Summary
The ISM Non-Manufacturing Index may have fallen to a 128-month low, but it’s not all bad news.
Sure enough, most business segments have done badly, and I would consider exiting their stocks.
However, a few service segments have gotten a boost from the COVID-19 disruption.
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Headlines, in a way, are what mislead you because bad news is a headline, and gradual improvement is not.
– Bill Gates
In April 2020, the ISM Non-Manufacturing Index crashed to 41.8%, a number that is 10.7% lower than the March 2020 number of 52.5%. What is more disturbing is that it represents a contraction that comes after 122 months of continuous growth. It also corresponds to a 2.3% decline in real GDP on an annualized basis.
I had noticed the Services PMI dipping in February 2020 and had warned about its implication on the economy in The Lead-Lag Report, and later followed it up with a tweet:
(Image Source: Twitter)
So, does the current data spell curtains for the entire services sector in the near term?
No. There are a few sectors that are doing well among the many that are doing badly. Let’s start with the underperformers:
The Laggards
1. Accommodation and Food Services: This business segment was very badly impacted because of the lockdown, and it will continue to suffer because COVID-19 is changing the way we interact. The virus is likely to linger in our memories for a long time, because more than 40% of American adults have experienced someone in their household losing a job or taking a pay cut. Therefore, even after hotels and restaurants reopen for business, they will experience a substantial drop in revenues. This segment may continue to underperform until a vaccine is developed and the fear of virus transmission completely disappears.
2. Agriculture, Forest, Fishing and Hunting: This segment has gone into a tailspin. Milk is being dumped, surpluses are being burnt, and livestock are being destroyed as agricultural products’ prices crash. Employees are afraid to work in close proximity of their colleagues, and meat plants are either shut or are not operating despite President Trump’s executive order. It, too, will take some time to recover.
3. Arts, Entertainment and Culture: Most venues in this service segment are either shut or may find it difficult to breakeven after a limited reopening. Even after a full reopen, venues may find it difficult to pull in the usual crowds (benchmark: January 2020). This segment, like the accommodation and food services segment, will see sunshine only after a vaccine is developed.
4. Construction: Stay-at-home orders, cancellations, supply chain disruptions, worker shortages, health, and safety of workers – the sector is passing through a “force majeure” event. In a PWC survey of the COVID-19 impact, 41% of respondents feared the COVID-19 impact on their workforce, 40% feared a drop in demand, while 23% were concerned about supply disruptions. Events are yet to unfold, and this sector may see further pain ahead.
(Image Source: PWC)
5. Healthcare and Social Assistance: Healthcare distributors tripped badly in planning the inventory, resulting in shortages and recalls of the critical PPE. Distributors who did not respond with alacrity to the pandemic may find it difficult to recover their business, especially because of the recalls. I would check which listed healthcare equipment makers and distributors faltered, and quickly get rid of their stocks.
6. The Usual Suspects: Retail suffered, which is obvious because people were at home and unemployment claims rose. However, it is too early to write off retail businesses that have been in existence for decades. Oil management and support services are suffering because the shakeout in the industry has just about started.
The Leaders
1. Select Wholesale Businesses: Though most of the wholesale businesses witnessed a substantial reduction in business, sales of janitorial supplies, sanitation, and paper picked up. That was natural given the boost that hygiene and cleanliness received because of the pandemic. These products are likely to remain in demand for a long time to come.
2. Finance: Though financial services were in demand for a variety of reasons – low interest rates, stimulus checks, refinancing, small business distress loans, etc. – banks have reasons to worry. For example, they have to make space for social distancing in their branches, and that may compromise on their real estate capacity. They also will face other challenges like:
- Servicing ATMs.
- They may have to increase call center staff to answer the increased volume of calls.
- They may have to face risks if they have outsourced their processes to third-party contractors.
- They may have to reach out to customers to manage brand perception (the disruption has angered many people).
So, the challenges to banks are many. That said, online banking and payment systems are two services that will do extremely well and may emerge as the leaders after the disruption goes away.
3. Insurance: According to Becker’s Healthcare, approximately 25-40 million Americans will lose their health insurance if the unemployment rate hits the projected 20%. But the Chicago Fed estimates the real unemployment rate to hit be as high as 34%.
More than 50% of Americans who lose their jobs will get covered by Medicaid in states that expanded the program under the Affordable Care Act (ACA). About 33% of newly unemployed Americans will qualify for health insurance in states that didn’t. Uncovered folks will have to fend for themselves.
To make matters worse, the economy is being opened up without fully understanding the virus or developing a vaccine. The economic hurt may intensify. These factors are likely to set off a flurry of activity in the insurance sector.
Summing Up
Here is the strategy I would play based on the analysis above:
(a) Exit hotel, leisure, bank, construction services, and restaurant stocks.
(b) Reduce exposure to dairy stocks.
(c) Consider investing in stocks in the hygiene, medical supplies services, online payments, and insurance sectors.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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