Stocks finished the second quarter with a solid rally. It was the best Q2 in more than two decades, following the worst Q1 over an even longer span of time. For the first half, stocks were down about 4%, although the tech heavy NASDAQ was actually up for the first half of the year. Thus, in a six-month interval where Covid-19 went from a back-page story to full pandemic, when central banks provided virtually unlimited liquidity, and where unemployment went from record lows to over 20 million Americans, the stock market, when all was said and done, did nothing.
While that may be true, assuming one did a six-month version of Rip Van Winkle and just looked at the beginning and ending numbers, anyone who has lived through the last six months would hardly describe what happened as very little change. The pandemic brought with it significant winners and losers. Most of us didn’t know what Zoom was in December. Many of us haven’t been in a restaurant or on an airplane in three months. Some of us haven’t even left our homes since the pandemic hit. Personally, I haven’t been to an ATM machine in 2020. Cash is no longer king. Cashless is.
Obviously, any company in the right place at the right time benefited. Zoom did update video conferencing and was on a path to success before the pandemic. But it was the pandemic that made it a household word. Similarly, while airlines collectively are some of the least admired companies in the world, their behavior isn’t what stopped everyone from flying. Supermarkets flourished as restaurants died.
But perhaps what was most remarkable was how quickly the best managed companies adapted to sudden change. Auto companies made ventilators. Paint companies made hand sanitizers. Fast food restaurants found ways to shorten drive-thru times and boost sales. Stores overcame mandated closures by directing customers to order online and pick up at the curb, or have the product shipped directly to them. If you couldn’t get to the restaurant, the restaurant brought the meal to you.
But look down Main Street. Look at all the shuttered stores, the ones that gave up. Yes, many had a website before and still do. A few orders trickled in, but not many. What happened was that the best got bigger and many of the small shriveled up. Some died. Others will. The best always gain market share in tough times. They are better capitalized and better managed. The biggest are public companies. Many of the small businesses are beneath the radar of the stock market.
But small business is America’s employer. Their inability to operate is why 20 million Americans remain unemployed. We will see the June figures tomorrow. Based on recent unemployment claims data, don’t expect much improvement.
If you look at the stock market closely, a 4% loss in the first six months is really a collection of big gainers and big losers. The gainers were companies in the right place at the right time, plus those that adapted quickly to the changing environment. That doesn’t mean that all earned more this year than last year. Few did. But it means that the winners have set themselves up for a much stronger future when the good times roll again. And they will.
The losers, similarly, fall into two buckets. Those in industries that are permanently impaired by changes directly related to Covid-19, and those who simply sat still or moved too slowly. The pandemic accelerated change. Those that speeded up and adapted were the winners. Those that played a pat hand did not. Some simply couldn’t change. The aforementioned airlines are an obvious example. Ditto cruise ships, indoor dining, event centers, etc.
While we are taking a closer look, maybe it is worthwhile to dissect the two quarters of the year so far. In the first quarter, stocks were rolling ahead until the pandemic hit home. Like the disease itself, markets weren’t aware of the pandemic’s presence until it was too late. When the news hit home and we all began to stay home, stocks fell 35% over 5 weeks. But just as in late 2008 and early 2009, central banks around the world provided enormous liquidity. This happened with an exclamation point in late March. Thus, while stocks hit their lows before the end of the first quarter, they began to rally during the last week of March. The rally didn’t save the quarter from being the worst in decades. But it served as a harbinger of what was to come in Q2.
Q2 saw markets recover the majority of losses to date. Even the companies in the epicenter of the storm came roaring back. The price of oil doubled, although still well below last year’s highs. Airline bookings are up 6-fold or more from their lows. But they are still down over 70% from normal pre-pandemic levels. Cruise ships are still idle. Restaurants are slowly reopening, and even theme parks now plan to open either this summer or soon thereafter. We might even see a shortened baseball season.
But with that said, life isn’t quite a bed of roses. As we have seen most recently, letting down our collective guard is causing a bit of a relapse. It isn’t that business is reopening too fast, it’s that many of us, especially those under 30, are disrespecting the dangers of Covid-19. The young aren’t going to die from this disease any more than they are going to die from the flu. But they will infect co-workers and relatives who will be more at risk. If there is truly good news out there, it is that nursing homes have adapted. They were the source of 40%+ of the deaths early on. Now they are testing better, treating better and isolating sooner. They haven’t eradicated Covid-19, but they have limited the risks substantially.
With all this said, the reopening celebration came to an end in early June. For the past three weeks, markets have taken on a new behavior pattern, one that may be the harbinger for Q3, just as the last week in March was the harbinger for Q2. The rally of the have-nots has stopped. Yes, airlines are filling up again, but the traffic numbers don’t approach levels necessary to be profitable, and the most profitable trans-oceanic flights remain grounded. Banks have allowed forbearance on loan payments during the quarantine period, but that can’t go on forever. Meanwhile, low interest rates mean they will make less money on the good loans. There is no solution in sight. Yes, someday the recession will end and Covid-19 will go away. Unlike 2009, we are not afraid that banks are going to die. But it will be a long time before their earnings power is restored. Oil prices have recovered to a point where low-cost wells can now make money, but drilling new wells is still a losing proposition.
On the other hand, technology is the DNA for online commerce, streaming media, and medical discoveries. Companies that facilitate all these trends are flourishing. The pattern of the last three weeks suggests an even wider gap ahead between the haves and the have-nots. The haves keep making more money, while the have nots continue to fight a survival battle. The stocks of the haves continue to rise, while those of the have nots are stuck in place.
There is another layer to the market action that is less visible. Look at the defense stocks. They have been acting terribly of late. I don’t think we can blame that on Covid-19. Instead, I would posture that this group is the stock market’s proxy for the odds of President Trump winning reelection. Whether Trump is better for the economics of the defense industry than Biden isn’t the point. Markets perceive he will be better. If defense stocks rally, I surmise that means investors think the odds Trump will be reelected are rising. Obviously, over the past several weeks, those odds have been dwindling. It is a very long time to Election Day, and I am not in the political forecasting game. But markets are, and I would suggest that watching how defense stocks act is as good an indicator of the election as any poll.
Thus, the markets are telling me that the Covid-19 winners will continue to outperform the have-nots. That suggests the market is saying that the end of the pandemic isn’t close at hand. We will continue to reopen in the weeks ahead, but normality is still over the horizon somewhere. Q3 is likely to be very different than Q1 or Q2. The tea leaves suggest a bumpy quarter without a strong overall direction, at least as we see it now.
Missy Elliot is 49 today. Pamela Anderson is 53. Dan Aykroyd turns 68 while Deborah Harry (better known as Blondie) is 75. I don’t usually mention deaths, but Carl Reiner was a big loss at 98. Today also would have been the 59th birthday of Princess Diana.
James M. Meyer, CFA 610-260-2220