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April 17, 2020

What started as a standalone case from an outdoor meat market in Wuhan district in China, has now become a global pandemic, the worst of its kind. From 1 isolated case, to almost 2mn cases globally, from cases in 1 country to ~200 countries and a death toll of ~100,000 and growing. Today, COVID 19 presents one of the biggest humanitarian and economic crises since the very existence of mankind.

The stock markets have been battered globally over the past few months. March has been a month of what I’d call ‘moderate turbulence with a growing resilience’, as global markets plummeted and then displayed a modest recovery. This also indicates that markets are perhaps close to ‘bottoming out.’ Global markets have fallen between 2-7% in March, with the exception of India where the impact has been felt more dearly (>10%). From the >15-20% falls in February, the markets seem to have taken cues from the declining number of daily cases in Europe and China, COVID 19 vaccines going into clinical trials and attractive company valuations that summarize the broad sentiment in the month of March.

This article attempts to dwell deeper into COVID 19’s impact on each of the sectors with an underlying focus on the financial services/banking sector.

With the context set, let’s look at the chart below that maps the total decline in select banking indices globally during the month of March.

Global banking indices have had a turbulent March keeping in mind that global benchmark indices were more or less flat in March. The average decline among the select group has been ~31% which is almost 10x the decline in the benchmark indices globally. This suggests that investors are still bearish in terms of their outlook towards the banking sector. The median decline was ~29% and the range was ~15% over the 1 month period. When you look at the 3 month decline among banking indices, this number inches up to 40-60% for most global economies, which is an unprecedented number even when you put the numbers together in context of the 2008-09 global financial crisis. An iterative pattern has emerged over the past few months which points in the direction of a timid sentiment towards banks and adds impetus to the eventuality that banks will end up on the wrong side of a credit trap as we head into a global recession.

Keeping the above chart in mind, let’s dwell into the impact that COVID 19 has had on the sectoral indices in USA and try to dissect the impact the current economic crisis has had on each sector. The chart below maps the total decline in the Dow Jones Sectoral Indices that Index over the period 14th February to 31st March.

Oil & Gas, Energy Indices: The oil & gas index has been hit the hardest; down 52% over the 45 day period from 14th February to 31st March. Oil prices plummeted ~31% on March 9th which was the largest decline since the Gulf War in 1991 as Saudi Arabia declared an output ramp up even as demand remained weak given the current circumstances. With oil prices nosediving, oil & gas companies are bleeding money, so much so that, Saudi Arabia, who have cost leadership when it comes to oil, would also be making a loss if oil prices continue to sustain below 30$ per barrel. The energy index was hit as badly, down 47% in the 45 day period. The energy sector which includes oil, natural gas and fossil fuels has also plummeted for the same reasons. Global energy demand has been hit significantly as most countries enter a lockdown which has essentially halted manufacturing and business activity, muting oil & energy demand. U.S oil & gas and energy companies are also highly leveraged which when combined with unsustainable oil prices and low demand could threaten business continuity.

Automobiles & Parts Index: The automobile & parts index was down 43% over the same 45 day period. Automobile and related stocks have tumbled on the back of both supply lockouts and a muted demand outlook. All automobile companies have shutdown factories which has put a standstill to production for at least a 3-4 month period. At the same time, consumers move into a ‘discretionary spending mode’, focused primarily on essentials items. Given social distancing norms, the utility for cars is close to none which again has demand implications for the near future at least. The demand pessimism in the short to medium term coupled with supply halts for the near term paint a bleak picture for the automobile industry.

Banking Index: The banking sector index was down ~41% over the same 45 day period. Banks are the vital cog to any economy since they act as a safe haven for savings and deposits and are the largest lender for both consumption and investment activities for retail, corporate and government entities. Banks will have to take centerstage during an economic collapse of this magnitude as zombie companies, small businesses and select retail customers begin to default on interest and principal payments which will lay the foundation for a vicious cycle that is likely to follow. Plummeting interest rates will further reduce deposits held with the bank and adversely impact liquidity. Fee income will be lower during these tempestuous times as a result of lower transaction volumes due to a sizeable drop in branch and ATM utilization. All these challenges pose significant risks to banks especially those that aren’t well capitalized.

Travel & Tourism Index: The travel and tourism index was down ~38% over the same 45 day period. While one would expect the sector to be battered, it is only not the case only because the sectoral index’s 3 month performance is ~-56% which suggests that the travel and tourism index already fell significantly in the earlier months. The travel & tourism sector was not only the first sector to hit a roadblock but will also likely be the last sector to resume any course of normalcy. While the sector presents some value bets considering the steep decline in the index price over the past few months, any hopes for a short-term revival or a revival in 2020 for that matter look bleak. All hopes for the travel & tourism sector rest solely on positive developments from clinical trials of vaccines and on lifting the currently prevalent lockdowns.

Industrials Index: The industrials index is down ~28% over the 45 day period. The industrials sector is almost perfectly co-related to business sentiment since it involves machines, equipment and supplies related to business activity. While all manufacturing facilities are closed and businesses are operating remotely, all expansion plans and opportunities have been delayed which puts a stop to any form of new demand for industrials companies. Current demand is also at risk since order fulfilment and operations are both on a standstill which risks the current order pipeline too. There are also supply chain and logistical issues with regard to order production and fulfilment which together pose a significant short to medium term risk for industrial companies because the demand outlook will take longer to revive than it will for other direct to customer sectors due to the ‘lag’ effect.

Consumer Services, Consumer Goods Indices: The consumer services index is down ~23% while the consumer goods index is down ~22% over the 45 day period. Consumer services have been hit severely since the lockdown has restricted customers to their homes, preventing any form of physical movement which has unfavorably impacted demand for any mode of consumer service. Consumer goods have been bit hit as well, especially non-discretionary items. Both expenditure and consumption has switched to primarily discretionary items as the situation would demand during times of economic uncertainty. This has muted sales of non-discretionary consumer products even as discretionary products have actually seen an uptick in sales volume as a result of ‘hoarding’ for the short term.

Utilities Index: The utilities index has fallen ~19% over the past 45 days. While power and gas utilities will always be essential services, the short term outlook looks grim. With most vehicles off the roads, manufacturing almost entirely stalled and commercial establishments closed, the demand for gas and power utilities has been hit sharply. Optimism coming from successful clinical drug trials and many countries passing the peak from the first wave of COVID may have limited the downside amid the utilities companies, along with the strategic importance that the sector holds for business continuity and economic development.

Technology Index: The technology sector index has fallen ~16% over the past 45 days. Technology and IT services companies are having a bit of a mixed bag really and hence the comparatively lower decline. The Bad: Technology spend estimates for FY20 & 21 are down to -2-3% from the 7-10% predicted earlier. Technology and digital transformation projects will have to either be delayed or carried out remotely in the event that an agile model can be deployed, which could pose further risks to the already strained topline. The Good: Digital! Firms will be looking to invest in fast-tracked digitization initiatives and look at emerging technologies such as cloud, blockchain and cybersecurity which will benefit technology companies with a wide gamut of digital products and solutions.

Healthcare Index: The healthcare sectoral index has escaped relatively unscathed in what has been absolute mayhem on global stock exchanges. The healthcare sector index was down only ~13% over the 45 day period. Healthcare institutions, especially those that treat COVID 19 patients are set to benefit from higher than anticipated bed days (occupancy rates) and pharma companies especially those with a product range effective against COVID 19 are set to benefit as well. However, some short-term supply chain issues exist especially for Active Pharmaceutical Ingredients (APIs) which will predominantly affect generic-drug companies. Overall, the outlook is neutral to positive as it is the only industry that has benefitted from a demand uptick and the future roadmap looks positive as well with more investments likely to be sanctioned towards R&D and pandemic prevention over the next 3-5 year period.

The COVID 19 pandemic has triggered a bloodbath across global markets and restricted both physical movement and business activity, all at once. Stock valuations have hit rock bottom and sectoral outlooks looks grim. These problems also couple up as opportunities for consolidation across sectors in what I see transpiring as a battle of the ‘survival of the fittest.’ Once the dust settles and the end of the tunnel comes closer, the companies that emerge out of the tunnel relatively unscathed are set to enjoy a rejuvenated growth story over the next decade, so put on your military gear because this war braces to be a test of patience, a test of resilience and most importantly a test of both leadership and character.

Written By,
Sooraj Mehta
Cedar Management Consulting International