What FRANdata Thinks

Will COVID-19 be the straw that breaks the US economy?

March 6th, 2020 by Luis Despradel

We’re still in the first quarter of 2020 and the world has seen a dramatic series of events unfolding every week. The most impactful being the COVID-19 outbreak, which started in China in the last days of 2019 and has rapidly spread across the world, disrupting people’s life and economic activities. COVID-19 is causing hysteria worldwide which has lowered consumer confidence and decreased spending across multiple industries. Since the Centers for Disease Control and Prevention (CDC) announced that it is not a matter of if the virus is going to spread in mainland US but when, FRANdata decided to keep a close eye on the matter.

It is key to note that franchised businesses aren’t in a special category that will get different results from the spread of the virus. The franchise industry will experience the same consequences as all the business lines that conform it. There is no point in making a distinction between franchises or businesses, but rather a holistic view of the economy and its different parts will help us understand what could happen overall.

The economy has already started to react, forcing many economists to modify their predictions for 2020. Economists expect the COVID-19 to restrain U.S. economic growth in the first half of the year to around 1.0%.  The OECD updated its economic outlook for 2020, decreasing its world GDP growth projections[1]. The loss of confidence among investors was reflected in the last weeks of February as the stock market had its worst one-week performance since the financial crisis of 2008. Analysts at Goldman Sachs expect the companies making up the S&P 500 to make little to no profit growth this year[2]. The bank had previously forecast a 6% increase in earnings.

One of the biggest impacts to the US economy will come from the supply chain disruption[3]. Tech companies, apparel makers, consumer-packaged-goods and industrial-equipment manufacturers are likely to be hurt most, given that they are most reliant on inputs from China and Southeast Asia. Restaurant brands are on the receiving end of a lot of products made and grown in China, where the outbreak and inventory shortage could push the cost of goods sold up, and further suppress the profit margin.

Companies may also struggle because investors are becoming more hesitant to lend them money. Banks may have to tighten underwriting requirements and lending standards. In a sign that investors believe the coronavirus concerns could hit banks hard, the stocks of the three largest U.S. banks — JPMorgan Chase, Citigroup and Bank of America — are all down by a lot more than the S&P 500 so far this year[4].

Industry-Level Estimated Impact

Industries will be affected by two main driving forces: policies and human behavior. Policies such as quarantine zones might be implemented, travel restrictions might be put in place, some public places might temporarily close including music festivals and sporting events, among others. As the government protects its citizens and tries to prevent further spread, it will create negative externalities that will impact firms nationwide. While millions of dollars will be used to prevent and control COVID-19, another large amount of dollars will be lost due to a decrease in economic activity, more especially in spending.

The private sector and individuals are going to react in a self-interest matter to prevent getting infected. Brick and mortar entertainment businesses will suffer dramatically from people avoiding unnecessary human interactions. Cinemas, theaters, concerts, baseball cages, golf simulators are among these businesses that will see a decrease in revenue. Gyms are among the most vulnerable businesses in these scenarios. They could experience a negative shift in demand by people substituting gyms for working out at home or not working out at all. This would decrease memberships and therefore affect topline revenue.

The lodging industry will be also amongst the most affected industries given the fact that travel nationwide is probably going to decrease. Individuals will cancel any unnecessary domestic tourism, depriving an inflow of money to certain states in the US. Like with China, flights between infected countries and the US might get cancelled, reducing international tourism.

The restaurant industry is a tricky one to analyze in this scenario. While food is a relatively inelastic good, the way individuals consume it depends on how it is offered. Sit-down restaurants could expect fewer costumers as they avoid places with many people. After the outbreak of COVID-19 in Italy, restaurants started to close early while some closed indefinitely. The QSR industry, however, could not be as affected as other restaurants. People might perceive that spending less time in a place reduces the chances of getting infected. Many people might opt for take-out, drive-thru, or even delivery. Delivery companies are expected to see an increase in the demand for their services in the upcoming months.

In order to mitigate the amplification of recession fears ignited by the COVID-19, the Fed initiated an emergency interest rate cut on March 3rd, and the stock market has since rebounded. Even though signs of an upcoming recession were creeping before the outbreak and COVID-19 might be the straw that breaks the camel’s back, taking the right actions by enacting health response protocols and implementing monetary and fiscal support could alleviate the risk of further economic slowdown.

The wonders of globalization are attached to negative unseen consequences like the rapid spread of an unknown disease. While the short-term consequences are unavoidable, predicting and accurately sizing the long-term COVID-19 impact to the economy at this point is still difficult, but the longer the situation lasts, the deeper the impact will be felt. FRANdata will closely monitor the market and provide periodical updates on the effects of COVID-19 on the franchise market.

 

[1] Boone, Laurence. “OECD Interim Economic Outlook, Coronavirus: the world economy at risk”. OECD, 2020 https://www.oecd.org/economic-outlook/

[2] Fitzgerald, Maggie. “Goldman sees zero earnings growth for US companies this year because of coronavirus.” CNBC, 2020. https://www.cnbc.com/2020/02/27/goldman-sees-zero-earnings-growth-for-us-companies-this-year-because-of-coronavirus.html

[3] Salzman, Avi. “Coronavirus Is Disrupting Supply Chains. These Industries Are Most Vulnerable.” Barrons, 29 Feb. 2020, www.barrons.com/articles/tech-apparel-profits-could-be-hardest-hit-by-supply-chain-shocks-51582938634

[4] Eavis, Peter. “How Bad Could It Get? Companies Gauge the Coronavirus Impact.” The New York Times, 28 Feb. 2020, www.nytimes.com/2020/02/28/business/economy/companies-coronavirus-economy.html?auth=login-google.

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