AIBC Covid-19 Report - Part 1
The outbreak of Coronavirus Disease 2019 (Covid-19) has disrupted society and the financial markets at a magnitude not seen since The Great Depression. With this catastrophic black swan event straining healthcare systems and crippling business activity, governments and corporations worldwide have scrambled to adapt to the crisis and mitigate its damage. At present, this crisis is also the single most significant event driving developments in the financial markets.
AIBC’s two-part Covid-19 report offers a round-up of the crisis. This article explores the crisis’ origins and its impacts on financial markets and on businesses across diverse industries. Part 2 (to be released next week – do stay tuned!) breaks down the policy response to the crisis and discusses its potential future trajectories.
Overview – Origin and Global Spread
In December 2019, 41 Individuals living in Wuhan, China was diagnosed with a virus that would come to be known as Covid-19. 27 of these 41 individuals had visited the Huanan Seafood Wholesale market. As the virus swiftly took hold within China, the initial spread outside of the country was largely contained within Asia, with cases emerging in South Korea, Japan, and Singapore in January. By the end of February, most countries in the Asia Pacific were dealing with Covid-19 to some degree, with enhanced border control and population quarantine measures beginning to be enforced across the region.
Over the period from late February to March, the Covid-19 situation escalates drastically in the western hemisphere to become a global pandemic (Covid-19 was officially declared a pandemic by the WHO on March 11). In Europe, the virus first took hold in Italy, with countries like Spain seeing a spike in cases soon after. The United States reported its first death at the end of February, with the infection and death rates increasing exponentially since then.
Overview – Current Situation
Wuhan city, the origin of the outbreak, has finally opened up from its mandatory lockdown after 76 days, with train stations and the airport reopening. Despite the initial explosion of cases, the present situation in China is relatively stable, with the growth in total cases reduced to only being in the tens per day.
Fig. 1.1 For countries like China and South Korea, which were initially at the center of the crisis, the spread of Covid-19 has been suppressed and contained to more manageable levels. The spread of Covid-19 is now heavily focused in countries in the western hemisphere. (Source: FT)
While the present situation within countries in the Asia Pacific is relatively stable compared to that in Europe and the US, measures to limit interpersonal contact, such as lockdowns and quarantining of visitors, have remained substantial. This is in view of a “second wave” of imported cases, stemming largely from the influx of people working and studying abroad returning to their home countries.
Europe and the USA
Despite not being affected by the initial onset of the disease in January, European countries and the United States are now the hardest-hit by the Covid-19 outbreak. Currently, the United States has the largest number of deaths out of any nation in the world, followed by Italy, Spain, France, and the UK. The United States also has the largest number of cases, with 819,321 (as of writing), which is almost as many as the next 5 most affected countries combined.
Most countries have implemented mandatory lockdown, and with no end to the crisis in sight yet, countries like the UK have extended their existing lockdown periods. Although the full effect of these measures can only be seen in the coming weeks, such policies may turn the tides against Covid-19, as it has done in some Asian countries. In many European countries, current infection trends mirror that of China at the peak of its domestic outbreak. While the present situation seems dire, the stabilisation of the situation in countries like South Korea and China offer hope that a turnaround can take place given that proper measures are implemented and complied with.
With the exception of the Chinese A-share markets, global equity markets were largely unaffected through the initial onset of the Covid-19 crisis. The US markets, for instance, were riding high, with the Dow Jones Industrial Average (DJIA), S&P 500 Index, and the NASDAQ Composite all hitting record highs in mid-February.
Yet as it became apparent in late February that the Covid-19 situation was going to have a significant impact on economic activity and corporate performance globally, the financial markets reacted resoundingly. In the week from 24 to 28 March, markets around the world logged their worst performance since 2008, as markets across the U.S., Europe, and the Asia Pacific simultaneously entered correction territory (a correction is defined as a >10% drop from the market’s 52-week high).
Dow Jones Industrial Average
The DJIA tracks 30 large companies trading on the New York Stock Exchange and the NASDAQ, and is amongst the most-followed indices (Source: CNBC)
The equity market sell-off accelerated in March. The Dow Jones Industrial Average (DJIA) dropped more than 2000 points on 9th March, its worst day since 2008, as investor fears over the global spread of Covid-19 were compounded by the oil price war between Saudi Arabia and Russia. This was followed by “Black Thursday” just three days later, where the DJIA fell 9.99% (2353 points, the single largest one-day drop since 1987 and the 6th largest in U.S. stock market history) and markets around the world saw steep dives, as President Trump’s announcement of a European travel ban failed to impress investors and the European Central Bank’s surprise decision not to cut rates further depressed market sentiment. Overall, in the period between late February and late March, the DJIA and the S&P 500 logged sharp declines of over 30%.
While the equity markets have since rallied on the back of drastic policy response and optimism that the spread in Western countries has neared its inflection point, equity markets remain depressed relative to their pre-selloff high. Through the market turmoil, many funds, including pensions, have been caught off-guard, taking sizeable losses. For example, New Jersey’s state pension had fallen by more than 13% year-to-date as of April 16th, and can only pay 40% of what it owes to its current and future retirees. On the other hand, some funds have been able to take advantage of the sell-off through short positions – U.S. shorts saw a one-month profit of roughly US$340 billion from February 19 to March 19.
Figure 2.2 The CBOE Volatility Index, more commonly known as the VIX, spiked in mid-March 2020 (Source: CNBC)
Besides the significant overall directional movements, the market through this stretch has also been marked by record levels of volatility, with securities logging wild swings on the day-to-day. This has created further market opportunities through employing volatility-based trading strategies (for instance, certain strategies bet not on the directional movement of securities, but on the degree of their price fluctuations).
Within the fixed income landscape, the yield on benchmark 10-year U.S. Treasuries dipped below 0.5% for the first time in history, sliding to an all-time low of 0.318% in early March before rebounding slightly since. This is in line with an unprecedentedly low interest rate environment – as the crisis evolved swiftly in March, the U.S. Federal Reserve cut interest rates to 0% through a series of emergency rate cuts, lowering the cost of financing in hopes of spurring the economy through encouraging borrowing and investing. (more on the yield curve can be found here)
Figure 2.3 The yield on 10-year U.S. Treasury notes dropped below 0.50% mid-March, and has remained at a low level (by historical standards) since (Source: CNBC)
While Covid-19 has significantly impacted the economy and the markets as a whole, this impact has been particularly marked in certain industries. Amongst the industries where present developments are leaving a landscape-altering impact are Consumer Retail, Hospitality, and Media & Entertainment.
Industry Impact – Consumer Retail
S&P 500 Consumer Discretionary Sector Index (Source: CNBC)
The impact of the Covid-19 crisis is particularly marked by companies in the consumer retail space. Industry players include apparel retailers (e.g. Nike, Foot Locker), variety stores (Dollar General, Target), and luxury fashion (e.g. LVMH, Kering). On 9 April, British multinational department store operator Debenhams went into administration as it faced piling rent liabilities and stagnant sales due to enforced lockdown in the U.K.. With many traditional retail segments already on a slow multi-year decline, a sustained Covid-19 crisis could well be the final straw triggering a retail apocalypse, bringing a wave of retail bankruptcies and store closures.
The impact and considerations for investors in the retail space are manifold:
1) Foot Traffic
While the secular shift of retail towards the digital space in recent years, sparked by industry disruption by e-commerce players like Amazon, has prompted retailers to build up their competencies in digital sales and shift towards an omnichannel model, most of these retailers still derive the bulk of their revenue through their brick-and-mortar presences.
Fig. 3.2 Change in consumer spending from 2019 for the week ending April 1 (Source: New York Times)
For brick-and-mortar sales, the hit from the Covid-19 crisis is devastating. In March, retailers like Nike and Gap announced sweeping store closures across their core markets. The present situation, with foot traffic and brick-and-mortar sales effectively 0 for potentially most of the year, is unprecedented in recent times. A shift in customer flow towards online platforms is unlikely to be able to offset this revenue shock, which could be multiple times that of even significant past downturns, such as the 2008-09 global financial crisis.
In the longer-term, there is also a concern that a prolonged crisis would lead to permanent shifts in consumer behaviour away from brick-and-mortar retail, as consumers become acquainted with and accustomed to shopping from home.
2) Cash Position and Liquidity
For investors in this space, the spotlight is more than ever on the near-term survivability and cash position of retailers. Retailers often operate with a significant degree of operating leverage, stemming largely from their “locked-in” long-term operating lease commitments. While sales tumble and store closures are enforced, the ability of retailers to scale down their cost base is extremely limited, resulting in significant cash burn over this stretch.
This tests the financial health of even the best-managed, cash generative retail companies, for it was impossible to anticipate such a shock – most retail companies are able to withstand a multi-quarter sales decline (as is the case in a “normal” recession), but are extremely unlikely to have been prepared for a complete halt in sales flow. This is reflected in a wave of corporate ratings downgrades of retail players over the past period, as the default risk of businesses in this space increasingly come under scrutiny.
3) Discretionary Spending Power
With the economy spiralling into a recessionary phase, the drop in household incomes necessitates a cut-back in overall spending, and discretionary retail spending is amongst the first to go. The impact is seen through the spike in retail collapse in the aftermath of the global financial crisis, only this time the situation is compounded by the further challenges described above.
Industry Impact – Hospitality
Hospitality is an industry that includes restaurants, hotels, amusement parks, cruises, and other tourism-related services. Core segments within this industry are undoubtedly amongst the most affected by the ongoing crisis.
Airlines and lodging are the two worst-hit industry segments in terms of consumer spending, with spending plummeting to near zero (source: Bank of America Research)
Fig. 3.4 Dow Jones US Airlines index (Source: CNBC)
Shares in major airline companies are all down more than 50% this year with air travel grinding to a near-complete halt. As a result of both mandatory lockdowns and disease fears, there is minimal tourist activity and thus flight demand, resulting in most airlines grounding a large portion of their fleet. As major airlines increasingly face cash issues, with minimal cash generation coupled with looming debt obligations, many are struggling to stay afloat, with insolvency being a very real threat – on April 20, Virgin Australia went into voluntary administration, with the Covid-19 shock being a final blow to the already-struggling airline company.
As a result, several airlines have looked to their governments for a bailout package to help keep them afloat. For instance, a group of U.S. airlines has reached an agreement with the U.S. Treasury for a $50bn bailout comprising of loans and payroll grants. This has presented an interesting debate, with many claiming that small businesses should be prioritised in the case of government bailouts, seeing that 99.9% of US businesses are small businesses. Should the present situation be sustained, such emergency measures may yet prove insufficient, and the fate of many airlines around the world remain unknown.
Closer to home, Singapore Airlines have decided to raise capital by issuing SGD$15bn to shore up its balance sheet in an attempt to stay afloat.
Occupancy rates in hotels are at new lows – for instance, Marriott International reported occupancy rates of less than 15% in China and less than 25% in Europe and North America. Several notable hotel stocks have also dipped more than 50% this year, with the underlying businesses crippled by the steep plunge in tourist activity.
Fig. 3.5 Shares of Choice Hotels International Inc (blue) and Park Hotels and Resorts Inc (green) both booked significant price declines, cratering in mid-March (Source: CNBC)
In countries like Singapore, the government has stepped in to lend a helping hand to hotels and resorts by housing quarantined citizens and patients in such facilities. This move not only eases the strain on hospitals, but also taps on the now-available capacity of hotels and resorts, offering them vital business and facilitating them in staying afloat during this crisis.
Much like air travel, cruise line operations have ground to an abrupt halt, with major cruise companies halting operations and mothballing ships. On top of the crippling revenue hit, cruise companies have further been mired in controversy as cruise ships became hotbeds for the Covid-19 virus. For instance, several hundreds of the 2700 passengers and crew of the Ruby Princess Cruise Ship have tested positive for COVID. Cruise operators have increasingly come under scrutiny for failing to disclose the scale of ship-borne infections before allowing passengers to disembark, risking all those living in the port destinations and accelerating the virus’ spread as thousands of potential Covid-19 carriers alight. As of early April 2020, at least 6,000 passengers remain “stranded” at sea aboard cruise liners.
Industry Impact – Media and Entertainment
For the media and entertainment industry, the crisis has left mixed impacts on diverse industry players. The domain of cable and streaming entertainment presents a compelling case study for how the current crisis poses distinct impacts on players within a broad industry segment.
For companies with streaming services as a core revenue pillar, the positives are apparent. With the present lock-down, the general populace is spending a significantly higher proportion of time at home. This has translated into a sharp uptick in time spent on entertainment offerings available from home. According to WarnerMedia, time spent by viewers on its HBO Now streaming service saw a 40% spike in the week following March 14 relative to the previous 4-week average, with daily binge-viewing (3 or more episodes per session) soaring 65%.
For relevant companies, it is interesting to see how this viewership spike is translated into more monetizable metrics, such as paid subscription signups. Initial indicators are promising – between Saturday, March 14, and Monday, March 16, Disney+ signups more than tripled compared to the same period a week ago, with other streaming services HBO Now, Showtime, and Netflix also booking strong gains of 90%, 78%, and 47% respectively. The present situation has clearly presented a compelling boost for these companies’ revenue stream and customer acquisition efforts – going forward, the longer-term financial impact hinges on the ability of these service providers to minimise customer churn and adequately monetise this enhanced user base.
Fig. 3.6 Shares of Netflix Inc (blue) and Walt Disney Co (green) have trended differently since the onset of the Covid-19 crisis. It is of note that a significant source of Disney’s share price decline has been a shut-down of its physical operating segments like its theme parks and resorts. (Source: CNBC)
An interesting development in this space is that of the cancellation of high-key sporting events, such as the NBA and the Olympics. For streaming services like Netflix, this eliminates a core substitute for their service offerings, and directs more viewers, who would originally opt to catch a sports game, towards alternative leisure and entertainment channels. On the other hand, this has severely disrupted a revenue stream for companies like Disney and Fox. Disney, for instance, owns and derives ~$11bn annually from cable sports market leader ESPN, while Fox counts its set of Fox Sports platforms as part of its core business. For these companies, the sudden and potentially sustained suspension of their core content has left them scrambling to fill air-time and retain viewership. This has also sparked the concern that with viewer migration from cable to streaming already being an increasingly significant trend over past years, a prolonged suspension of core cable content could be the trigger for a sizeable, permanent exodus of cable subscribers.
Policy Response and Potential Crisis Trajectories
The Covid-19 crisis has critically disrupted lives, markets, and business operations, and the full extent of its impacts on societies and markets is yet to be seen. In Part 2 of the AIBC Covid-19 Report next week, we look at what policymakers have done in a big to alleviate the damage, and explore core potential developments the trajectory of the crisis hinges on.