David Garrity on Bloomberg: New ’Stay-At-Home’ Paradigm Favors Big Tech in COVID-19 Sell-off
1) Current Thoughts On The Market with S&P500 Down -24% Versus Wed 2/19 High:
In the spirit of the Chinese curse, “may you live in interesting times,” we are certainly in the thick of it at the moment as efforts to contain the COVID-19 coronavirus to China have failed. There are now 140 countries that have reported infections and the weekend has seen the announcement of radical steps such as major U.S. cities (e.g. Chicago, IL; Los Angeles, CA; New York, NY) taking steps to sharply curtail public activities as the U.S. Centers for Disease Control & Prevention (CDC) has issued guidance that events involving 50 people or more not be held for the next two months. Meanwhile, Trump administration officials on Sunday took to the TV talk shows to let Americans know that it will possibly take a few months before life returns to normal as part of an effort to “flatten the curve” of coronavirus infection to preserve healthcare system capacity in the face of the expected surge in cases, not a confidence-building move.
Clearly, economic activity is grinding to a standstill in the face of growing COVID-19 coronavirus quarantines. This is making it challenging to estimate global GDP growth and, of more immediate concern to investors, corporate EPS. A week ago, sources such as Bloomberg Economics estimate that economic fallout from the COVID-19 coronavirus could be as much as a $2.7 trillion hit to global GDP, a -3.1% decline from the 2019 level of $86.6 trillion. With China’s economic statistics for the first two months of 2020 (i.e. retail sales -20.5% y/y, industrial output -13.5% y/y, fixed-asset investment -24.5% y/y) indicate the likely COVID-19 coronavirus hit to the global economy will be worse than the -3.1% decline forecast previously. This in light of the uncertainty associated with expectations for the shape and pace of the eventual recovery.
Also, it is important to consider how COVID-19 coronavirus will have a lasting impact on consumer and business behavior, much as previous crises (e.g. Great Depression) have done. The likelihood is that the “stay-at-home, work-from-home” mentality will limit recovery for airlines and travel/leisure/tourism sectors and favor the technology providers that cater to the “stay-at-home, work-from-home” paradigm such as cloud computing (GOOGL, MSFT, AMZN), e-commerce (AMZN), distributed workforce productivity (WORK, ZM) and distance learning (TWOU) providers. The shifts here are significant as by some estimates approximately 10% of all workers are employed in the sectors experiencing a sharp, immediate reduction in demand from the spread of COVID-19 coronavirus.
In broader terms, COVID-19 coronavirus is having a negative effect to both supply (e.g. through supply chain disruption) and demand (e.g. consumers are hunkering down), so this is an economic shock that differs markedly from the 2009 Great Recession. Before addressing the question of the timing and shape of the expected recovery, it is best first to assess when the global spread of COVID-19 coronavirus might be expected to peak.
To that point, a RAND Corporation expert panel indicated that this is unlikely to occur until 2Q20 with the possibility of 3Q20 indicated. One important point from the panel is that the COVID-19 coronavirus may not abate seasonally and is likely to see multiple waves of infection. All this underscores the importance of developing a vaccine, a process likely to take until mid-2021. All this serves to highlight the vulnerable state the global economy will be in for 2020 and going into 2021.
2) Recent Economic Data Was Positive, But Does It Have Any Significant Meaning Now?:
On its own the recent February 2020 economic data was very encouraging, but it serves now only to set a baseline for how well the U.S. economy was performing before the containment efforts around the COVID-19 coronavirus failed. The Services PMI reading of 57.3 was a great number, historically consistent with 3% real GDP growth on an annualized basis. The U.S. Employment report of a +273,000 gain in jobs was very solid, coming well ahead of expectations. Nice economy we had here. Too bad COVID-19 coronavirus had to come ruin it.
3) Oil Price Collapse Should Serve To Stimulate Economic Activity, But Will It Now?:
Our thoughts in December 2019 when drafting the “Laidlaw Five” was that oil might reprise its exogenous shock role to the global economy with an upside spike stemming from hostilities in the Persian Gulf. That said, we did not anticipate that the production cooperation between OPEC and Russia would collapse. The ensuing moves by Saudi Arabia to seize market share from Russia now has WTI crude quoted at $29.05/bbl and Goldman Sachs is calling for crude prices to fall to the $20/bbl level.
Now, normally a collapse in oil prices would be seen as stimulative, but the demand environment with the COVID-19 coronavirus is quite different as consumers are hunkering down across the globe. Oil is historically a leading indicator commodity. With likelihood of oil breaking below $30/bbl, this price move does not bode well as it has negative implications for the high-yield bond market as well as for energy sector exposure for the banks. Also, with $45/bbl being the break-even level for the U.S. oil shale producers, look for U.S. employment in that sector to be cut back, something to add to the reductions noted above for the airline and travel/tourism/leisure sectors.
Meanwhile, away from the oil price move, there have been signs that China has been slowly ramping up production in an effort to restart global supply chains. This is based on weekday traffic volumes in major cities in China (Beijing, Shanghai, Shenzhen), but weekend traffic which reflects consumer activity remains depressed. These weekend traffic patterns are also becoming depressed in major European cities (Milan, Rome, Paris) and U.S. cities (Seattle, San Francisco, NYC). So, the takeaway from this data is that while China is trying to restart global supply chains, consumers are not buying but instead hunkering down. All we appear to be seeing from China is an effort to replenish inventory, but consumers are not drawing down due to the impact of the global spread of the COVID-19 coronavirus.
4) With All Of The Negative News Coming Out On Multiple Fronts, Are You Constructive On The Stockmarket?:
Mindful of historical performance that clearly favors equities, I consider myself to be a bull. However, with significant uncertainty around where 2020 earnings will come in, it is difficult to determine where a good entry point might be for long-term investors to step in front the current level of market volatility. With the global economy experiencing sudden retrenchment from COVID-19 coronavirus, it is challenging to determine where exactly corporate earnings might be thought to reach a trough level.
As chaotic as US equity markets may be, they are simply trying to discount normalized earnings power: the average of peak and trough bottom line results. A look at the last 2 recessions (2000 – 2002, 2017) shows the S&P 500 bottoms at an average of 13x prior peak earnings and 20x current trough. Assuming markets decide 2020 S&P 500 earnings will decline a not unreasonable -30% this year, that puts the floor on the S&P 500 at 2100, a level that represents a further -18% decline from current levels.
Meanwhile, our 2020 S&P500 target level of 3,420 is essentially in line with the Goldman Sachs bull case of 3,400, all of which is highly dependent on how rapidly the global economy recovers from the COVID-19 coronavirus pandemic.
5) Other Topics Investors Should Focus On At Present?:
Earlier we discussed the challenge of determining the likely parameters around the global spread of the COVID-19 coronavirus, one important subsidiary consideration is to determine what is the available healthcare system capacity to address the epidemic. Capacity is measured by hospital beds and the medical staff necessary to provide adequate levels of care.
One of the challenges the U.S. faces is that among developed countries it has one of the lowest levels of hospital beds per citizen. That said, we have reviewed analyses that indicate that at current infection rates, the available U.S. healthcare system capacity will be fully used up by May 2020. Clearly, there will need to be a significant U.S. government-led effort to increase the supply of hospital beds and medical staff.
Note that the draw on U.S. healthcare system capacity from addressing the COVID-19 coronavirus may crowd out patients with other ailments from receiving care. Stay healthy.