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These Sectors Performed Best and Worst in the Pandemic

We look at the industries for those most affected by social-distancing and stay-at-home orders.

Stock markets crashed last year as the impact of the coronavirus pandemic on economies around the world became clear. To stop the spread of the COVID-19, many governments issued stay-at-home orders and social-distancing guidelines. This new way of life kickstarted existing trends like working and shopping from home, and at-home entertainment. Some sectors have benefited, while others were severely hurt.

A year later, markets have largely recovered, but the economic impact of the pandemic remains. Here, we look at some of the sectors and industries that have fared best and worst over the past year, and what Morningstar's stock analysts see ahead. Herd immunity to COVID-19 is key to an economic recovery and healthcare strategist Karen Andersen keeps a close on vaccine development and distribution. Though rollout has been slow, she expects herd immunity by midyear 2021 in the U.S. and by the end of 2023 worldwide. Andersen's research and Preston Caldwell's economic outlook are incorporated into our analysts' valuations and outlooks for the industries they cover.

Travel Demand Expected to Rebound in Second Half of 2021, with Full Recovery by 2023 Travel was one of the hardest-hit sectors in the last year. Social-distancing guidelines and stay-at-home orders decimated travel plans for many people. Despite travel increasing since the initial shock between March and May 2020, airline travel is still at less than half of 2019 levels, as a case resurgence has kept travel demand at bay in recent months. Despite this recent pause in demand, many travel stocks saw significant price appreciation on strong COVID-19 vaccine data from Pfizer PFE and BioNTech BNTX, which brings with it optimism of a stronger return to travel in the later parts of this year.

Morningstar Economic Moat Ratings are still intact for most travel companies. Online travel agencies like Booking BKNG and TripAdvisor TRIP hold competitive advantages in planning leisure trips, vacation rentals, and experiences, but are seeing growing competition from large online platforms like Google (GOOGL/GOOG), AMZN, and Facebook FB. We see the popular Airbnb ABNB as significantly overvalued, trading at a near 200% premium to our fair value estimate as of Feb. 18. Other travel sites like Booking and Expedia EXPE are closer to fairly valued and are worth considering in the online travel agency space.

Airlines may continue seeing headwinds as families opt for local vacations and car trips, rather than cross-country or international flights. And corporate travel will likely lag leisure travel as videoconferencing becomes more commonplace. Our analysts expect leisure air travel to recover by 2024 and corporate air travel by 2026. This creates concern for hotel names like Marriott MAR, Hyatt H, and Hilton HLT, which pre-pandemic depended on business travel for 60%-70% of revenue.

Technology Benefited the Most from the Pandemic The pandemic accelerated existing trends. People shopped from home, sought entertainment at home, and 45% of U.S. workers said they worked from home in 2020, compared with 9% in 2019. Technology names like AMZN, Netflix NFLX, and Microsoft MSFT benefited from these trends, and the tech sector soared in 2020: The Morningstar US Technology Index was up 47.5% in 2020 while the Morningstar US Market Index was up 20.9%.

Technology was both a safe haven and a growth area for investors, says director of technology equity research Brian Colello. Wide-moat software businesses like Microsoft and Salesforce CRM have sticky customer bases: White-collar workers didn’t stop using Microsoft Office, and sales representatives didn’t stop using Salesforce while working from home. Colello also says secular growth drivers like the shift to cloud computing, which involves the outsourcing of IT workloads, have continued during the pandemic, creating tailwinds for Microsoft’s Azure platform, for example. Semiconductor and computer hardware manufacturers benefited from a near-term boost in IT spending as companies equipped their employees for work from home.

The tech companies that rose the most in 2020 rode trends that were counter-cyclical to the pandemic and will persist after it. The acceleration of remote working and e-commerce benefits companies like Zoom ZM and Shopify SHOP. Demand for cybersecurity boosts names like Okta OKTA and CrowdStrike CRWD. And the continued rise of cloud computing and software as a service is propelling companies such as Twilio TWLO and Coupa COUP. Many of these names remain overvalued, so interested investors may want to wait for a pullback.

Energy Is Still Down but Will Recover Heading into the pandemic, energy was already an unloved sector. The Morningstar US Energy Index finished the 2019 calendar year up 10.0% while the broader market was up 31.2%. The pandemic decimated the sector in 2020--and it wasn't even close. The sector finished down 33.1% in 2020 while the broader market was up 20.9%. In our view, energy remains the most undervalued sector.

Demand for oil dried up when stay-at-home orders went into effect. Fewer people are commuting to work, and business and leisure travel has declined significantly. Transportation demand won’t recover until “normal life” returns--and commuting may never return to previous levels. But director of energy equity research Dave Meats doesn’t believe the downturn’s peak 45% work-from-home rate is sustainable (as of today, this number has dropped significantly), and that the long-term effect of telecommuting on global oil demand will be less than 1% in the long run.

Electric vehicles are becoming more popular--a factor behind the dramatic rise of Tesla’s TSLA stock--but Meats believes they won’t make a significant dent in gasoline demand in the next decade. He notes that most cars being bought today aren’t electric--and that, even if they were, those bought today are a small fraction of cars that are currently on the road, as cars have an average life of 15 years or more.

Increasing demand for renewable energy such as solar and wind power is a long-term threat to traditional energy. However, renewable energy is highly intermittent--solar power only works well when it’s sunny. Meats notes that until better storage solutions are developed, fossil fuels will remain essential as a backup. Overall, Meats expects global crude demand to rebound in the next few years and remain flat for several years thereafter.

Communication Services Benefit From Advertising Rebound Advertising spending was one of the first places businesses went to cut when the COVID-19 downturn hit the U.S. This could have spelled trouble for social media platforms like Facebook, Twitter TWTR, Snapchat SNAP, and Pinterest PINS, whose revenues rely heavily on advertising demand. However, as shopping from home and e-commerce surged, online advertising rebounded.

The U.S. Capitol riots on Jan. 6 sparked legal debates regarding content moderation on social media platforms. Senior equity analyst Ali Mogharabi believes the controversy will ultimately have a minimal impact on these companies. He notes that Section 230 of the Communication Decency Act offers immunity from liability for Internet content, and he believes Section 230 will not be repealed but changes are likely.

The suspension of former U.S. President Donald Trump’s Facebook and Twitter accounts will have a modest impact for each company’s network effect. Many Trump supporters left and may remain off both platforms in favor of Parler (which just recently began operating again after Apple AAPL and Google removed it from their app stores, and Amazon suspended it from AWS). Some advertisers likely wanted to avoid taking political sides and used other platforms. However, we think with increased moderation, advertisers now see these as safer for their brands.

Even regulators can’t slow the momentum of Google and Facebook, which are being investigated by the Department of Justice and the Federal Trade Commission, respectively, for monopolistic practices. Michael Hodel, director of communication services, equity research, agrees with Mogharabi and believes both investigations will go to the U.S. Supreme Court, and that it will ultimately decide in each of the firms’ favors. He says prosecutors will struggle to demonstrate how consumers and advertisers have been harmed by Google’s and Facebook’s behavior.

A Tale of Two Stories for Retail, Food, and Auto Retail had a mixed performance in 2020. Companies with a strong online presence captured customers shopping from home while those struggling to grow their e-commerce suffered. Department stores like Macy's M were struggling going into the pandemic and have been hit hard while Amazon continued to dominate throughout 2020. The COVID-induced housing boom has created tailwinds for home improvement companies like Home Depot HD and Lowe's LOW, which have done very well, as DIYers have looked for projects around the house while under stay-at-home-orders.

As of Jan. 6, attractive valuations made restaurant stocks one of the limited investment opportunities in consumer cyclical. Social-distancing guidelines hurt many food establishments as indoor dining was limited and even prohibited in certain parts of the U.S. Quick-service restaurants such as Chipotle CMG and pizza quick-service like Domino's DPZ performed the best in 2020 while fine dining and casual dining fell. We believe most publicly traded restaurants will survive the pandemic, but the worst may be yet to come for the broader restaurant industry.

In automotive, our analysts projected pre-pandemic that over 16 million light vehicles would be sold in the U.S. The actual number was much lower at 14.6 million. We anticipate low-single-digit growth in vehicle sales for 2021. As COVID-19 vaccines are distributed, this number may increase as the U.S. heads toward herd immunity. Tesla's stock saw significant price appreciation in 2020. While the company's technology has the potential to change the world, Tesla's stock comes with great uncertainty. Industrials strategist David Whiston says Tesla's brand cachet and cost advantage create a narrow economic moat, but its mass-market volume remains very limited as it continues to sell vehicles mostly at a premium price point.

Healthcare Remains Stable Despite a global pandemic, the healthcare sector didn't experience as much volatility as the other sectors. The Morningstar US Healthcare Index posted a 17.41% gain in 2020, which is slightly lower than the 20.9% gain from the broader market. The median U.S. healthcare stock is trading at a 9% premium, and values can be found in the drug manufacturing and managed care industries. Drug manufacturers will likely have goodwill with U.S. regulators because of their quick vaccine development, which may help them avoid price reforms in the near future. We don't expect major healthcare insurance reforms--even with a Democratic-controlled White House and Congress.

Many drug manufacturers are working toward developing a coronavirus vaccine, and biopharma companies are working on COVID-19 treatments for those who have the virus. Damien Conover, director of healthcare equity research, sees a $10 billion market in 2021 for COVID-19 treatments. This market opportunity for biopharma will continue into 2022, but Conover thinks sales potential after 2022 is limited.

Historically, vaccines have been the best way to control viruses, and we don’t see COVID-19 as an exception to this. Heavy vaccination in 2021 and 2022 will significantly reduce demand for treatments past 2023, but until then, treatments will still be in high demand. We see the highest sales potential from Eli Lilly LLY and Regeneron’s REGN/Roche RHHBY treatments for mild to moderate COVID-19 patients. By 2022, we expect COVID-19 treatment sales to fall by 75%--with an even sharper decline in 2023.

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