandemic favourite: toilet paper.

Demand and supply patterns have been thrown in disarray and this is putting a huge challenge for both companies and individuals alike.

There are ways this can benefit your portfolio.

Being long in the local well-stocked retailers, having exposure to key commodities who are in short supply and gaining exposure to areas of new or substitute demand.

A good example is in battery minerals, where Australia is poised to be a massive exporter to the world as it decarbonises. Prices for the commodities have rallied massively in the case of spodumene/lithium over 10 times from the sectors brush with insolvency in 2020.

But mines are taking much longer to commission and build due to lack of labour and equipment, particularly in our west.

Buying into companies producing the other critical battery minerals like nickel, cobalt and graphite is also adding value more recently. Even fossil fuels like gas, oil and coal are spiking, mainly because supply is coming on and there is a delay between decarbonisation aspirations and the time taken to achieve them in our disrupted reality.

Staff shortages are acute across so many fields in Australia right now that wage inflation must spike.

The much-touted Great Resignation has been mixed with a huge surge in COVID infections, taking the cumulative cases in Australia well over a million as daily case loads continue to climb.

Absenteeism is understandably rife. Many frontline care and essential workers are burned out after such a long and tough campaign. This means wages are increasing rapidly and all the zero rates in the world are not going to change that as central bank zero-rate setting mistakes stoke huge inflationary momentum.

The US just recorded a 7% inflation rate, the highest since 1982 and one wonders whether a similar trajectory is in store for us down under.

There are risks for share prices too. Margins are key for profitability in this explosively inflationary environment. To justify a position in your portfolio you should be assessing whether stocks can hold their margins when all these input costs are rising.

We have seen several retailers come out and warn profits will be down on rising costs of doing business, Woolworth was the largest company to mention this before Christmas, but certainly won't be the only one impacted.

In essential services, we see wages and restricted services such as elective surgery impacting healthcare services providers such as Estia and Regis in aged care and hospitals like Ramsay. While these short-term margins are a headwind, it's not hard to see that the long-term ramifications of the pandemic may well mean the value of this healthcare infrastructure will actually go up.

There are wild card sectors too.

Travel and entertainment are still tough sectors, until the virus runs through. Flights are being cancelled due to lack of staff and capacity is also being cut due to low demand. Accommodation and holiday parks near the population centres may continue to be the winners for now.

Empty sports and arts festivals threaten the solvency of some of these events. We continue to like the casinos due to their property backing, as we saw a slightly better bid for Crown recently from Blackstone.

So while the milder variant Omicron rages through our economy, it's important to remember that these disruptions won't last forever but it's one that you want to keep your portfolio on the right side of this squeeze. Stay safe out there.

This article first appeared on FS Advice

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Dermot Ryan is a co-portfolio manager of Equity Income Generator and has been working as a portfolio manager in Australian equities since joining AMP Capital in 2014. Prior to that he worked in Commonwealth Private and Colonial First State Global Asset Management investing in both equities and multi asset portfolios. Dermot has a Masters of Economics (Hons) from University of Sydney and a Bachelor of Actuarial and Financial Studies (Hons) from University College Dublin.