COVID Fallout
A few weeks into the lock-down, I listened to a presentation by my favorite economist. He summarized, in three short words, the efficacy of all the projections by all the talking heads about the effects of the pandemic: NOBODY KNOWS NOTHING.
We are in uncharted territory. Certainly, there have been lots of devastating epidemics throughout human history. And we had some close calls (Ebola, SARS and MERS) the last few years. This is our first experience in shutting down the economy in a highly interconnected global ecosystem. We have no real idea of what things will look like after we get a vaccine or if we don’t get one. Human beings are bad predictors. Our minds aren’t built for it. We tend to project the present plus one or two variables. Almost invariably, our predictions about the future are wrong.
Based on analyzing four months of unpleasantness, I will tentatively state that I think that three trends are emerging that will be enduring in the mid-term. Mostly, they are an acceleration of trends that predated the disease.
A ton of money is cascading into the biotech sector. That piece of our economy was getting some attention from investors and developing some real cures prior to the virus outbreak. For the first time ever, as an industry, it was making a profit. The pace has increased considerably. The new focus on public health (until memory of the virus fades) will keep medical innovation at a high pitch. We might even figure out enough about virus behavior to control all of them. There could actually be a cure for the common cold.
Our divorce process with China is picking up momentum. We were economically married to them. They produced (by decimating our manufacturing sector) and we consumed. They made a lot of promises and we let them into the WTO. They broke many of those promises without even bothering to mask their behavior. We found out that they were the sole source of medical supplies, which they allocated to themselves before sending any to us. They decided that military might and authoritarian control were more important than customer relations. The marriage is falling apart.
Fortunately, we are ready to resume production of our own goods. Manufacturers fled environmental regulations and unions. A combination of right-to-work laws, cheap natural gas, cleaner operations and programmable robots means most manufacturing can be done more cheaply and efficiently close to home. We can hold our own in the divorce proceeding.
Finally, commercial real estate has, at least semi-permanently, lost its luster. For the last 30 years or so, institutional investors have allocated more and more dollars to that sector. It wasn’t as volatile as stocks and had more cash flow than bonds. Agonizing reappraisal is now going on.
The retail sector was badly overbuilt. Many jurisdictions were anxious to approve retail construction because is was a net generator of tax revenue — good revenue, few services required. Oversupply has now met cratering demand. It will be many years before equilibrium is achieved. Weak retailers are going broke on a daily basis. Tens of thousands of stores will be vacated. Nobody is in the wings to fill the vacancies. Hundreds of malls will go dark and be abandoned.
Hotels are in extremis. The leisure trade may rebound slowly once we get a vaccine. Business travel may remain constrained indefinitely, since former road warriors have discovered Zoom and its competitors.
Office space is a huge question mark. Certainly, WeWork and its imitators are toast . That was about 20% of the demand for new space. It remains to be seen how many people will continue working remotely.
Industrial is the only bright spot. It benefits from increased on-line shopping and it will benefit from the re-shoring of manufacturing. Buildings that service air freight and seaborne traffic may suffer.
Apartments should be a good sector. The demand is there and supply is constrained in most markets. However, left wing city and state governments have destroyed it as an investment vehicle. They have declared eviction moratoriums. That renders the payment of rent optional. No investment proforma I’ve ever seen projects optional cash flow. Future investment will probably be very hard to come by.
All of this could be wrong. My own plan is to stay as flexible and open minded and fact based as possible. Continuous adjustment is going to be required. That is always true, but now more so than ever.
