Stocks rallied once again yesterday but finished well off their morning highs. The economic news continues to be poor but survey data, which is real-time, suggests that the low point was in early April, the time of maximum quarantine. As the country slowly reopens, and the emphasis is the word slowly, investors will be watching to see the pace of pickup. Whereas early on there were hopes of a V-shaped recovery, now the buzzwords you hear regularly are “check mark”, signaling a sudden slowdown and a slow recovery that could take years to complete.
A lot of that is priced into the market. Look at the shares of Disney#, which reported earnings last night after the market closed. Shares are down about 1% this morning after Disney reported poor earnings and a dismal near-term outlook. While the new Disney+ streaming service is off to a fast start with well over 50 million new subscribers, its theme parks are all closed and so are movie theatres. Disney offered some hope. Its Shanghai park will open May 11, and it still has a slate of summer movie releases on the schedule. Universal has had some success recently introducing new movies via pay-per-view, and that is an option open to Disney as well. Thus, there is some hope. Disney’s stock clearly already reflects the shutdown of parks and the closure of movie theatres. But the stock, after rallying sharply off the March lows, has stalled as investors surmise the recovery is likely to be slower and more difficult than originally thought. However, it isn’t like the shares are falling off the cliff. The Disney franchise is solid and when the virus passes, whenever that might be, investors are confident that visitors will return to theme parks and its film franchises will find waiting audiences.
Nonetheless, the emerging vision of the world clearly has its haves and have-nots. Disney is caught in the middle. Covid-19 proved to be an accelerant for its new streaming services. It has been perfect timing to start a new service when everyone is locked up at home looking for something to do. But theme parks and movie theatres aren’t going to be crowded until the threat of virus dissipates. When is that? Your guess is as good as mine. Clearly, not this year. Hopefully before the end of 2021.
For Disney the crisis sears the income statement. But it isn’t life threatening. The same cannot be said for cruise ships, airlines, or restaurants. While Carnival bravely talks about a few cruises this summer, Norwegian Cruise lines is contemplating bankruptcy. Airlines face the same dilemma. Right now, few want to travel on crowded planes. Airlines are flying at less than 10% of capacity. Despite relief money from the government, airlines could be near bankruptcy before the fall in some cases. JC Crew filed for bankruptcy yesterday, Neiman Marcus is preparing a pre-packaged bankruptcy filing, and JC Penney isn’t far away. Hertz is another company that is so damaged that recovery without entering bankruptcy seems almost impossible. The number of restaurants that won’t reopen will be in the tens of thousands, maybe much higher.
While we can see over the abyss, that doesn’t mean every company can get there.
On the other hand, what the virus does is accentuate advantages of those with strong hands. By strong hands, I mean great balance sheets, good management, and the ability to move quickly to take advantage of the changing landscape. One also needs to throw in a measure of good luck. Supermarket chains were struggling under intense competitive pressures before the virus. Now they are seeing strong double-digit sales comps and record profits. On the other hand, gas stations are all open, but no one is driving. There isn’t much they can do to help themselves.
All these economic factors show up in the stock market. But the biggest factor aiding stock prices is the impact of the massive stimulus efforts of the government to combat the effects of Covid-19. By flooding markets with money and handing out trillions of dollars to companies and individuals to compensate for lost business and lost jobs, the effect has been to lower interest rates and, less directly, raise P/E ratios. The equity risk premium, a measure of the spread in valuation between stocks and high grade bonds, has risen even as earnings collapse. It sounds perverse, but it is real and likely to be long lasting, at least until the excess capacity created by the virus and all the governmental counter measures are fully absorbed.
The most puzzling thing to individual investors is wondering how stock markets can rise during periods of terrible economic news. The answers are two-fold. First, stocks look ahead. As noted, the worst impact of the economic shutdown is behind us. Second, government reaction in times of economic crisis is almost always to flood markets with liquidity. Not all the liquidity is spent immediately. The rest is invested.
At the beginning of this note, I talked a bit of companies that are being severely impacted in a negative way by the virus. Most of those are obvious. There are fewer companies that are benefactors. I mentioned supermarkets. Clorox keeps setting new highs. But when life returns to normal, even a new normal that gets adjusted by the virus, are these going to be the best investments? Maybe not.
There are real trends, many of which have already been in place, that will accelerate due to the virus. I suspect Disney+, for instance, will keep the vast majority of its viewers. But the real trick is to think a bit more out of the box. Betting on Amazon may work, but there isn’t a person on this planet that doesn’t recognize the trend toward on-line purchasing. CVS# reported good earnings this morning. It is one of those fortunate companies deemed providers of essential services in most states. Besides pharmaceuticals, it also sells toilet paper. We can argue in these days which is more valuable. But less obvious to many is the transformation CVS is making from a drug store that also sells sundries up front to a full-scale integrated health care company. At least for the next few years, we are all going to be more aware of our state of health. That means more use of instore clinics, more drug testing, and more preventive measures. CVS doesn’t just operate drug stores. It also is the middleman in the pharmaceutical distribution chain and owns Aetna, a major healthcare insurance company. While it has been criticized as a villain causing high drug prices, in fact it has been working to deliver quality care at lower costs to individuals. Good companies succeed when they provide customers better values and outcomes. The virus has helped steer business CVS’s way, but the real story is going to be whether CVS and all its subsidiaries becomes a bigger part of our lives in the future.
The message is to think out of the box. Look at the world after the virus passes and decide not just who wins and loses, but how the world will change as a result. Will it change our online behavior, how we communicate, where we shop, how we spend leisure time, the consumption of healthcare, or the impact of new technologies? Answer those questions correctly and you will be a successful investor.
Today, Meek Mill is 33. George Clooney turns 59. Bob Seger is 75.
James M. Meyer, CFA 610-260-2220