Coronavirus: Financial Pandemic or Just a Little Sniffle?

Thursday, February 27, 2020

By: Christopher Cline

The Coronavirus (or COVID-19, as the disease is known) is becoming a huge concern all over the world. On Monday, February 24, the World Health Organization said the virus had infected more than 79,000 people worldwide, killing at least 2,600. While the disease is most widespread in mainland China, cases have been reported in Iran, Italy, Japan, South Korea, Switzerland and the United States.

Financial markets initially had a muted reaction to the virus, but starting this week the economic effects of the virus hit the markets with a vengeance. Over Monday and Tuesday, the Dow Jones Industrial Average and the S&P 500 had each dropped more than 7.8% from their record highs earlier this month. Tech stocks like Apple and Facebook were down by more than 10% (technically moving into correction territory. The bond yield curve inverted, with the yield on 10-year Treasuries dropping below that of 3-month Treasuries (an inverted yield curve is often seen as a harbinger of recession).

So are we at Riverview worried? Let’s look a little closer at the virus and at history for the answer.

1. The Virus.

The coronavirus was first discovered in the industrial city of Wuhan, located in the Hubei province of China, in December. It probably originated in animals but spread to humans through the many open markets in the area. After a brief attempt to cover up the outbreak, Chinese officials imposed “the most extensive quarantine measures ever enforced during an epidemic,” according to The Economist magazine. Hubei province is on the tightest lockdown, being “all but sealed off from the rest of the country” since January. These stringent measures seem to be working, as the daily numbers of newly diagnosed infections in China has mostly fallen since February 13.

However, outbreaks in South Korea (the hardest hit outside China, with 977 reported cases), Italy (322 reported cases) and Iran (at least 100 cases and 15 deaths) continue to grow. Closer to home, the director of the National Center for Immunization and Respiratory Diseases at the Centers for Disease Control and Prevention said Tuesday that “the agency expects a sustained transmission of the virus and called for businesses, schools and communities to brace themselves and plan for potential outbreaks,” according to a report in The Wall Street Journal. In the U.S., 57 cases have been reported (with 40 coming from the Diamond Princess cruise ship in Asia). The CDC believes that the question isn’t if the virus will expand in the U.S., but when.

2. The Economic Impact.

China is fighting the virus on two fronts: stop its spread and minimize its economic impact. Unfortunately, however, the more effective it is in achieving the first goal, the harder achieving the second becomes. Wuhan, a city with a larger population than London, is an industrial hub, and Hubei province has a GDP bigger than Poland’s. Although businesses in Hubei had been scheduled to reopen on February 21^st, the date had to be pushed back to March 10^th. This economic disruption has moved throughout China, affecting virtually every economic sector.

Because we live in an economically interdependent world of global supply chains and “just in time” manufacturing (under which companies keep very little inventory), a blow to China’s economy is a blow to the world’s. In the auto industry, for example, “if even minor parts are missing because China-based suppliers are unable to make them, it could force assemblers around the world to halt production.” According to The Wall Street Journal, this is already happening in South Korea, with Hyundai and Nissan halting some production. Problems in supply chain can linger for months, even if the global spread of the virus is halted soon.

All of this means that we should not expect a smooth and relatively quick recovery, as happened with the SARS outbreak in 2003. In fact, while many are trying to analogize the potential impacts from the current virus with those from SARS, the analogy doesn’t really fit. In 2003, China represented about 3% of the world economy; now it represents more like 16%. If China’s economy continues to slump, it could create a deflationary pull on Western economies. Further, while more deadly, SARS was less contagious and therefore much easier to contain than COVID-19. Finally, if COVID-19 spreads around the globe (a distinct possibility), central banks may have to step in to try and stimulate their respective economies. This could be extremely difficult in the current environment in which interest rates are already very low.

3. How Worried Should We Be?

The answer to that question is to buckle up. Be ready for a lot of bumps ahead, but don’t make significant portfolio changes. Here’s what we know:

• We don’t know a lot yet about the disease. Spread of the disease is still very hard to track, test kits are hard to come by, a vaccine is a ways off.
• Given the damage that’s already occurred, be ready for an extended period of economic disruption and market volatility. If the spread of the virus is not contained fairly quickly, the volatility could be deeper and the economic disruption longer.
• Market prices always bounce back. A balanced portfolio of stocks and bonds regained all of the losses it suffered during the Great Recession within two years of the event. The effects of COVID-19 will not be as financially devastating as that earlier event was.

So stick to the fundamentals. Continue your investment strategies. Make sure you have enough cash on hand (or existing cash flow) so that you don’t have to sell in a down market. Keep rebalancing. And please call us with your concerns or questions.