Dow Teeters After 6th-Biggest Stock Sparks Fear of ‘K-Shaped’ Recovery

July 28, 2020 1:42 PM UTC
The Dow Jones teetered on Tuesday after the index's sixth-biggest stock reported earnings that stoked fears of a "K-shaped recovery."
  • The Dow fell on Tuesday after several of its component stocks reported earnings.
  • McDonald’s – the sixth-heaviest stock in the DJIA – recorded its worst earnings miss in three decades.
  • The economy may be making a “K-shaped” recovery that’s fooling investors into believing conditions are brighter than they really are.

The Dow Jones Industrial Average (DJIA) drifted lower on Tuesday as a critical day for corporate earnings converged with concerns about the health of the U.S. economy.

Dow Slides on Big Day for Earnings

Stocks opened lower across the board. As of 9:36 am ET, the Dow had lost 93.99 points or 0.35% to fall to 26,490.78.

The Dow Jones fell slightly on Tuesday after several of its core stocks reported earnings. | Source: Yahoo Finance

The S&P 500 dipped 0.18% to 3,233.57, and the Nasdaq dropped 0.39% to 10,494.99 to round out a disappointing day on Wall Street.

A slew of Dow 30 stocks reported earnings before the bell on Tuesday. Pharma giant Pfizer beat estimates and raised its revenue outlook. Industrial conglomerate 3M grew its quarterly profit despite a 12% drop in revenue. Raytheon rode a “good performance” in its defense segment to an earnings beat too.

Dow Jones Restaurant Giant McDonald’s Suffers Revenue Collapse

The most closely-watched results came from restaurant titan McDonald’s. And they could bode ill for the health of the services sector recovery.

McDonald’s posted its largest miss in more than 30 years, earning an adjusted 66 cents per share vs. 74 cents expected. Revenue ($3.77 billion) slightly exceeded estimates ($3.68 billion), though this still constituted a 30% plunge.

For hulking chains like McDonald’s, an economic crisis like the one we’re weathering is disruptive. It’s going to accelerate closures of underperforming locations – the company estimates it will permanently close around 200 stores in 2020 – but U.S. sales had begun to stabilize by June.

For the locally-owned mom-and-pop restaurants that chains like McDonald’s compete against, it’s an extinction-level event. Margins in the restaurant industry are notoriously thin during the best of times. Few small businesses are equipped to survive a once-in-a-century catastrophe.

That’s Bad News for the Economy as Permanent Closures Pile Up

According to Yelp data, 60% of restaurants that shut down during the pandemic will never reopen.

That’s all the more alarming considering that these closures came despite the federal government pumping trillions of dollars in stimulus into the economy.

A majority of restaurants that closed during the pandemic have shuttered permanently. | Source: Twitter

Some of this went directly to small businesses through the Paycheck Protection Program (PPP). The bulk of it fueled economic activity indirectly.

Stimulus checks and federal unemployment benefits kept U.S. households solvent even as the national jobless rate spiked to Great Depression-era levels. And while financial uncertainty caused the savings rate to spike, much of this cash made its way back into the economy.

Without this stimulus, it’s highly unlikely personal spending would have recovered as aggressively as it has. During June, retail sales actually rose 1.1% from the same month a year ago. Restaurant spending surged 20% from May.

Two threats have begun to converge that could make this recovery short-lived.

The first is that the continued spread of the virus in the United States has prompted state and local governments to begin reimposing lockdown restrictions. Even in regions that haven’t gone back into lockdown, some corporations – like McDonald’s – have halted reopening plans.

The second is that the $600 weekly federal unemployment benefit – which is set to expire at the end of July – will almost certainly shrink when Congress passes its next stimulus package.

This federal benefit currently accounts for roughly 15% of overall U.S. wages.

Reducing it will take a toll on discretionary spending, putting the pinch on the services sector businesses that have already struggled so much during the pandemic. Large companies will lay off lower-income employees; small businesses may shutter entirely.

It’s not hard to envision how this could spiral into a vicious cycle.

Is a K-Shaped Recovery Making Dow Bulls ‘Delusional?’

This shaky state of affairs encapsulates why some analysts believe the U.S. economy is making a “K-shaped recovery.”

For Americans at the top, it feels like a V. They likely haven’t suffered any income disruption because they’re working from home. And between rising home prices and a rapidly-recovery stock market, their assets are worth more than ever.

It’s not so rosy for the bottom half of the income ladder.

This disconnect may explain why investors continue to bid up equity prices greedily despite gloomy earnings forecasts. The half of Americans who own stocks aren’t feeling the economic pain that’s all too apparent to those who don’t.

Ed Yardeni, the president of Yardeni Research, told CNBC that if stock market bulls aren’t delusional yet, they’re on the brink:

I don’t know that they’re delusional yet, but if this market just keeps going higher I’ll have to conclude that’s exactly what’s happening…

Prices have gone up at the same time that earnings expectations have gone down. They’ve only recently started to level out. So I think the market needs consolidate, it needs to give some time for the fundamentals to show that the recovery is still there.

If he’s right, the Dow could be primed for a wake-up call.

Sam Bourgi edited this article for CCN.com. If you see a breach of our Code of Ethics or find a factual, spelling, or grammar error, please contact us.

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Josiah is the U.S. Editor at CCN.com, where he focuses on financial markets. His work has also been featured on Yahoo Finance and Investing.com. He lives in rural Virginia. Connect with him on LinkedIn or Muck Rack. Email him directly at josiah.wilmoth(at)ccn.com. Josiah Wilmoth is a Trusted Journalist.