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Two Pandemic Era Trends are Reversing

  This week we highlight a post from Yahoo’s Emily McCormick who details out how to big trends that took hold in 2020 are starting to change.  First, we are seeing a reduction in big ticket spending (i.e. houses and cars) that is rate sensitive and shifting towards services.  Second, tech earnings are starting to fall behind their value focused neighbors.   The COVID-19 pandemic has permanently altered our lives in many ways. For instance, a lot of white-collar workers will never work five days a week in the office again. Still, more than two years into the pandemic, two significant COVID-era trends in markets are finally unwinding.   “Underneath the surface, two big COVID demand reversals are happening this quarter. First, a rapid shift from rate-sensitive big ticket items (housing and autos) to services,” Bank of America’s head of equity and quantitative strategy, Savita Subramanian, said in a note.   “Second, Tech earnings are lagging,” she added. The Nasdaq 100’s 2022 consensus earnings as a percentage of S&P 500 earnings “are now below where [they] stood at the end of 2020, implying a full reversal of COVID-driven demand pull forward.”   Let’s break these down. Earlier on during the pandemic, consumers stuck at home had shifted spending toward goods, and away from in-person activities like traveling, dining out or seeing movies or sporting events that could have exposed them to a potentially lethal virus.   But now, the pendulum has swung in the other direction, and Americans are finally going out again. And with inflation running at multi-decade highs and cutting into consumers’ disposable income, that increase in services spending has come, in many cases, at the expense of purchases on goods.   The latest batch of economic data underscores this phenomenon. March’s retail sales report from the Commerce Department showed consumers were pulling back on buying big-ticket items, with motor vehicle and parts dealer sales down by 1.2% on a year-over-year basis (and by 1.9% on a monthly basis), and electronic and appliance store sales down 9.7% year-over-year. By contrast, bar and restaurant sales were up 19.4% compared to March 2021.   U.S. manufacturers have also begun to show signs of slowing growth. The Institute for Supply Management’s manufacturing index fell to the lowest level since September 2020 in April, reaching 55.4.   Michael Pearce, Capital Economics senior U.S. economist, pointed out in a note that this was “mostly due to weakening demand amid a broader slowdown in global manufacturing, rather than a renewed supply crunch.” He also noted that the ISM manufacturing orders backlog subindex — an indicator of demand — declined notably to 56.0 from March’s 60.0.   The rotation back to services spending is no doubt a positive for the restaurants, travel and events companies and movie-theater operators that had struggled throughout the pandemic. It’s also generally good for U.S. economic growth, with services comprising the majority of GDP.   But the shift could dampen S&P 500 earnings, which rely disproportionately on goods demand for growth compared to the broader economy. According to Bank of America’s Subramanian, S&P 500 earnings have 50% goods exposure, whereas the services-driven U.S. economy has just 20% goods exposure.  

‘The big COVID boost … obscured the picture’

  The second trend reversal is related: Many tech companies, like goods-producers, had seen a significant pull-forward in demand during the height of the pandemic that’s now rapidly turning around.   The past two weeks’ worth of tech earnings have been a clear — and for many investors, painful — reflection of these trends. And the fear for investors has been that the surge in demand seen during the pandemic was not, in fact, the kick-starter of sustainable growth, but was instead a temporary spike in business that cannibalized future growth.   Case in point: Netflix (NFLX) suffered its first subscriber loss in more than a decade in the first quarter of this year, shedding 200,000 users after adding as many as 15.8 million in a single quarter in early 2020. It also guided toward a drop of another 2 million users in the current quarter this year.   “Our revenue growth has slowed considerably,” Netflix acknowledged in its first-quarter letter to shareholders. “The big COVID boost to streaming obscured the picture until recently.”   “There’s a buyer’s strike going on, especially in the tech sector. No one wants to dip in. They don’t know where the dust is going to settle,” Santosh Rao, Manhattan Venture Partners head of research, told Yahoo Finance Live. “There are a lot of ongoing issues. The China lockdown is a big issue. We don’t know if it’s going to be contained, if it’s going to spread further, so that’s a wild card. The war is a wild card. And [with] the inflationary pressure here, the demand side of the equation is also a big risk at this point.”   “Now even the demand side is under question,” he added. “People need to just hold on, don’t panic, and just kind of wait.”