Predicting how the 2019-nCoV coronavirus epidemic will play out, both in terms of its distressing human toll and in financial markets, is impossible. Like you we wait and see. But history provides some guidance on how markets might unfold. While the SARS epidemic of 2003 was different, and China was very different then, it is instructive. Markets fell and fell more than they have so far in this outbreak but swiftly recovered as the incidence of new cases tailed off. While case numbers are still increasing we think that caution is warranted. We remain defensive in portfolios where we have discretion. That said, we are likely to add to risk positions should any sell off in prices accelerate or the news get better.
The very word epidemic is scary. The photos and video smuggled out of China are scary. And the headlines we are reading are scary. The human toll is worse than scary and devastating for those families facing losses or locked down in quarantine facing an uncertain future.
It is natural for all of us to feel nervous about what the coronavirus epidemic might mean. At its core this nervousness stems from a very natural fear of the unknown. How big will the epidemic get? Will it affect me and the people I love? And with our investor hat on, what effect will it have on the economy and markets?
Answering these questions with absolute certainty is impossible. No one knows. This is partly because much is still unknown but also because chance plays a role in how long the Coronavirus outbreak will last and the impact that will have in both human and economic terms.
While we can’t truly know what might happen, insights from past virus outbreaks give a sense of the likely path of this epidemic.
From an investment perspective the good news is, that in the past, these events have proven to be transitory and markets have quickly rebounded from any fall.
What do we know or can we infer from previous epidemics?
It is well publicised that the novel coronavirus outbreak in Wuhan China, 2019-nCoV, shares many similarities[1] with SARS, a viral outbreak that occurred in 2003. That doesn’t mean that the coronavirus epidemic will behave in the same way as SARS but it is instructive to look at the similarities and differences between the two and how financial markets behaved during the SARs outbreak in an effort to draw some conclusions.
SARs and 2019-nCov appear to be about as infectious as each other – this is still the subject of scientific research but both SARs and 2019-nCov seem to be, according to one scientist “moderately infectious”. This is bad news for people who get the virus but good news in terms of the containment efforts. Face masks, good hygiene and isolation of suspected cases will likely see the incidence of new virus infections trail off over time.
2019-nCoV appears to be less deadly – while the patchy data makes hard and fast conclusions difficult, the fatality rate from 2019-nCoV is, so far at least, tracking at less than 3% compared to SARs which killed around one in ten people who contracted it.
Research published in the British medical journal The Lancet suggests infection rates in key Chinese cities may continue to rise for another two months – predicting the timing and path of the Coronavirus is extraordinarily difficult. There are many variables that will ultimately guide this but some interesting analysis has been published seeking to answer the question we all have[2]. The goal of this research is to help authorities refine the appropriate response, and with planning. The key conclusion they draw is that we should expect this to get worse before it gets better but that the response to date, including some of the more draconian travel restrictions and border controls, is appropriate.
SARS had a material impact on economic growth – although this was only over a one quarter period. At the epicentre of SARS, economic growth in China fell from 11.1% in the first quarter of 2003 to 9.1% the following quarter before rebounding, as SARs was contained, in the third quarter to 10%. The effect of global growth was minor.
2019-nCoV will likely have a bigger economic effect than SARs– the Chinese economy is many times larger today than it was in 2003 and its factories are integral to the global supply chain of many of the goods that we consume in the West. This means the tentacles of coronavirus will stretch far even if the virus itself doesn’t. But, if history is a guide, this will be a transitory and not permanent effect.
During the SARS epidemic markets followed the rate of change in new cases not the number of new cases – the Hong Kong share market was the epicentre of financial market action during the SARs epidemic, falling materially as it unfolded. At its lows the Hang Seng Index had slumped 15.4%. The recovery from this fall was sharp. As the speed of new cases being declared slowed, the market rallied, recovering its losses 54 days later. In the United States the S&P 500 share index dropped 8.3%. At the same time, the price of gold jumped 4.8%. The US share market, like Hong Kong, more than made up for its losses, gaining 18.6% over the six months following the scare.
To date share market reaction in developed markets has been surprisingly muted – this is despite the volume and tenor of headlines, and the scale of the human tragedy. In the United States the S&P 500 index has only fallen 2.4% from its all-time highs. Of course the reaction in China has been much swifter with a precipitous fall when the market reopened after the lunar New Year break. The share market reaction in New Zealand has been in line with global markets. The S&P/NZX 50 index is down 3.3% from recent highs. Of course averages hide a lot. For New Zealand companies most exposed to tourism and Chinese trade, share prices falls have been more dramatic. As an example Sky City Casino has dropped by 14%.
How are we positioning portfolios? And what can you do?
We are taking the 2019-nCoV outbreak seriously. We expect the impact of the epidemic to continue to build and for it to be headline news for a number of months to come. The risk of it establishing a foothold outside of China is real although authorities are taking the right actions to reduce the likelihood and impact of this happening. We can only hope from a humanitarian and investment perspective that this is successful.
Caution is warranted. Western share markets have been surprisingly sanguine and the news flow over coming weeks could still be negative. Where we have discretion we have less invested in shares than usual and are comfortable maintaining that position.
We have also positioned portfolios for falling interest rates. We have done this both by increasing exposure to international fixed income but also by adopting a longer than typical average fixed income maturity in portfolios - longer maturity bonds are worth more as interest rates fall. Thus far both of these moves been right.
With that all said, history shows that epidemics like this get resolved, the economic impacts are temporary and normal service reasserts itself. We will be looking to add exposure to the share market should any sell off in prices eventuate. Similarly volatility at an individual company level can present opportunities which we will look to take advantage of.
And what about for our clients? How might you respond? For most of our clients, particularly if you have at least a medium term investment horizon, over reaction to events like this typically proves to be a bigger risk than inaction. Patience and a long run perspective are critical ingredients to successfully compounding your wealth over time.
For those of you looking to build your investment portfolio this looks more like an opportunity than a long run threat.
[1] http://www.thelancet-press.com/embargo/coronavirus3.pdf
[2] https://www.thelancet.com/journals/lancet/article/PIIS0140-6736(20)30260-9/fulltext
