As expected, choppy market action continues after the massive rally off March lows runs out of steam. A combination of full valuations, rising Covid cases and a cooling in reopening data is leading to horrible action in cyclicals while the FAANG+ group keeps the market afloat. You can throw in European tariff comments, a higher likelihood of a Democratic sweep and China relations as well. Two steps forward, one step back.
A few weeks ago, the cyclical rally was led by stocks that benefit from a successful reopening and a return to normalcy. Airlines, restaurants, retailers and travel-related stocks were up 50% – 100%, in short order. Large jumps like these are unsustainable, and a retracement naturally occurs. Many of those companies are down 35% – 50% already, giving back a large chunk of those gains.
The rise in infections is certainly a reason to worry for that specific group of the market. These areas depend on foot traffic. To date, the number of daily deaths is still declining. However, protests and reopening efforts brought masses of people together, some in tight quarters. Masks help, but are not overly effective outside of N95’s unless you are six feet away from an infected person. Being outdoors helps too, but who knows what happens before and after tight gatherings. We are a couple weeks from the rush and unsurprisingly, the case count is rising. That is just domestically. As the Southern hemisphere enters their winter season and sees cooler temperatures, they are seeing record numbers of new infections for Brazil, India and South Africa.
To date, hospitalizations are only fractionally higher in most states. Hotspots like Houston are a bit worse. The newly sick are younger and show minor symptoms as compared to a few months ago. What concerns us is if the death rate starts to perk up in the coming weeks. The rate of decline in deaths has been a straight line down so far. Economically, that is great news. The closer we get to zero deaths, the better.
What the market is concerned with today is the action of consumers. Media hype around the number of newly infected and a 2nd wave (we’re still in the 1st wave) is already crimping consumer movement. By focusing on new cases and not the lower death count, people are scared. That is neither wrong nor right. Comfort levels vary person to person. There is no way to force one’s personal response to this.
The latest CDC data shows that 80% of Covid-19 deaths were from ages 65 and over. This represents 16% of the population. Under 35 was only 0.8% of the deaths and is 45% of the population. The plan was to flatten the curve, help hospitals from being overwhelmed and get herd immunity along with medical treatments. That plan is on track for the most part, even with the rise in new cases. It all changes if the death rate stops declining and accelerates.
The majority of America will not shut down again. That is not a big concern. People and corporations are. They decide if/when they are willing to stop isolating their families and store fronts. If mobility doesn’t pick up, this recession will last longer.
There was a reflex pop in May spending rates. Pent-up demand only lasts so long. Same with Government stimulus checks. Consumer spending surveys are already pointing to a drop in June. Apple, among others, is re-closing stores. That is not encouraging. Pair that with a fully valued market and you get a digestive, hopefully sideways, response. Stay-at-home beneficiaries keep winning while 2/3 of the market declines. That is not healthy.
This leads to a discussion of valuations, which Jim Meyer aptly touched upon already. I just have one metric to add. Sales are one of, if not the most critical aspect of, any business. What an investor pays relative to sales is important, as it can determine the upside or downside potential for a particular investment. Each sector varies and is dependent upon profitability of each $1 in revenues. For example, supermarkets only keep 3% of every dollar of income. That results in a much lower price to sales metric.
Software companies have high margins and are very profitable. They deserve a higher price to sales multiple. Microsoft#, for instance, trades around 10X sales. Zoom, which is up nearly threefold this year now trades at 40x sales. Snapchat#, which doubled this quarter, is at 17x current sales. Assuming sales are flat, investors in Zoom would need to collect every dollar in revenue for 40 years to break even. 17 years for Snap stock holders. This is excessive to say the least.
Even world class companies get out of whack on occasion. Semiconductor stocks are pricing in a much brighter future. Covid has pulled forward years worth of demand as corporations adjust to work-from-home, cloud based services and 5G. This means a boom in demand for chips. Intel# is the behemoth and trades at 3x sales. Nvidia#, which is up 60% this year and a world-class operator, is back up to 17x sales. That is not to say these are good buys or sells today.
Growth rates account for a lot of these disparities but you get the picture. The market is pricing in a lot of good news. Anything that alters the time line will affect stock prices. That is why the rise in Covid cases is so critical. In a few weeks, if we see the declining death rate take a turn upwards, future projections need to readjust. Consumers will hoard cash. Unemployment will be higher for longer. Businesses will keep cutting costs. Margins contract and earnings don’t improve enough to support equity prices. We are nearing a crucial juncture and we haven’t even made it to the winter months where the 2nd wave is expected to really hit.
Optimistically, this could prove the exact opposite. Healthcare officials have a much better understanding of the disease today. We know who it effects and how it reacts to certain treatments. Getting sick is normal. Dying from a virus is not. Crush the death ratio and many will get back to normal life as we await a vaccine for the high-risk group. The slowdown here may also force the Government’s hand and we may get a larger than expected July stimulus bill. Money would then flow back into the cyclical names and broaden out the rally. The fuel is there for either scenario. Prepare for the former and hope for the latter.
Ariana Grande is 27 today. Yankees great Derek Jeter turns 46. Parks and Recreation fans will be happy to know Nick Offerman is now half a century old.
James Vogt, 610-260-2214