Everything In Between

On Saturday morning, I offered a take on America’s economic future that was simultaneously optimistic and somber.

A modicum of sanity at the federal level alongside what are likely to be multiple effective vaccines presages the return of something that looks enough like “normal” to resurrect profits for corporate America, helping to allay fears that equity prices are detached from reality.

Note that this discussion was couched in literal terms earlier this year. “Detached from reality” was no longer just a derisive way of describing a situation where investors are paying too much for a dollar of earnings. Rather, “detached from reality” meant that, for a few months, it was no longer clear what exactly stocks were, in a metaphysical sense. Here’s how I described the situation back in April:

When abstraction collides with the tangible

Economic data and asset prices ostensibly reflect something real, whether that means the production of goods, the provision of services, cash flows, operating income or even sentiment, which, while hard to measure, is real too.

Although monetary accommodation in the post-GFC world impaired price discovery, we mostly spoke in terms of engineered disconnects between prices and fundamentals. In some cases, those disconnects became patently absurd. For example, some European corporates saw their entire curves go negative last summer, which effectively meant that for those companies, debt had become an asset. Sovereigns which had no business tapping the market at all based on fundamentals were able to borrow at what, just a decade ago, would have been low rates even for a developed economy. And on, and on.

But, in all cases, there was still something there. The prices for fixed income may not have represented the risk associated with a given borrower, and equities were of course distorted by the very same dynamics (as the voracious appetite for corporate issuance allowed management teams to plow the proceeds from record bond sales into EPS-inflating buybacks), yet through it all, sovereign borrowers still had tax bases. There was still an economy to reference. Corporations, even unprofitable ones, still had operations.

Now, there’s a very real sense in which the underlying “stuff” (so to speak) does not exist. Economies are shuttered. Tax payments have been delayed. Rather than take in revenue, governments are handing out cash. Businesses are idled. Corporate titan after corporate titan is withdrawing guidance.

This is a temporary state of affairs, but the point is simply that some of the assets you own are, for the time being anyway, claims on things that don’t exist.

Again, that’s a passage from a piece penned during the first wave of the pandemic.

When you think about the Q3 rebound in economic activity and the outlook for a 2021 characterized by the assumed distribution of a vaccine and a science-based approach to containment, it helps to conceptualize the situation as a return to a state of affairs where the assets you own actually represent something.

You might argue that new lockdowns in Europe and similar containment efforts in the US threaten to plunge the western world right back into the kind of surreal dystopia I was describing in April. What’s different now, of course, is that multiple vaccines developed by western pharma giants are right around the corner, and the world’s largest economy won’t be operating under the delusion that ignoring the problem is tantamount to fixing it.

While it’s obviously the case that management teams are wary of fresh lockdowns, you can be sure they’re having different discussions now than they were in March and April.

Record debt issuance (figure below) has filled corporate coffers, vaccines and therapeutics suggest science will eventually win the war, and lawmakers in developed nations have demonstrated that when push comes to absolute shove, trillions can be conjured to avert a depressionary spiral.

Meanwhile, central banks simply aren’t going to allow a destabilizing wave of high-profile corporate defaults. You can lament “moral hazard” all you like, but your lamentations, no matter how shrill, will fall on deaf ears at the Fed, the ECB, the BoE, and the BoJ.

But none of this means the world hasn’t forever changed. As it happens, my rather peculiar assortment of life experiences gives me a unique lens through which to view the pandemic and its economic fallout.

I’ve spent as much time in the smallest of cities as I have in the largest of metropolises. I’m an outcast by choice, but I can blend in anywhere. I can make small talk about the weather with the owner of local hardware store in West Virginia just as easily as I can talk econometrics with the ivory tower crowd the same as I can make a haughty debutante blush at a bar in Manhattan with my granular assessment of this season’s offerings from Yves Saint Laurent.

American cinema fans might recall a famous scene from Indiana Jones and the Last Crusade, when Harrison Ford is trying to throw the bad guys off the trail by pretending his friend is infinitely more worldly than he actually is. “He sticks out like a sore thumb! We’ll find him,” one of the antagonists says, to which Ford replies:

The hell you will. He’s got a two day head-start on you, which is more than he needs. Brody’s got friends in every town and village from here to the Sudan. He speaks a dozen languages and knows every local custom. He’ll blend in, disappear and you’ll never see him again. With any luck he’s got the grail already.

Unlike Marcus Brody who, in the film, is the furthest thing from the kind of chameleon Ford pretends he is, you could easily lose me out the back door of an Asheville hookah shop, just like you could turn your head to hail a cab on 42nd, only to turn back and see the top of my hat bobbing swiftly away through the crowd at Grand Central.

What I know from my extensive experience with locally-owned shops and restaurants, is that even as corporate America recovers, revenue streams return, and profit growth inevitably surprises to the upside (if only because the bar is deliberately set too low), tens of thousands of businesses you never knew existed in locales you’ve never heard of, will close, if they haven’t already.

As I finished up writing the piece linked here at the outset, I was reminded that it’s been a few weeks since I scanned readily available sources for information on how things are going for some of these small businesses. Not surprisingly, the answer is that while those of us fortunate enough to have the luxury of owning stock were busy debating whether to sell our winners ahead of a prospective Joe Biden capital gains tax hike, the total number of restaurants closed due to the pandemic reached nearly 100,000. (And, no, that is not a misprint.)

According to a survey released in mid-September by the National Restaurant Association, almost one in six restaurants had closed either permanently or long-term, affecting some 3 million employees. The industry, as a whole, was on track to lose almost a quarter of a trillion dollars in sales by the end of the year.

“60% of operators say their restaurant’s total operational costs (as a percent of sales) are higher than they were prior to the COVID-19 outbreak,” the color that accompanied the survey reads. “On average, restaurant operators say their current staffing levels are only 71% of what they would typically be in the absence of COVID-19.”

40% of those surveyed said they probably wouldn’t be in business in six months in the absence of additional government support. That was two months ago. And there’s been no additional government support.

“This survey reminds us that independent owners and small franchisees don’t have time on their side,” Sean Kennedy, executive vice president of public affairs for the group said, in September. “The ongoing disruptions and uncertainty make it impossible for these owners to plan for next week, much less next year.”

A look at one subsection of Yelp’s latest Economic Average Report (also from September) tells a somewhat surprising story considering the environment. “Yelp data shows there’s a significant number of entrepreneurs opening up restaurants and food businesses at this point in the pandemic,” it reads.

In addition to being back at pre-pandemic levels, Yelp notes that “there were only 100 fewer new restaurant openings in September of this year, compared to September 2019.”

But there’s more than a little ambiguity in the numbers. Yelp notes a jump in farmers markets, food trucks, “pop-up restaurants,” seafood markets, and “food businesses that specialize in sweet treats.”

What isn’t immediately clear from the accompanying color is whether all of that is captured in the data used to construct the figure (above) or not. The section of the report which documents these trends refers to restaurants and “food businesses,” but the subsequent paragraph summarizing trends in new openings only refers to “restaurants.” The page that describes the methodology isn’t much help.

However, when one peruses the latest edition of Yelp’s Local Economic Impact report, the picture appears to be less rosy. Specifically, the percentage of restaurant closures since March 1 denoted “permanent” ticked up again from the last report (to 61% from 60%) while permanent closures in the “bars and nightlife” category rose from 45% to 54%.

As of July 10, Yelp’s data showed 26,160 total restaurant closures. On August 31, that figure was 32,109. The number of closures for bars and nightlife establishments over the same period rose to 6,451 from 5,454.

Admittedly, is difficult to discern the “big picture” takeaway from this data (which is ironic, because that’s exactly what it’s supposed to represent), but I suppose what I would suggest based on my decades of experience, is that an increase in farmer’s markets, food trucks, seafood markets, and “sweet treat” shops, isn’t going to compensate for the loss of tens of thousands of traditional restaurants and bars. While a good chef might indeed get excited about a food truck business, no bartender wants to sell cupcakes. And you won’t find many servers interested in hustling produce at the farmer’s market either.

Around the same time Yelp was gathering data for their latest reports, the National Restaurant Association cited a survey of 1,000 adults, 56% of whom “reported that they are aware of a restaurant in their community that permanently closed during the coronavirus outbreak.”

The breakdown is interesting. As the Association noted, “city dwellers were the most likely to report restaurant closures in recent months.”

That could be because urbanites are more prone to eating out. Or it could simply reflect the reality that there are fewer restaurants in rural areas, and that rural populations may be less inclined to avoid the lonely, local diner than urban patrons would be to steer clear of crowded, trendy restaurants, where the odds of someone having COVID-19 are much greater.

In the same vein, I’d note that depending on how “rural” respondents to the survey were, the dynamics I mentioned in a classic piece from August could be in play. Recall the following:

Ironically, just about the only businesses one can imagine escaping this vortex are the smallest of the small – a dive bar in a frontier town in Alaska – a barbershop in some modern day Mayberry – a burger stand in some totally nondescript Midwest township – the diner from Monster’s Ball. In short: businesses with no connection to modernity and no aspirations to serve anyone other than the same two-dozen people (and their descendants) they’ve been serving for decades.

And maybe that’s the ultimate irony – the only way to avoid not mattering is to never have mattered in the first place.

That is still a poignant passage (if I don’t say so myself).

The most tragic aspect of the pandemic is obviously the death toll, but beyond that, tens of thousands of small businesses are either lost to America forever, or on the verge of being lost.

That isn’t going to change with a vaccine. Most small business owners don’t operate with large capital cushions and don’t have a lot of room for error. They may have relationships with local lenders for small credit lines in the event a walk-in cooler (for example) breaks, but the wherewithal to navigate something like the Paycheck Protection Program or the Fed’s Main Street Lending facility simply isn’t there.

By the end of 2021, things may feel almost “normal” on quite a few levels, and corporate profits will likely have rebounded enough to help justify higher stock prices. The Fed will ensure both investment grade and high yield borrowers can keep tapping the corporate debt market. And after the winter virus wave is behind us, the pandemic will probably recede, and COVID-19 will be “downgraded” (if you will) to something that’s controllable and treatable.

But the virus will live on. Its economic legacy in America will be defined by a mass extinction of small businesses where the will, the way, or both, to survive, simply wasn’t there.

The biggest companies will make it. And, I think, the tiniest will too, because they never had any connection to the ebb and flow of the broader economy in the first place.

Everything in between, though, still faces an existential reckoning.

---