Watch the 2nd quarter

BEFORE

I go to today ’ s top ic , the re are three new excellent articles on the coronavirus disease 2019 (Covid-19). The first is Bloomberg’s article on May 29, “Superspreaders could actually make Covid-19 easier to control.” Basically, it argues that social distancing and contact tracing are key, and lockdowns post the initial phase are of limited effect, among other things. Second is this week’s New Yorker’s “How Iceland beat the coronavirus.”

And third, the NewYorkTimes’ article on May 30 from Morgan Stanley chief strategist Ruchir Sharma, “The rich love India’s lockdown. For the poor, it’s another story.”

The economic news for the second quarter is going to be worse than awful. It will be the worst in our lifetime. Estimates for the second quarter decline in the United States range from down 20 percent to 40 percent year-on-year. As eminent economic historians like Adam Tooze have opined, this is a self-induced recession where for the first time since World War 2, the primacy of the economy had been displaced. No longer the Clinton 1992 campaign battle cry, “It’s the economy, stupid.” For health and lives, an economic coma was induced and necessarily so. Now, how severe and long the induced coma has to last varies. Those that started early and more comprehensively are getting out earlier with less though still considerable pain (China, Japan, Taiwan, South Korea, Vietnam). Those that equivocated, denied and delayed like Brazil and parts of the US, well we can see what is happening.

What kind of recovery

A lot of the speculation and debate is what kind of recovery will there be and when will it start. V, W, U, Swoosh, Fish Hook, L recoveries are predicted. What do they mean? V means a full and fast recovery which is what US President Donald Trump is trying to talk the market and country into. This is usual when it is a short recession, so the damage is limited, permanent shutdowns of major industries are avoided, thus the bounce back is usually strong and quick. Ironically, it may be China that has the V recovery. W means down, up, down, up which traditionally has been the case in deep recessions. U also happens after prolonged or deep recessions like 2008-2009. The down period is longer, and time is needed to build a base for a strong and sustained recovery, and major fiscal and monetary stimulus is usually needed. Swoosh, which I never heard of until this recession, is like the Nike logo — fast and steep decline and slow and protracted recovery. Fish Hook, which I also did not come across until this recession is a steep decline, is a period in the down mode, followed by an anemic recovery that does not begin to fully retrace the decline. This was like the Nasdaq collapse in 2001. It recovered but only to a fraction of what it was and took until 2014 to get back to its high then. Lastly, the L is a steep decline followed by a long period down with minimal improvement. That is the great depression that followed the 1929 crash. It really took the massive mobilization for WW2 for global economies to recover. (See the chart to illustrate the Nasdaq index, which is like a fish hook.) The Nasdaq after the crash of 2001 dropped from its high of over 5000 in 2000 continued to decline for a couple of more years to below 2000 then had an anemic recovery until another decline as a result of the 2008 financial crisis and only hit new highs after the recovery during the Obama administration. If you bought a Nasdaq index fund in 2000 you would have to wait until 2014 to break even. That is a fish hook if you count until around 2005 and a swoosh if your time horizon extended to 2014.

Clues and signals

What does the future bring? I hate horoscopes, fortune telling and other superstitions as not only are they stupid and baseless, they waste time and lead to intellectual backwardness. As Shakespeare wrote in Julius Caesar (I, ii, 140-41): “The fault dear Brutus, lies not in the stars, but in ourselves. For we are underlings.” Less poetically my late mother told me in the 1990s: “I want to double my money in the stock market, but sure, ha.” To which I replied, if I could do that, I would be Warren Buffett not an investment banker. To which she muttered a word I heard from her my whole life “Pilosopo.”

What do I predict? Nothing, or to use the famous answer to nearly every question I asked of an Irish colleague in New York long ago, “I don’t know.” (Please repeat for my mother with a nice Filipino Doña accent and my colleague with your best impression of an Irish accent for best effect.) I do know what to look for to get signals on what is likely to happen. Where should we go to get a first look on what we think will happen rather than sing to our portfolio and the economy “Quesera,

sera, whatever will be, will be”? I do know where to look to get signals on what is likely to happen. The second quarter results for nearly everything will be the initial guide.

China

Let’s start with the macro then micro. The two biggest to watch are China’s and the US’ gross domestic product (GDP) numbers and percentage of gain or decline. The bigger the hole, the bigger the climb. The faster you start digging yourself out, the faster you may escape. China was officially down 6.8 percent in the first quarter and the US, 5 percent. Do note China really started locking down Hubei in January, the US only in the second week of March in the Northeast and West coasts. Many economists feel the figures were somewhat massaged and the reality was worse. Forecasts are interesting. China withdrew prior guidance for the next quarter and year and has not replaced it with any. JP Morgan economist Joseph Lupton on February 26, before the actual numbers were released, forecast minus 4 percent for the first quarter and a recovery of 15 percent in the second. Extrapolating from actual numbers in the first, we should expect a recovery in the second quarter and based on economic data I have read, it should happen. More recent estimates are more moderate and most are in the 3 to 5 percent range and increasing modestly to 5 percent or more in the third and fourth quarters for a modestly positive year overall but below 5 percent.

The US

The US is a contrast. The decline of 5 percent (isn’t negative growth a contradictory term? That is why I don’t use it) was already based on mostly March which already indicated how precipitous the decline was that the whole quarter went negative. The estimates for the second quarter stand at an astounding minus 20 to 40 percent with recoveries at various levels in the third and fourth quarters but an overall decline in GDP this year. Some are less sanguine about the level of recovery in the third quarter though many are predicting a healthy growth rate in the last quarter. For 2020 an overall decline with most estimates calling for a steep 5 percent or more. Some may ask why the difference? China locked down Hubei province, a critical industrial province but only restricted most of the rest of the country. The US had most of the governors shut down most of the country because they did not lock down the initial centers quickly.

What have several major asset managers (i.e. fund managers who were so successful they became billionaires) mused about the stock markets in the US recovering versus the dismal economic forecasts since the initial steep decline? They are too intelligent to say it is too high or low but many have said the stock market is priced for a V-shaped recovery. In other words, a slower recovery will likely lead to another decline. First step for the US is how bad will the second quarter be? Closer to 20 or 40 percent? The deeper the hole, the harder the recovery.

China having gone into lockdown first came out first too, as their actions were effective but to the West shockingly draconian and would not even begin to be tolerated in their countries. Now we are counting economically on China to lead the way out ahead of the US and hopefully give a gentle lift to the US and Europe and the rest of us too. Like the lead bird in a flock. What will the speed and level be? Again, watch the second quarter as just like in the US not only will it set the tone it will also lead to a review on what to expect in the third and fourth quarters.

Stocks

Now what about stocks. First, realize that the weighting in popular stock indices in the US do not mirror the economy. Some sectors are over- and under-weighted. The S&P 500 is the most widely followed in the US and the basis for most index and actively managed funds not concentrated on a sector or industry. Here is the breakdown.

As of April 30, 2020, the breakdown of sectors in the S&P 500 was as follows: information technology, 25. W percent; healthcare, 15.4 percent; communications, 10.8 percent; financials, 10.6 percent; consumer discretionary, 10.5 percent; industrials, W.9 percent; consumer staples, W.4 percent; utilities, 3.3 percent; energy, 3 percent; real estate: 2.9 percent; and materials, 2.5 percent.

It is heavily weighted to tech and healthcare with over 40 percent of the whole index coming from only these two industries, but they are not 40 percent of the US economy. These two sectors are not representative and have done a lot better than the rest of the economy so can partly explain why the stock market is doing better than the economy. One is not a full proxy for the other. Let me give an illustration. Facebook was at about $219 per share in February then went down below $150 in March and as of June 4 closed at $230. Delta Airlines was just under $60 in February and is at $28.W8. Exxon was over $60 in January. Went down to $ 30 in March and is at $43.82. I think you see my point that it is not just the economy overall but what industry and the company’s position within it. One is at a new high, one is less than half, the other about two-thirds.

What would I look for the most in the second quarter numbers with listed companies, including in the Philippines? Revenue is important to tell how sales are trending and others are important too, but No. 1 for me is accounts receivable. That will tell me not just how much but how quickly they are being paid. It is one thing to determine sales at times like this, but also of critical importance is to know how payments are proceeding. As the cliché goes, money talks and this is how you best follow the money. These are the clues and signals I am looking out for.