Coronavirus Update: Market Risk of Epidemics
Financial markets have steadied after this week’s coronavirus-induced sell off. Notably, the yield curve has flattened and may prompt the Federal Reserve — weary of inversion that suggests recession — to consider further rate cuts. We are not out of the woods on the coronavirus, so we think it’s worth taking a look at the equity market with past health scares.
Market Effect: Epidemics Before and After Declared Crisis
The outbreak was declared a global health crisis by the World Health Organization on January 30. Exhibit 1 shows the performance of the S&P 500 Index for other epidemics, three months prior to the announcement of a global health crisis to six months after.
As can be seen in the exhibit, in many cases, the epidemics are non-events for global equity markets. Markets are positive throughout the full nine-month period in six of the eight instances. Further, half of the time, markets are positive in both the three months leading up to and the six months after crisis is declared.
In Exhibit 2, a few cases stand out: 1) The 2009 Swine Flu showed a notable decline and recovery, but that’s attributable to the global financial crisis. 2) The 1957 Asian Flu showed negative performance both before and after the official announcement and killed 1.1 million people. 3) The 1968 Hong Kong Flu had the worst post-crisis announcement return and killed 1 million people.
Many have compared today’s coronavirus to the 2002–2003 severe acute respiratory syndrome (SARS) outbreak, given they are similar viruses. Based on early numbers, it appears that the coronavirus is less deadly but more contagious. It will likely surpass the number of SARS cases given the current trajectory. At last count, coronavirus has surpassed 4,500 cases versus 8,000 for SARS. With those caveats, SARS has a 6% “prior three-month” loss and a 22% “next six-month” return. However, other factors were at play, including the Iraq war and the bottoming of the tech bubble deflation that helped the recovery.
Why This Time May Be Different
Here’s how the coronavirus may increase risk to the global economy and market performance versus the SARS crisis:
- The virus is less deadly but more easily spreadable. It has a longer period of time before symptoms show.
- Social media increases the speed of news circulation, which impairs short-term economic activity as people “stay in.”
- The Chinese government response has been much swifter and more cautious than in previous incidents. About 45 million people have been quarantined, further impairing economic activity. However, this could also limit its severity. Still, it should be noted that an estimated 5 million Wuhan residents were able to leave the city before the quarantine was established.
- The epidemic is hitting during the Chinese Lunar New Year, a traditionally busy travel season. Oil prices are off 15% from recent highs.
- China’s economy is three times bigger than in 2003 and a much bigger driver of global demand.
Positioning for a New Risk
Without more information, and given the historical road map of these types of market events, we believe selling into weakness would be premature. Our tactical positioning is modestly “risk-on,” favoring the “lower risk” risk assets such as high yield and U.S. equities (over non-U.S. equities) as well as interest rate sensitive asset classes (global real estate and listed infrastructure). Still, investors should ensure their portfolios are prepared for these types of risks through diversification and the right investments for potential volatility.
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