Welcome to Thoughts on the Market. I'm Adam Virgadamo, U.S. Equity Strategist and Head of Thematic Investing for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about how investors may want to look for nuance in the reopening trade. It's Monday, May 3rd, at 11 a.m. in New York.
Much of our focus this year has been on an obvious, but an important theme for markets. And that is; what does the reality of reopening really look like versus the hope of reopening?
Let's start with the notion that the covid economy brought immense change to the way we work, to the way we live, and to the way we consume. For many of us, the past year has meant working more at home and consuming more at home, and our ability to do that required the acceleration of an ongoing trend - the digitization of the economy.
With reopening now underway, vaccine distribution rising, and warmer weather ahead, we think that means an even faster move toward reopening. But as we approach the return to normal, the post covid normal won't look exactly like it did before.
So as the economy emerges into this new normal, we think the market will be rightly focused on which changes are here to stay, and which are reverting to old patterns. And to add a bit of complication for investors, we have to discover whether the market is correctly pricing this new normal.
So, there are few debates we're watching that are tied to reopening. First, where do margins shakeout as productivity gains seen during the pandemic meet cost inflation coming out of the pandemic? Out of necessity, many companies adopted technological solutions to help defend margins last year. The evidence is now overwhelming that this worked. Sure, earnings fell 15% last year, but these losses were fairly concentrated, and the median company actually did an exceptional job defending earnings and defending margins.
Those same efficiency gains we saw last year are helping to support the 30% plus growth rate we're seeing in earnings this year. At the same time, though, reopening bottlenecks and tight supply chains across commodity, freight, and labor markets are rapidly forcing operating costs higher. We think companies will continue to use technology to drive efficiencies, but, we suspect that in the short term, a lot of that optimism around efficiency gains may already be in the price, and that means rising costs bear watching.
Second, even within industries, it's important to know that not all reopening is created equally. Let's consider travel. We're already seeing signs of a robust return in demand for leisure travel. For example, Las Vegas is now running near peak occupancy on the weekends. Our analysts tell me that it's like a switch flipped for demand in February. Now, that said, business travel has been much slower to return, and it may take some time for that to return to prior peak. Said another way, hosting a meeting at work via video may be just fine, but for your time with friends and for your time with family, it's really a poor substitute.
Perhaps an even better example of divergences is in the real estate market. Now, real estate serves all kinds of end markets - think housing, warehousing for e-commerce, office, retail, medical care, and so on. This is an area where we think the market can and should be more discerning in pricing what a reopening really looks like, since most of the sector has been priced for some form of structural impairment. Now, that assumption of lasting impairment makes more sense in some end markets than it does in others. Is it really reasonable to think that demand for apartments won't come back as we reopen? We don't think so.
The bottom line is that the reality of reopening has some nuance to it, and how the market is pricing, or failing to price that nuance, will continue to be a key theme for markets this year.
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