Picking winners in the pandemic stock market
A great brand or business model is only part of successful formula, Diane Francis writes.
The gradual reopening of society as COVID-19 infection rates ebb is welcome news, but the pandemic’s effects on the economy are far from over. This is what is behind the market correction this week.
The biggest casualties, in economic terms, will be any business that was marginal, new or unprofitable before the crisis struck. Their prognosis is dim and most will remain permanently shuttered or limp through a lengthy recuperation process. Sadly, the victims will include many of the small, immigrant-owned or family owned restaurants and convenience stores. But equally vulnerable will be the large, established retailers with tiny margins and high rents in posh locations. Many will suffer or disappear.
An April survey of 86,000 small American businesses showed that 31 per cent of owners said they had already gone out of business and 11 per cent expected to fail within three months if current conditions continued. Taken today, those numbers would undoubtedly be worse.
Overall, economic conditions will remain lousy for everyone until a vaccine eradicates the pandemic and the requirement for social distancing. For instance, even though Starbucks weathered the storm, it recently announced that it will be closing hundreds of its stores, including up to 200 in Canada.
Stock markets are searching for three types of companies: those that benefited from the crisis, those that will do well after a vaccine is discovered and those that will benefit from the failure of others, or from consolidations. These survivors will rationalize their own operations, but also snap up competitors, thus shrinking the total number of jobs in the economy. Underpinning their business model is the reality that the economic pie will shrink rapidly and then grow slowly over a number of years.
So, hunting for the consolidators and reopening champions is the name of the stock pick game. But having a great brand, business model or organization is only part of the formula for success. Those with low debt or no debt are preferable, most other things being equal, than those saddled with overheads. Thus, some are picking the less-encumbered United Airlines over the indebted American Airlines, or lean discount chain Dollar General versus over-stored Macy’s.
Businesses that have prospered — such as Zoom, Microsoft, Netflix and Amazon — also bode badly for the rest. For instance, remote work means less commercial real estate will be needed, maintained and managed. Online shopping means the permanent disappearance of stores, malls and jobs. Home entertainment, such as Netflix or Microsoft’s video games, means the demise of many cinemas, theatres, arenas, museums and theme parks.
Rent relief has propped up some public-facing businesses, but social distancing requirements in the absence of a vaccine blow up any business model based on clustering or gathering — sports, entertainment, transportation, cruises, theme parks and eateries. Put simply, a reduction in seats or tables available to customers equates to a disaster in terms of revenues. If a restaurant is restricted to using only half its tables — and cannot double the cost of its food — it is doomed. Same applies to airplanes, trains, theatres and ball parks.
Despite all this, as the economy tanks and falters, the stock markets are booming. This is partly because stock markets, mostly punters in small volumes, have been optimistically overstretched, casting about for the Zooms and vaccine makers who will sail through this mess, irrespective of its duration. Now they are doing the same searching for the reopening or comeback kids. These are companies, according to stock pickers, that hit bottom during the crisis and will bounce back during the reopening. This includes companies like Carnival Cruises and Boeing. I question this logic, but go figure.
My own take is that a vaccine is at least a year away and this economic catastrophe will go down in history as a “flash depression” that will dog economic growth and job creation for half a decade. It’s not Armageddon, but it’s certainly tragic for all the victims.