As I mentioned in our letter to clients last Friday, these are unprecedented times. I again want to acknowledge that the SARS-CoV-2 pandemic is a tragedy and I am deeply sorry for those that are affected. However, in my role as CIO of North Pier, I am often asked to bring a logical viewpoint to a highly emotional issue. Please do not mistake my use of statistics to imply that I don’t feel deeply for the human lives affected and lost in these trying times. I know full well that each datapoint discussed in the following analysis represents actual people and families and I feel deeply for them.
I want to reiterate my statement in my letter to clients on March 13th that this is a panic-based selloff. Yes, the panic is based on a serious, unfamiliar, and destructive pandemic, but it is still a panic, nonetheless. There is no question that there will be a significant short-term financial impact on the U.S. and global economies. The magnitude is completely unknowable. Those who engage in conjecture are partaking in sensationalism or projecting fear, denial, or outright hubris. There is simply no way to forecast the trajectory of the U.S. economy beyond the very immediate future. We simply have never dealt with anything like this and can only guess at what is to come beyond just a few weeks. Even that short period has too many variables to accurately forecast.
Statistically speaking, we are fortunate that the outbreak here in the U.S. occurred approximately a week into March, meaning that first quarter GDP data will only reflect the impact of approximately three weeks of crisis-level inputs, added on top of what appeared to be a strong January and February. Though the end of the quarter will represent a dramatic pullback in activity, Q1’s numbers will exhibit only a glimpse of the true impact of COVID-19. The real question that will remain unanswered is the fate of Q2, which lies in the hands of the trajectory of the virus.
Along the way, we will receive several datapoints that will reveal the extent of the collapse in U.S. consumer and business-to-business activity. The first arrived today, with the first round of layoffs hitting the initial claims for unemployment data. The Department of Labor announced that initial unemployment claims for the week ending March 14th increased by 70,000 to 281,000.
We must brace for an increase of several million people being added to this statistic over the coming two months, as most companies had not yet reacted to the initial ramp up of the spread of the virus in the U.S. as of March 14th . Up until last week, continuing claims (those continuing to collect unemployment benefits) had been holding steady at under 2 million for nearly two years. Prepare to see that number triple, or more, in the coming two to four weeks.
Demand destruction in the travel industry as well as the government mandated closing of restaurants and other social gathering areas could well add six million to that number alone. As a reference point, airlines laid off less than 50,000 employees in relation to the September 11th attacks. The hospitality industry reported laying off 30,000 workers due to the attacks and the corresponding drop in travel industry demand. Snippets of anecdotal news stories coming out of MGM, Marriott, the state of Ohio, and other sources indicate that these 2001 numbers will pale in comparison to today’s. The Bureau of Labor Statistics estimates that there are over 10 million jobs in the leisure and hospitality sector. The National Restaurant Association lists over 15 million people as employed by the restaurant industry, with 7.5 million of those employees in states that have already closed or limited restaurant services. It is easy to conceive that at least 25% of these jobs could at least temporarily be in jeopardy. That would lead to 6 million new claims for unemployment in those sectors alone. Given the data rolling in, it is quite possible that we will see as many as 2.5 million or more of those claims in the coming two weekly reports.
It is highly likely that we will challenge the nearly 7 million in continuing claims that we saw at the peak of the financial crisis. However, it needs to be noted that almost all of these jobs will be rehired by these essential industries as soon as the quarantines are lifted, and the virus is arrested. Whereas it took five years for unemployment to return to pre-financial crisis levels, a large portion of these jobs would return in just six short months once the virus is behind us. The key question is… when will that be?
As I stated, to conject on the severity of the impact on the U.S. economy is nothing more than guesswork. The reason is because the fundamental input in the equation is how bad the virus spread will be in the U.S. and international communities and how long it will last. Regardless of the models used, members of the government, the finance community and even the healthcare industry are applying a very small sample set of prior virus progressions that broke out during a different time in the seasonal calendar in forming their models. And importantly, they are projecting viruses that had completely different demographic characteristics and subsequent public responses to SARS-CoV-2 (the base virus leading to COVID-19). Make no mistake – they are guessing, plain and simple. And so am I. However, I argue that the best chance we have at navigating through this fog is to not rely on low probability guesses based on prior pandemics, or even past financial crises. At times like this, you focus on what you actually know.
The only true models that we have that might be of use to us are of the actual outbreaks of COVID-19 in different countries. Here, we have two mature models and two that are beginning to mature. Firstly, China and S. Korea have seen nearly a full cycle of the path of the virus. The ‘isolation’ response of those two countries has proven highly effective. Once their societies greatly reduced interpersonal interactions, both China and S. Korea were able to quickly beat the virus down to benign levels of spread. Within one month from the time that the outbreak began to reach critical mass in those countries (cases exceeding 1000 in total by our definition) both countries began to see meaningful reduction in the number of new cases.
Though the timing of the enactment of social distancing and the severity of policy implementation has varied in China and S. Korea from the measures deployed by western Europe and the U.S., in the end, the result hopefully will be the same – growth rates of the virus declined below 1.0 X, signaling shrinkage.
Further evidence that this may be a reliable pattern can be found in Iran. Iran experienced a rapid acceleration of the virus less than three weeks ago. There too, isolation measures have begun to evidence containment, with seven consecutive days of significant suppression of the growth rate of the virus. (Today’s new case numbers are not reflected in the graph to the right, but they showed a drop of over 4% from the day before). Though it is premature to be fully confident in the data coming out of Iran, the latest signs are very encouraging. The coming days/weeks will tell whether we will see a meaningful descent in the number of new cases there as well.
Even Italy, which has suffered the most severe outbreak, may have seen the growth rate of the virus begin to slow meaningfully over the last five days (also approximately three weeks after the number of cases in Italy eclipsed 1000). Germany, France, and Spain eclipsed the 1000 infected mark approximately two weeks ago. Will their growth rates abate in the coming week or two as well? So much more stands to be learned in just the next several days.
We have taken massive action as a global society. In the U.S., the private sector began social distancing two weeks ago, with many major companies eliminating non-essential travel and industries canceling conferences. As early as March 6th, the South By Southwest festival (popularly attended by multi-discipline thought leaders) cancelled, unleashing a wave of such actions. On March 11th, Live Nation postponed or cancelled all upcoming concerts. Last week, the NBA and NHL voluntarily suspended their seasons and most concerts were cancelled across the nation. This was a remarkable step rising out of the private sector; a collective consciousness that was willing to sacrifice personal (or corporate) interest because it was the right thing to do. Some local governments were quick to respond. Santa Clara County (home of San Jose, California) was one of the most notable, instituting its ban on gatherings of over 1000 on March 9 th (thus impacting upcoming home games of the NHL’s San Jose Sharks).
These early adopters created a domino effect unleashing large gathering bans, “shelter in place” mandates, and restaurant closing directives. One can be critical of our state and Federal government’s response if one so chooses. Regardless of your viewpoint, substantial action has been taken and is continuing at the private, public and personal level. And it absolutely will have an affect on the spread rate and eventual containment of the virus. Slower or faster, we will follow the patterns set before us of countries that have adopted similar social distancing and isolation measures.
As I mentioned in our letter to clients last Friday, “One thing is almost certain, at some point, the equity markets will have overreacted. This point may already have been surpassed, or potentially won’t be seen until the sell-off capitulates. The progression of the virus will be a large determinant of that revelation.” So, are we there yet? Again, a lot of that answer depends on the length and severity of the COVID-19 pandemic. However, at times like these when trying to sense a valuation bottom in a market crash (and I have seen more than a few in my 30 year career), it is best to focus on what you actually know, not on conjecture.
One solid place we have routinely gone to is price-to-book values on banks. Apart from the 2008 financial crisis (a time when banks’ book values were seriously in doubt and transparency was made worse by suspension of market-to-market reporting under FASB 157) bank P/Bs have been a good indicator of a bottom. Bank assets are usually readily ascertainable compared to, say, the value of patents for a biotechnology company. When banks trade at a deep discount to their book values (even if those values may come down somewhat due to a crisis like this), you are frequently near a bottom in the overall markets, at least from a valuation perspective. So, where are we? I’ll let you decide. How different is today from the 2008 financial crisis or the European Debt Crisis in 2011? (Remember the PIGS?) Again, the path of the virus will likely dictate.
Sooner or later, we will recover from this. If the virus lasts any longer than the very best case scenarios, overleveraged companies or those with just in time revenue needs and high fixed costs will still suffer greatly… and some will never make it back. But from those ashes, new leaders (and employers) will emerge to take their place, as consumer consumption of goods and services will surely return to stride. Other industries will bounce back quickly. Still others are continuing operations, only mildly impacted. Even if it takes a while to get fully back to norms, the ascent will be rapid. The current impact to the economy is largely one disrupting ‘business as usual.’ It is fundamentally unlike the financial crisis, where there was a grossly inflated asset bubble in a core staple of American life – housing. Housing took approximately four years to bottom, and several more years to see new construction reignite. Hospitality will mostly return in less than 12 months once we are safe to interact in public once again.
Beyond just a simple recovery to look forward to, something even greater will emerge. The way we interact will be (and already has begun to be) fundamentally changed. Who among us hasn’t heard the phrase, “We will meet via Zoom” less than a dozen times in just the last week alone? Virtual connections have been possible for over a decade, but their uptake has been shockingly slow in the broader business community. Now everyone is forced to meet this way. As the old adage says, it takes 21 days to form a new habit… well we only have 14 more days to go folks.
This will spawn a new age of interconnectivity. How about shifts in work life balance? Companies that are not part of the gig-economy are quickly adapting to virtual work life. Once we prove that we can accomplish much from our own kitchen tables, won’t we adopt a more commonsensical approach about where we need to work and when? I, for one, am optimistic regarding the ingenuity of the American worker and our entrepreneurial companies. As they say, “necessity is the mother of invention.”
However, it’s not just new ways of life that will spawn new growth opportunities as we recover. Let us not forget that America’s growth was actually being restricted due to the tight 3.5%- unemployment labor market. Where I sit as an institutional consultant, I get to interact with C-level officers from a wide variety of industries, locations and sizes across the U.S. on a regular basis. For two years now, I have consistently heard from employers that they were starving for new talented workers, especially those at a reasonable rate. Many positions were going unfilled or were being filled sub-optimally. This is the trappings of a full/over-employed economy. According to USA Today, a survey conducted just last week by UBS “found that 26% of business owners plan to hire workers even if the outbreak worsens.” We at North Pier, are one of those companies and apparently, we are not alone. Hiring may be put on pause temporarily at some companies, but as the dust settles, there is a pent-up appetite that is not being factored. Some of it will persist post-COVID-19.
Some industries will actually be hiring because of the virus. Amazon recently announced that it will be hiring 100,000 new workers to meet the massive demand in consumer staples. Healthcare and related industries will also likely take up some of the slack, at least temporarily. As sad as it is, there are also dozens of states that have already reported that they will increase hiring to meet the impending influx of unemployment claims (after years of benign activity in those offices).
Lastly, I am encouraged to hear from our clients (many of which are in the hospitality and services industries) that most are not terminating employees outright. Many of those that are reducing their active workforces are furloughing those employees with the intent to reactivate them as soon as possible. With assistance from Congress on the way to American families and likely to many American businesses, perhaps all we will need is to tighten our belts for a short while to get through this. And here is where we find one more piece of good news. Unlike 2008, when American families were beyond leveraged going into the financial crisis; this time most Americans are actually in reasonably good financial shape. Americans have been on a savings boom since the financial crisis, with household savings rates challenging 8% of income recently. This, coupled with low interest rates, has led to household debt service as a percentage of disposable income to sink to 50-year lows. Though it is true that many workers in some affected industries like food service will not likely share this cushion, it is a significant positive factor that must not be ignored.
There is still more darkness ahead. More questions than answers. But just a few short weeks, or even days, can shed light on this mania and give us more solid direction. As I said last week, to focus on the mania and try to predict the unpredictable is to engage the insanity. I have tried to stay grounded in the facts we have at hand for this analysis, what little they may be. There are slivers of hope in there if you look for them. As more becomes clear, one way or another, we will keep you apprised of our thoughts. Until then, may you and those you know and love stay safe and stay grounded.
Wishing you all the best,
Jim Scheinberg CIMA
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The information and statistical data contained within are from sources which North Pier Fiduciary Management, LLC believes to be reliable but is in no way warranted by us to accuracy or completeness. Source for selected data and charts: JP Morgan, U.D. Dept. of Labor, YCharts,com, Statista.com and Worldometers.info. North Pier does not undertake to advise you as to any change in figures of North Pier’s views. This is not a solicitation of any offer to buy or sell securities or services. North Pier, our affiliates, and any Officer, Director or Stockholders, or any member of their families, may have a position in and may from time to time purchase or sell any of the securities mentioned herein.