If you’d gone away for a silent meditation retreat last week, you’d have come back to find your portfolio little changed and would have remained fairly calm, but only until you turned on the news. The S&P 500 finished last week roughly flat, but the violent ride from Monday to Friday was anything but calming and reflected the ebb and flow of good news and bad. As we said in last week’s commentary, the number of virus cases is certain to increase and heighten concern. We continue to formulate strategies to best take advantage of the gyrations and to achieve our clients’ long-term portfolio objectives. There are opportunities for adjustments that adhere to the lessons of history (don’t try to time the market) but go beyond simply sitting tight (make smart trades).
Over the weekend, we learned that cases have surpassed 109,000 globally and Italy has instituted a regional shutdown affecting one-quarter of its population. China achieved great success by shutting down swaths of the economy and its new case load has declined dramatically. OPEC appears to have fallen apart after its efforts to secure production cuts were stymied by Russia’s refusal to cooperate. Oil prices are plunging again – bad for the energy sector but good for any company or household which pays an energy bill (all of them). COVID-19 test kits are now arriving across the U.S., which will help get a better handle on the infection’s spread, but will also drive case numbers—and general fears—higher.
The impact on stocks has been anything but uniform. Travel and leisure, financials, materials, and energy stocks have been hardest hit. Healthcare, consumer staples, and even some information technology companies have fared far better. These dislocations create opportunities, but whether this temporary shock turns into a protracted recession has become a growing concern.
Fear is bound to rise despite good news about the U.S. economy. While the U.S. employment number was surprisingly high on Friday, investors recognized that it only tells us that the economy was strong heading into this crisis. Can it tell us anything about economic prospects? The U.S. labor market remains very tight, and unemployment dropped slightly to 3.5%. Firms continue to struggle to find and to secure new staff. As we emphasized last week, this pandemic will most likely cause a temporary demand and supply disruption to the U.S. and global economy, even if it reappears next fall and winter. In the face of a temporary reduction in demand, and temporary disruptions to global supply chains, will firms reduce headcount and face the risk of not being able to rehire their skilled workers when this abates? We have seen some firms respond to temporary disruptions in the past by furloughing (but not firing) skilled workers, in order to be able to ramp up quickly when demand returns. That seems more likely in this case since supply chains are already being repaired as China factories ramp up.
The key word there may be “skilled.” The travel and leisure sector will be hurt more than others and those providers rely less on skilled workers than other sectors, such as financial services, information technology, and chemicals. We could see widespread layoffs at movie theaters, cruise lines, airlines, hotels, restaurants, and theme parks. Then again, summer is approaching and, if China is a guide, COVID-19 infections may abate in time for seasonally peak demand for many of these companies. The contagion may also slow as the weather warms, as with the flu, although experts remain unsure about those prospects. Even in northern Italy on Sunday, where a regional shutdown went into effect, restaurants and cafes continued to do a booming business. Do U.S. operators of movie theaters, theme parks, hotels and restaurants want to let even unskilled staff go now and then try to rehire them in two to three months? It’s possible, but even then, summer hiring needs suggest an uptick in unemployment within many of these areas would be short-lived.
Investors should always be prepared to ride out recessions by setting holdings of equities and fixed to comfortable proportions. The severity of COVID-19 for the U.S. economy over the coming quarters remains highly uncertain, but the tight U.S. labor market and high costs of searching and hiring new workers suggest that firms will be reluctant to initiate mass layoffs in the face of a temporary demand hit. Forecasts point to slower GDP growth in Q1 and Q2, with rebounds starting in either Q3 or Q4. We have also yet to see stimulative fiscal policy actions, but those are likely coming in the U.S. and elsewhere, and those could help mitigate the drag from supply chain disruptions and declines in spending. Ultimately, the response of companies within travel and leisure and beyond may depend on the size and persistence of the virus’s impact, and that will depend on the efficacy of treatment, the fatality rate, and the prospects for vaccine deployment next year. Some may suffer a long-term decline in business, but even there, we are seeing some company valuations which have built in a more severe drop than is likely to persist indefinitely. This is a time to adjust holdings to take advantage of buying opportunities where valuations have dropped significantly more than probable declines in long-term earnings power.