It’s been nearly three months since economies around the globe started going into lockdown due to the COVID-19 pandemic. But as the number of cases in certain regions begins to decline, there’s plenty of discussion about reopening economies that have been severely impacted by policies aimed at stopping the spread of COVID-19. So far in the US, more than half the states have started to reopen their economies, and others have plans to do so.
Here in Canada, Ontario has put together a framework for reopening the province, and has started to lift some restrictions. Other provinces, such as British Columbia and Quebec, have also begun to lift restrictions. But there is still much uncertainty about what will happen after the removal of restrictions. Will there be an uptick in cases of the virus? Will people feel safe leaving their homes to resume work and other regular activities? Will economic activity pick up enough to improve the situation for the large number of businesses hampered by the shutdowns and help save those that are on the brink of collapse?
Lifting the restrictions will not magically cure the damage that has been inflicted on the economy. Economic data shows that this will be the worst recession since the 1930s. Almost 21 million Americans lost their jobs in April and the country’s unemployment rate, which was 3.5% before the pandemic hit in March, has climbed to almost 15% – an unprecedented increase in a matter of months. This compares with peak unemployment during the Great Depression of almost 25% in 1933 versus 3.2% four years before that.
As a result of the coronavirus, growth expectations for the world and the US are in negative territory for the year and US and European growth forecasts for the second quarter are well into double-digit negative territory. EU President Christine Lagarde warns that growth for the region this year could come in at -14%. If these forecasts materialize, growth contractions during this crisis could outpace those experienced in the Great Depression. In 1930, GDP declined by 8.5%, then 6.4% the year after and 12.9% the year after that.
The pandemic has hardest hit the travel and Leisure (hotels, airlines, and restaurants) sector. Warren Buffett’s Berkshire Hathaway recently dumped all holdings in four US airlines, citing the unfavourable conditions and the large capital requirements of the industry. Other sectors adversely affected have been energy, financials and industrials. In a vote of no-confidence, Berkshire Hathaway surprised the market by selling down most of its holding in Goldman Sachs and cutting back on its exposure to JP Morgan.
While the pandemic has shaken the playing field for the travel and leisure industry, we believe that there are some well-run businesses in this and related sectors that have the potential to do well going forward. We are currently spending time evaluating these opportunities.
The energy industry has been knocked sideways with the sudden-stop in demand for crude oil causing considerable dislocations in the pricing of the commodity and supply concerns adding to the sharp downward pressure on the price.
The agreed-upon OPEC+ 10 million barrels a day supply cuts in April did little to prevent crude oil prices from going into free-fall. In an unprecedented move, the price for West Texas Intermediate (WTI) futures contracts maturing in May fell to almost -$40 a barrel as investors panicked about the glut in oil supplies and attempted to offload the futures before the contract closed out.
Analysts anticipated that oil producers would run out of storage and some producers had to resort to keeping the oil on tankers floating at sea. But as the tankers fill up with no place to go there is a potential problem for producers who will need to shut-in more production.
However, the storage problem, while a concern, may not be that big an issue because there is more storage available than estimates imply. Typically the working capacity of the storage units is beneath the maximum capacity as there is some contingency space in the storage tanks. There have also been other solutions to the storage issue, such as Enbridge converting an unused section of its Mainline pipeline system to a storage facility.
OPEC+ responded to the bargain basement prices by cutting production by a further 1 million barrels per day. Also, as economies come out of lockdown, the build-up of crude oil supplies is likely to slow. Thus, while the situation is not entirely bullish, it is less dismal than many market analysts are predicting.
The main question is if, and when, demand for crude will reach pre-pandemic levels. Many oil traders are warning that it may be a year or more before this happens. Recent actions by global energy giant Shell are cause for concern. The company has cut its dividend, while others, like Chevron and ExxonMobil, have meaningfully cut capex given the uncertain outlook for the energy industry.
As leaders battle, through a process of trial and error, to get their economies back on track, there are some structural changes that may transform the way we do things well after the pandemic is gone.
1) The pandemic has resulted in half of US workers working from home, and it has highlighted that far more people can work from home effectively. Thus there is a growing consensus that many people will continue to work from home after the crisis is over if they are given the option. Some companies are already doing so. Twitter, for instance, has announced it will allow all their employees to work from home permanently should they wish to do so. A Gartner survey found that almost three out of four finance leaders planned to move at least 5% of their employees to a full-time, remote working arrangement.
2) Another structural change expected is a decline in people’s willingness to congregate. With strict distancing measures in place, seating capacity at restaurants will decline, home delivery will increase, and travel will decrease. Attendance at restaurants and sporting events at stadiums are likely to take the longest to resume, and there could well be some permanent impact on the number of people willing to attend significant scale events and regularly visit sit-down restaurants.
3) The pandemic has exposed the lack of access of many to affordable healthcare in the US and other countries, which has set a series of reforms in motion that are likely to result in lasting, positive changes to healthcare systems.
The US Congress has passed two pieces of legislation that require private insurers, Medicare, Medicare Advantage, and Medicaid, to cover COVID-19 testing for all citizens after millions of recently unemployed could not afford to cover these costs. The pandemic has also strengthened the case for universal access to healthcare regardless of insurance or employment status, in line with Canada’s healthcare system.
4) The COVID-19 crisis is likely to see governments improve their welfare or social nets. Many US citizens have experienced food insecurity and have come under extreme financial strain.
The idea of a basic income has been floated in Canada and, in immediate response to the crisis, government has instituted the Canada Emergency Response Benefit (CERB). The program pays beneficiaries $500 a week for up to 16 weeks if they have not worked for 14 consecutive days as a result of COVID-19. More than seven million Canadians have applied for the benefit, and the federal government estimates it will spend $35 billion on the program.
5) Although retailers are hoping they will experience a quick bounce back once the economy opens up again, there are signs that the resumption in consumer spending may not be as fast as expected. China, which is leading the curve in reopening its economy, has eased its lockdown but is finding that consumers are not spending, with sales of furniture, clothing, household appliances and jewellery falling between 25% to 30% in March year on year.
Consumers appetite for spending has been dampened by the shock of the shutdown and the pressure this has put on their sense of financial well-being. Many Chinese consumers are prioritizing savings so that they can build up a cushion of savings to rely on in the event of future crises.
Just as the pre-coronavirus Americanized Chinese big spenders may be changing their spending habits, so may other consumers around the world.
European unemployment has risen at a slower rate than the US. The Eurozone unemployment rate rose 0.1% to 6.6% in March compared to the more than trebling in the US unemployment rate. But the latest growth figures show that the Eurozone contracted by 3.8% in the first quarter. Consumer confidence in both have been decimated so it could take a while for consumer spending to revive in these two economic powerhouses.
Dismantling the global supply chain
The coronavirus has laid bare the vulnerabilities countries and companies face when they rely on global supply chains. The US has already begun to dismantle the Chinese supply chains on which its industries are dependent and are looking at ways of incentivizing companies to source and manufacture supplies locally. However, it will be a considerable challenge to turn the tide, with many US companies’ manufacturing operations and suppliers firmly entrenched in China.
The US-China tariff agreement is again at risk as President Donald Trump increases his criticism of China for, he claims, not alerting the world early enough to the threat the virus posed. In an escalation of his anti-China stance, the Trump administration recently directed the US federal employee retirement fund not to invest some $4 billion in Chinese investments as planned.
Waiting on a vaccine
The world is not going to be able to put the coronavirus behind it once and for all until a vaccine is developed, and, to date, there is no cure in sight. The European Medicines Agency says the expectation that a vaccine could be approved in a year is an optimistic scenario. However, the European countries and the World Health Organization are pursuing multilateral initiatives to fast track its development. In contrast, China and US are going it alone. There are reportedly about 100 vaccines in the testing phase by pharmaceutical and biotech companies around the world. Once the vaccine has been developed, the next major challenge will be to produce it in large enough quantities to distribute it worldwide.
Are the shifts permanent or transitory?
There are a lot of coronavirus investment themes floating around the financial markets and talk of a “new normal”. While some businesses were well situated to benefit from the lockdown, for certain other companies (like those transitioning to online), COVID-19 has simply expedited what was already in motion. Still, others are just beginning to adjust to this new normal.
Ultimately, the success of such investments themes will depend on whether the changes we see today are permanent or merely transitory. Our primary focus, as always, is on companies that we believe will do well regardless of the presence of the coronavirus. Admittedly, some of these companies may fare better without this virus, but nobody knows when the coronavirus will be eradicated. We will not invest in a company for the long-term where the thesis or value is solely dependent on the presence of the virus.
We need to believe in the longer-term implications of the change. One has to ask, if, by some miracle, we were to find a vaccine in short-order, would a business investment based on such a theme still be viable? For the record, I do believe a lot of the technological adoption and work-space changes resulting from the impact of the coronavirus will have lasting effects as this unprecedented situation has opened our eyes to how we can do things better.
On the other hand, if a vaccine is way off in the distant future, we need to understand the conditions under which government and health officials will reopen the economy, and how consumers will react knowing there is a virus lurking out there. Much of our behaviour will be dictated by our ability to flatten the curve, preventative measures, or whether we can find a vaccine. I sense that human nature will simply drive us back to what we have always done and are yearning to do, and that is to congregate and be social given enough time, and even if this means embracing new ways of doing so.
Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm with a dedicated team of investment professionals that manage investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 20 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at gpowell@allvista.ca