Complacent market bulls got mugged by data this week. It wasn’t pretty.
But before we address the data, let’s back up a bit.
Wall Street has a contingent of smug optimists who (still) expect everything to bounce back quickly. From where we stand, this viewpoint is almost bizarre. Its very presence inspires armchair psychology hypothesizing.
Is it magical thinking? Data blindness? Devotion to Norman Vincent Peale gone wrong?
Perhaps it’s a reliance on “gut feel” ill-served by novel developments (no pun intended).
Or maybe it’s a kind of Dorothy and the Wizard of Oz syndrome, wherein those who pine for the old bull market (2009-2019 R.I.P.) close their eyes and click their heels and chant, “there’s no place like home.”
People can believe weird things sometimes. Really, really weird things. So weird that it tempts the observer to wonder, silently if not out loud, “What in the heck is going on inside your head for you to believe that thing? What side issues do you have going on because, man, just — what??”
For example, take the idea that things are going to be “normal” a few quarters from now.
The logic appears to go like this: With a quick return to normal consumer behavior, and back-to-normal earnings and profits, the events of first quarter 2020 should be written off as a mere blip — a temporary discount mechanism shunting stocks into the bargain bin, or even the “buy of a lifetime” bin.
Back to normal? In a quarter or two? Really?
As we write these words, a red banner flashes across the CNBC website: “New York Gov. Cuomo to order all people to wear masks or face coverings in public.”
Yes indeed, right on the ol’ path to normalcy!
But getting back to the strangeness of this “normal’ invocation, and the idea that earnings and revenues for well-known companies will achieve normal any time soon:
Let’s try a simple thought exercise involving Starbucks.
Imagine going to your local Starbucks this fall. It’s a crisp October day, you’re craving a hot drink, and mandatory mask-wearing hasn’t dampened your mood.
Is Starbucks going to be packed with a line to the door?
Not if everyone is still wearing masks and practicing a scaled-back version of social distancing.
Then, too, who will want to stand in a Starbucks line circa Fall 2020 — or even Spring 2021? Who will want to sit elbow to elbow at those little tables with strangers nearby?
Heck, who will want to “hang out” in a Starbucks at all, even just for ten minutes? Some people will, but what greatly reduced percentage of the population will that be, relative to all the casual customers who liked Starbucks before?
Maybe Starbucks will remove half the tables and chairs in order to provide more space. Maybe they will also mandate more line spacing — a minimum of two feet ahead and behind (or something to that effect).
In fact, states like California might force Starbucks to do this regardless, along with all other coffee shops, restaurants, and so on. California governor Gavin Newsom is already discussing potential anti-crowding rules when shops and restaurants return. No more packed dining areas or compressed checkout lines by order of state decree.
The establishments in question may hate this, but governors likely won’t give them a choice. And their customers may want the built-in distancing buffers anyway, simply to feel more comfortable.
(And by the way: The more horror stories the public consumes about COVID-19 side effects, the more that average Americans realize, “You really don’t want to gamble with this thing.” This is gradually turning social distancing into a naturally embraced habit, rather than an imposed mandate.)
And yet, on a Starbucks revenue-and-profits basis, if you take out half the tables and chairs, and require the line to be spaced out, you are going to kill unit revenue on a permanent basis.
Lower crowd densities, spaced-out seating, and longer lines (with fewer customers per line) will result in lower product turnover, which in turn means lower revenues, lower profits, and lower earnings per share.
Then, too, some portion of sales will be lost permanently, because if someone looks at a distance-elongated Starbucks line and changes their mind about ordering a pumpkin spice latte, that lost latte order never comes back. It’s not like two lattes get ordered later to make up the shortfall.
And if that pumpkin spice latte craver gives up Starbucks entirely, a whole string of future orders is gone.
Maybe Starbucks customers will just go to the drive-through instead of going inside.
But then again, have you ever sat in your car in a Starbucks drive-through line? It’s like entering an alternate dimension where time has slowed down.
A greater emphasis on drive-through sales (via greatly reduced walk-in sales) will depress revenue and profits too, via slower delivery and reduced quality of experience.
Then, too, the real economy has been smashed by layoffs and work stoppages, and a lot of ordinary folks — those who earn a buck in “the real economy” — used to enjoy a regular four-dollar frappe-grande-mocha something-or-other at least a few times per week.
In a great many cities and towns, Starbucks was one of the guilty pleasures of the ordinary income earner — not the most efficient way to spend a paycheck, but low-impact in the big scheme of things, and worth it for the immediate pick-me-up.
Those marginal sales are gone now, too — for a really long time, if not forever.
When economic circumstances force the great majority of working Americans to nervously eyeball their wallets, and heave nickels around like manhole covers, the first thing they cross off their discretionary spending list is Starbucks, and other marginal indulgences like Starbucks.
Besides, coffee lovers with a newly tight budget can buy a Keurig machine — 59 bucks at Walmart these days — and enjoy a hazelnut coffee with cream in their own kitchen at 40 cents a pop, no sitting in a drive-through line or standing near strangers required.
Starbucks revenue won’t go to zero, of course. The point is that it won’t look anything like “normal,” either. Not for a very long time, and maybe not ever again.
As for “normal,” the only realistic normality to expect is that, when Starbucks fully opens again in your town or city, profits will be lower because turnover will be lower, simply by dint of post-pandemic logistical realities and fewer people splurging in the first place.
Now take the Starbucks template and project it out to any consumer brand that relies on discretionary purchases (the sale of something consumers like or enjoy at the margins, but don’t really need) and layer in the realities of “permanent social distancing buffers” on top (spaced out lines, fewer tables, and so on).
What do you get with that recipe?
Lower revenues and profits on a structural basis — not just for a quarter or two, but over the much longer term, in part because the tail impacts of a real economy crisis can stretch out for years, and in part because behavior shifts that last for a year or more tend to show permanence.
Ah, but what about a vaccine?
Weren’t they just saying in such-and-such place that so-and-so pharma company had a promising lead? Couldn’t the arrival of a vaccine be a “game changer” in terms of getting consumers de-masked and back to normal quickly?
If only it were true. We would deeply prefer the reality where a vaccine quickly ends all this.
But a key thing to consider, in hoping for a vaccine-powered deus ex machina, is the reason why vaccines take so dang long in the first place.
The timeline for developing a vaccine is obnoxiously long not because of the discovery process at the front end, but the incredibly stringent safety protocols on the back end. Coming up with a promising configuration in a lab is one thing. Making sure the vaccine is safe to mass-inject into a billion people is another thing entirely.
Before bringing a coronavirus vaccine to market, absolute safety has to be demonstrated with iron-clad assurance. How else could you stick it into a billion arms? This in part includes making sure the “inoculum” of virus exposure in each dose is properly calibrated. Imagine getting that wrong!
The safety vetting process is a separate challenge from initial discovery, and mass manufacturing and distribution is yet another layer of complexity to be worked through. It will all take a while.
As to the data mugging mentioned earlier:
“The economic data is even worse than Wall Street feared,” an April 15 CNBC headline blares. “The economy is clearly in ruins here,” the headline adds for good measure.
Of course the March data was worse than Wall Street feared. The place is packed with analysts who look backward rather than forward, who rely on rules of thumb rather than real-time analysis, and who lean heavily on outdated models that need to be thrown away.
March retail sales reportedly fell 8.7%, the biggest single-month drop in the history of the data series. Car-buying, furniture, and eating and drinking revenues were all down more than 25%.
We all knew March would be bad, but Wall Street was shocked into a wake-up call anyway.
Meanwhile, on the banking front, JPMorgan Chase reported that first-quarter profits were essentially vaporized, that defaults were rising, that things could get far worse, and that second-quarter unemployment could hit 20%.
The International Monetary Fund (IMF) darkened the mood too, as the New York Times reports:
The International Monetary Fund issued a stark warning on Tuesday about the coronavirus’s economic toll, saying that the world is facing its worst downturn since the Great Depression as shuttered factories, quarantines and national lockdowns cause economic output to collapse.
The grim forecast underscored the magnitude of the shock that the pandemic has inflicted on both advanced and developing economies and the daunting task that policymakers face in containing the fallout.
With countries already hoarding medical supplies and international travel curtailed, the I.M.F warned that the crisis threatened to reverse decades of gains from globalization.
In terms of corporate earnings, a single month doesn’t matter. From a long-term perspective, entire quarters can be ignored if the future looks bright enough. This is because stock valuations are based on a stream of future cash flows that extend well into the future, not the input from any lone month or quarter. This is why the market, when it chooses, can look past today’s bad news and focus on a brighter future.
And yet, when talking about structurally negative behavior changes that last for years or even become permanent — in an environment where 70% of workers have been hammered and 70% of the U.S. economy is built on consumer spending — Wall Street should be paying attention, and shedding pollyanna optimism, and adjusting equity valuations lower.
Our advice? Forget Starbucks, forget Hilton Hotels, forget all the “iconic brands” that consumer-tilted value investors so love to wax eloquent about, even if they appear cheap.
That whole retail-driven thesis, and any “buy ’em cheap” value thesis dependent on resurgent consumer behavior as a catalyst for justifying valuations of old, is at risk of being blown out of the water by a deeply impaired consumer spending outlook, coupled with the long-term behavioral impacts of sharply reduced incomes and semi-permanent social distancing measures, in a broken real economy that could take years to heal.
Instead, if you want a sector to be bullish on, look to gold stocks.
As we have said repeatedly in these pages — and expressed aggressively through our actions in TradeSmith Decoder — this is the best environment for gold stocks in 40-plus years, in part because the fiscal and monetary powers that be are spewing out trillions without actually fixing anything.
You don’t need consumer retail to bounce back impressively (not gonna happen) in order for gold stocks to go vertical. Instead you only need the perceived value of the dollar, and most other fiat currencies along with it, to head toward confetti status — and we are seeing that happen at an accelerating rate.
Then, too, in a world where central banks have lost all control, and are frantically pushing on a string, the old “normal” is nowhere in sight. What counts for normal these days requires assimilating facts on the ground in real time. Like mandatory mask-wearing, it will take some getting used to.