What Keeps Me Up At Night? The Bullwhip Effect Plays Out

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When I look around at the risks facing the market expectation, there is one main concern I have. The Bullwhip Effect.

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We saw a massive “destocking” of inventories occur in 2020 (the initial response to the pandemic). Then, a massive “restocking” occurred as demand returned with limited inventories. But on the other side of that is typically another “destocking” cycle as supply chains tend to under and over shoot.

What we saw in 2020-2021 appears to be a bullwhip effect on steroids.

In other words, today’s shortages become tomorrow’s gluts. What appears to be endless demand may be simply pulling forward purchases to replenish inventories, leading to oversupply.

I was listening to Joe Weisenthal on the Notes from the Crises podcast and he put it well. He said something like:

A pork producer does everything to prepare the pork, but then he doesn’t have styrofoam trays to put it on. He can’t deliver the meat despite solid demand and the customer’s shelves go empty. The customer thinks supply can’t be met due to unexpectedly strong demand, so they double order to make sure they have it. The pork supplier says he won’t be caught short again too… so he triple orders styrofoam. On and on…

As you go further and further upstream (that is, further away from the customer), these swings are more pronounced (that’s why it’s called the bullwhip effect – the handle of the whip barely moves, but the end of the whip – the upstream producer – swings massively up and down). Demand information has to travel up the chain, like the telephone game, before it arrives at the upstream supplier.

Is it any wonder we’ve seen a lot of these shocks and surges in pricing commodities?


To further explain, we had a massive, but short lived, demand shock in 2020. Companies halted purchases and decided to sell down inventory to better match demand in what they thought could be a depression or GFC 2.0.

Here’s an example from Atkore, a company that sells conduits around electrical cords for buildings, talking about this in May 2020. They are essentially saying they think demand is going down a lot so they are destocking in the channel.

What happened with Atkore? Well, demand held in very well. Pricing surged as they have commodity pass-throughs, so Atkore is going to do $900MM of EBITDA in ’21. Normally they’d do ~$300MM. They even are telling the street that it isn’t sustainable, yet street estimates still have them at $600MM of EBITDA in ’23 (likely a wet finger in the air)…

Here is another great one from Louisiana Pacific, which sells OSB (a type of plywood into buildings) as well as siding in May 2020:

Neither these companies, nor their customers, knew that demand would actually come roaring back. Inventories, in turn, would be *too* depleted, caught short, and prices surge.


Winter Storms and Hurricanes of 2021 Exacerbated Normalization

Let me add another piece into the mix. Chemicals. You know, the upstream products that go into everything?

PPG had a great comment on how much the Winter Storm Uri impacted 2021 in getting supply chains back to normal:

Yes, 95 plants (!!!) in Q1 2021. That surely can cause a disruption, tighten inventories, causing key input prices to surge… which they did for key plastics.

What are two key end markets for plastics and chemicals? Autos and housing.

Lyondell, another major chemical producer, but very upstream, noted in one of their earnings calls that they weren’t actually sure what demand is!

“We really don’t know where the real level of demand is because we’re so supply constrained.”

Now, Lyondell spun that as a positive, but that’s concerning to me.

In hindsight, it is obvious to see how that rippled through supply chains. But many smart investors are saying, “too much stimulus, so that has resulted in inflation.” That is way too simple. As prices rose, that had to be passed down the chain in a market desperate for supply. What does this mean for when supply relaxes?


Shipping Adds in Another Layer of Complexity

Another thing you can point to rippling through the chain is simply global shipping is normally deflationary (the more containers per ship, from low cost areas, the lower the cost per each individual unit). But bottlenecks prevented that.

In addition, in a globalized economy, high shipping costs can keep low-cost producers OUT of the market, driving up prices. If this happened in many industries, but you think shipping normalizes, why do you think those prices won’t normalize?

I bring up shipping because the constraints there caused further scrambling for orders, which again makes me think the bullwhip effect is on steroids – it is on a global scale.

Each of these things will be resolved. In some cases, I think we are already starting to see them being resolved. Shipping rates are coming down from peak, polypropylene and polyethylene prices are coming down as “supply has now outstripped demand”, steel is coming down from meteoric peak. Lumber ripped, fell, and though admittedly is coming back (though there are persistent supply / demand issues there).


No auto dealer likes having nothing to sell. No retailer wants to be the one without seasonal items for the holidays.

In fact, in an Odd Lots podcast, Joe Weisenthal and Tracy Alloway discussed how a small-fry customer can be booted from the container ship in favor of a large customer (a la Walmart). Companies are doubling ordering there too so they don’t get kicked from the boat. All this double ordering leads to very strong backlogs, but is it “real” demand?

Inflation in my mind right now is very much being caused by a supply chain issue and that will be resolved. It is inter-relatedly tied to these inventory & shipping issues.


I am actually very bullish for the next few years. I think we are operating in a very exciting time for investments. At the same time, I am highly cautious underwriting things right now that say they have amazing backlogs. The market is forward looking. As some companies burn through insane 1x earnings, I don’t think they will perform well.

I also think despite some podcasts and WSJ articles, investors are impatient and may ignore the bullwhip reality until they see it with their own eyes. If they don’t see the market “normalize” in 6 months, they tend to think we are in a “new paradigm.” I’m cautious saying much actually structurally changed post-COVID.

I’ve written up some things that still look cheap, like select retailers, but I would much prefer something like auto suppliers in the cyclical space where I think I have a high degree of likelihood of where production is going.

Oh, and by the way, this isn’t the first time we’ve seen something like this. Arguably post-GFC with China stimulus was similar (go back and look at what happened to commodities then), but that didn’t last. That said, this is on steroids…

3 thoughts on “What Keeps Me Up At Night? The Bullwhip Effect Plays Out”

  1. My first thought was: excellent point, this makes so much sense!
    The one thing giving me pause is why the restocking period is so much longer than the destocking period (15 vs 3-6 months or whatever). If you compare the downturn and upturn in e.g. copper prices since the pandemic started, they are not even comparable. Interesting…

    1. I think in this case, restocking has been exacerbated by global supply chain issues. Further preventing knowing what “actual demand is”

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