Market volatility and the coronavirus

InvestSense
Jonathan Ramsay
Jonathan Ramsay
InvestSense Director
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If you stay in the game long enough you will often thank yourself for playing a steady hand in the face of a market fright, but every now and then this can feel like complacency or, worse, turn out to have actually been complacent.

The market is down around 3% over the past few trading sessions and the coronavirus epidemic has put a large dent in the liquidity fuelled rally that started the year. 

However, to put this in context it means most equity markets have only just given back their gains from the first couple of weeks of the year and the Australian market is still up by more than 5% (although that is a bit of an illusion as much of it is due to a rebound by the banks and the local markets underperformance of 6% in the previous quarter).

The case for complacency is made by history and the chart below (from Charles Schwab via Marketwatch.com) which shows that market panics centred around previous epidemics have been invariably short-lived. 

Bizarrely, markets have tended to be up on average by 8.5% over the following six-months (that is probably because the SARS and the Swine Flu coincidentally occurred at the nadir of the Dot Com and Global Financial crises respectively). 

While health scares like the coronavirus in each case are very emotive, they have, thus far, failed to meaningfully affect the global economy or equity markets. 
 That said, there’s always a first time. Each outbreak, by its nature, presents the experts with unprecedented scenarios and it is not inconceivable that we encounter something more severe from both an economic and societal point of view. 

Much of the modelling for the current crisis is based on the SARS crisis although there are apparently some important differences. In the case of SARS, the world was ‘saved’ by the severity of the symptoms and the fact that the disease only became contagious when those symptoms became apparent. This meant it was relatively easy to find and quarantine carriers of the disease. 

This version is seemingly less lethal but, from what little we know, has a longer incubation period and often less obvious symptoms. Accordingly, there is a fear amongst the medical community that the growth rate of this virus could become exponential (if it hasn’t done so already) and may last much longer. That might lead to a far greater economic impact as well as the inevitable human tragedy. 

So, what are we doing about the current crisis, if anything?

We speak regularly to Andrew Hunt of Hunt Economics and he was yesterday involved in a conference call with a prominent expert in the field who suggested that at some point in the following few days we may know whether this exponential growth pattern has become inevitable.

He is also carefully monitoring financial issues like, for instance, the unintended consequences of extended public holidays in China on an already stretched financial system where various trade finance and foreign debt liabilities will come due over the month-end. 

In that respect, we consider ourselves relatively well-informed. We are also monitoring portfolios very carefully and will weigh up any information as it becomes available. 

Usually the market discounts this kind of information very quickly but if we do get a sense that there is likely to be a longer-term financial impact that the market has not discounted, we are ready to make the necessary portfolio changes.

In the meantime, you may be somewhat comforted to know that Australian diversified portfolios have actually done relatively well due to a confluence of factors. 

These include the more pronounced rebound of Australian shares earlier in the month, as well as the weaker Australian dollar that has bolstered unhedged overseas equity returns by an additional 4%. We estimate that the portfolios remain up by 1-3% for the month so far.

Clearly, we have no edge in understanding disease control, but it probably pays to be on one’s toes and to try and understand how markets are likely to react or even have reacted in a situation like this. 

Even if markets fall by 10% and you have done nothing to mitigate that then understanding why might stop you doing the next silly thing - under-reacting or over-reacting. 

Our understanding is that the reproduction rate (how many people are typically infected by one carrier) is still unknown but estimated to be somewhere between 1.5 and 4.  At the lower end, it should be containable but at the upper end, it would probably ‘go exponential’ within a few days. 

Going exponential means that a high and constant rate of growth in infections would very quickly mean it was affecting a large part of the global population and would probably be here to stay for a long time in the way that SARS didn’t. 

To put this in context the number of confirmed cases reported yesterday grew by 60%. A constant 20% growth rate every day would mean that 1.4 million people would be infected in 30 days’ time. A week after that the number would be over 5 million. 

SARS affected 8000 people and caused a little under 800 deaths during 2002-2003. Even if the mortality rate remained well below SARS (as it seems to be) a failure to slow the growth rate in the next few days would lead to potentially tens of thousands dead and likely a complete halt in global travel and severely restricted economic activity. 

As ever we are sensitive to the potential human cost when we write these words but, in our role, remain focused on the financial impact. This is also not us being armchair epidemiologists, it is just a feature of exponential growth that affects financial markets as it does diseases. 

There is no reason at all to suggest that will happen, but it is also why we think it is worth keeping an eye on that growth rate quite closely over the next few days. 

The graph below from Johns Hopkins University shows that while the growth rate is not accelerating anymore it remains high at more than 30%. This is a reliable source although they are in substance tracking numbers provided by the Chinese Government. 

Modelling by credible academics in the West suggests that the number of infected may already have been in the tens of thousands last week and be over 100,000 now. That is not say that the Chinese numbers are necessarily wrong, just that the number of infected people might be several times that of confirmed cases, given the virus’s stealth compared to SARS. 

We are also learning that the data is quite lumpy and that one appears to get a better read late in the Southern Hemisphere day. 

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