From Iowa to China

The flooding in our nation's heartland is bad enough. But in taking a global view it is clear that we are not alone. The worst floods in 50 years in Guangdong, China are starting to take a toll on factories and finished goods inventory across all industries - including apparel and footwear. Not to diminish the pain being felt by US farmers, the floods in China have affected 5.8mm people (equal to twice the size of the entire state of Iowa). It's vital to step back and look at the progression of Mother Nature's wrath in China - debilitating snowstorms in February, Sichuan earthquake last month, and now the flooding. Three's a charm.

Capacity growth (measured by number of factories) was already slowing headed into the year. But now we're seeing an increasing number of factories close their doors. As I've been commenting on, migrant workers are not showing up to work at the seasonal peak when they are needed most. Add on the fact that we're seeing minimum wage increases better than 15% in certain provinces (18% in Shenzhen on July 1) as well as raw materials head higher, and the outcome is not good. Also keep in mind that in advance of the Olympics, the Chinese government instituted mandatory back pay for vacation days at bottom-tier factories producing lower-end product with questionable labor standards. Clearly, this serves as a financial 'incentive' for the factory to take up its mix and work standards (making China look better while in the Olympics fishbowl), or pay the penalty. Yes, another example of the sheer power of the Chinese government to push its own agenda at the expense of anything remotely resembling capitalism.

Bottom line, costs will continue to rise. Yes, they have already gone up, but they will accelerate in 2H and make their way into the US supply chain by 1H09. Short weak content and distribution (SKX, ADS, DKS). If you need exposure here, long brand strength (NKE and even UA), as well as turnarounds who can sidestep this impact (FL).

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