What the Coronavirus Means for Investors
Don’t Count on an Immediate Recovery
|Written by Tom Yeung, CFA | CDFA|
Investment Advisor & Fund Manager, Jurnex Financial Advisors
Updated for March 2020
In the final week of February 2020, global stock markets fell by 10-15% as investors reassessed the risk of an impending Coronavirus pandemic. The vast majority of investment managers urged people to remain calm. Some, including JP Morgan, even suggested buying on the dip.
But are they right? History suggests perhaps not. Just like the Coronavirus itself, investors shouldn’t count on an immediate recovery
How did we get here?
Scientists first identified the Novel Coronavirus (COVID-19) in December 2019. At the time, stock markets were reaching new peaks. Investor sentiment was buoyant. But that wouldn’t last.
As the reality of the coronavirus set in, markets began to sink. Selling culminated in the last week of February, where markets suffered their single one-week loss since the 2008 financial crisis.
Yet, something strange happened. Despite thousand-point declines in the Dow Jones, few investors seemed to panic. John Arthurs, a writer for the Financial Times, noted how unusual it was that investors were responding in such a calm and orderly fashion.
Gold prices show an orderly exit
In the late-February selloff, gold, which typically rises in price during panics as investors rush into safe-haven assets, went down in price. Even Bitcoin suffered losses.
Gold’s performance is indicative of an orderly exit from markets. Participants, realizing that stock prices are too high, are calmly reducing their holdings.
Yet, market commentators often mistake inaction for prudence. While a do-nothing attitude is appropriate when things are positive over the long-run, it can be devastating when situations change. The Chinese stock market went to zero during the 1950’s revolution, as did the Russian market in the early part of the 20th century.
The Coronavirus will not have such lasting effects; in 1-2 years, its impact will largely have passed. But does that mean investors should choose inaction over action? To understand the full potential of the coronavirus on your investments, it helps to understand the virus itself first.
What is the Coronavirus (COVID-19)?
In December 2019, a group of health care professionals in Wuhan, China, noticed a new type of virus. What eventually became known as the Coronavirus (or COVID-19) was ten times deadlier than the regular flu, and almost twice as contagious. However, it took nearly three months (and 75,000 infections later) for world stock markets to start comprehending the potential fallout of the virus.
And notice, they did. In the last week of February, markets suddenly dropped 10-15% on news that the Coronavirus had spread to Italy and beyond.
Coronavirus mortality rates
The coronavirus is not a very deadly disease when compared to other epidemics.
- Common flu. 0.1%
- Coronavirus COVID-19. 2.3-3.8%
- SARS: 10%
- Measles: 15%
- MERS: 34%
- Ebola: 90%
Nor is the disease frighteningly contagious. The R0 measure gauges how many people one sick person will infect on average (source)
- MERS. <1
- Common flu. 1.3
- Ebola. 2.0
- Coronavirus COVID-19. 2.3-2.7
- SARS: 3-4
- Measles: 12-18
As the reality of the Coronavirus sets in, people will realize that the best way to prevent it’s spread is rather dull.
1. Good hand-washing practices
2. Disinfecting surfaces
3. Isolating people as much as possible.
Any loss of life is a human tragedy. And in the worst case, COVID-19 could be just as devastating as the 1918 Spanish Flu, which killed 30 million people.
Just because the coronavirus isn’t as deadly as Ebola nor contagious as the measles doesn’t mean investors should let their guard down. While best practices for containing the coronavirus is relatively mundane, its effects on the overall economy are not.
How will the Coronavirus affect investors?
The US market has undergone more than ten years of constant stock gains and economic recovery. The coronavirus has the potential to slow demand and to jolt investors awake from their decade-long slumber in four key ways.
1. Short-Term Impact on Earnings
Firstly, the coronavirus will almost certainly affect 2020 earnings. Last week, Goldman Sachs announced their updated projections on corporate profits. Rather than increased by 7%, they called for a 0% earnings increase.
Fears of the US falling into recession are also mounting.
Meanwhile, the German economy, already slated to go into recession before the Coronavirus, will now almost certainly see a severe economic impact.
Analysts are worrying. Why aren’t we?
Goldman Sachs’ stock and bond analysts are on the mark to worry about 0% earnings growth in 2020. The potential closure of schools and public areas in the United States will almost certainly depress demand for goods and services the same way it has done so in mainland China. The US economy, primarily driven by consumer spending, will grind to a halt under extended quarantine.
- Manufacturing and job stoppages. The 2019 GM worker strike reduced US manufacturing output by 0.5%.
- Service industry stoppages. The federal sequester of 2013-2014, which displaced almost 1 million federal workers, cost the economy nearly $90 billion in FY2014.
- Uneven demand. Stockpiling of ammunition in 2008-2013 by gun owners caused a multi-year slump for manufacturers after demand declined.
Yet, few investors seem to be panicking with the Coronavirus. The reality of deserted malls delayed purchases, and food hoarding hasn’t truly set in. Perhaps it’s because Americans haven’t experienced such large-scale closures in modern history. But one only needs to look at photos from mainland China to understand the impact that deserted public areas will have on the broader economy.
The Coronavirus may create a vicious cycle on demand
The short-term effects will act as a vicious cycle. Just as store shelves were bought up by panicked consumers during hurricane Katrina, the spread of the Coronavirus in the United States will bring the expected media blitz on the dangers of leaving home. Once it’s America’s turn to don facemasks by the thousands, people will start to realize the gravity of the situation.
2. Medium-Term Impact on Confidence
The short-term impact on earnings will have a medium-term effect on investor confidence.
Notable studies have shown at the stock market is influenced by the weather. Sunny days in New York and Chicago tend to raise stock prices, while rainy days tend to do the opposite.
Currently, investor sentiment has been relatively mild in the face of a global pandemic. The US government hasn’t yet asked investors to stay at home. People haven’t seen medics in full protective garb wandering up and down the streets. That will soon change.
People need first-hand experience
Years ago, Bernie Marcus, the founder of the Home Depot, lamented that Wall Street analysts failed to recognize his company. Despite its growth in rural America, Home Depot had largely avoided expanding into major cities. And stock analysts were unable to notice the company. All that changed when the Home Depot opened its first store in Jersey City, NJ. As Wall Street analysts began to file into the store, the Home Depot suddenly became a stock “discovery” and a Wall Street darling.
In the case of the coronavirus, the same principle will hold in reverse.
Monkey see, monkey panic
So far, few Americans have seen the realities of managing a pandemic. Despite a blanket ban on travel to China, travel to Hong Kong, Japan, and other commonly visited countries have remained open to American travelers. Only the cruise industry has seen a significant decline in bookings.
In other words, investors aren’t mentally prepared for widespread panic.
It’s been more than ten years since the US financial crisis of 2008. Since then, the US stock market has been on a tear. An entire generation of investors has only known ever-higher share prices, having seen almost a decade of uninterrupted stock market gains.
Pessimism has a bad habit of compounding on itself.
Coronavirus fears this week lowered corporate earnings expectations, leading to lower stock prices. In current thinking, the stock market declines end there. But it doesn’t.
That’s because stock markets run on a feedback loop. Seeing their nest egg shrink by 12% in a week from the Coronavirus will cause many consumers to lower spending for three reasons.
- Psychological. “I’ve made a big loss, and so I don’t feel like spending on a $4,000 vacation right now.”
- Logical. “I need to save an extra $4,000 to rebuild my losses.”
- Practical. “The Coronavirus has made it impossible for me to spend $4,000 on vacation right now.”
In all three cases, decreased consumer spending will lead to even lower corporate earnings expectations, further depressing stock prices. While some market pundits have suggested buying on the dips, this is a mistake.
3. Longer Recovery in Certain Industries
One thing the market has gotten right, however, is that the coronavirus will disproportionately affect specific industries.
- Cruise lines. The three major cruise lines, Carnival, Royal Carribian, and Norweigian, are down between 25%-35% in the past month vs. 8% for the broader market
- Airlines. From IAG (parent of British Airways) to Delta Airlines, travel stocks are down by 20-25%
- Miners and manufacturers. Vale (mining) and heavy manufacturers saw stock prices down 20% or more
There are some (slight) winners, too, including healthcare and software companies.
Don’t count on a V-shaped recovery in stocks
After a decade of continually rising stock prices, investors have become accustomed to buying on the dips. Also known as bottom fishing, this involves purchasing beaten-down companies when stocks go down in expectation for a quick recovery.
As Howard Marks famously put, buying a market on the way down isn’t so much like catching a falling knife. It’s more like catching a piano.
That’s because habits take time to recover. After the 9/11 attacks, the airline industry suffered enormous demand declines. It wasn’t because of a clear and present danger of future flights getting hijacked. It was a broader fear that had permeated the US psyche on airline travel.
American Airlines and United were particularly affected (having been choice carriers for hijacking thanks to their corporate names). Both companies would file for bankruptcy over the following decade.
In the same way, cruise industries and other related industries will likely perform worse for longer than people expect. After a foreign-policy debacle, few would be readily willing to board another cruise ship named the Diamond Princess.
Re-branding takes time. If the post-9/11 airline industry was any indication, the stain of the Cornovirus on the travel industry would take time to pass.
Tech players are winners
Companies such as Zoom Technologies, Microsoft Azure, and Google Enterprise stand to benefit from increased work-from-home policies. As companies build practices to allow workers to work remotely, these technologies will thrive.
For years, futurists have imagined a future where people can work remotely. The reality has been far from expectations, with just 5.2% of people able to work full-time from home.
But mandatory quarantines by the coronavirus can help jumpstart new company practices of remote working.
Public/private healthcare funding will also get a boost from increased corporation between drug-makers and desperate governments seeking a vaccine. Public ire of excess biotech profits will take a backseat.
eCommerce companies may lose
Not all online companies will win.
It’s tempting to assume Amazon, Grubhub, and other e-Commerce companies will be big winners. As experience has shown in mainland China, however, investors ought to beware.
Consider the different paths of Alibaba (the Amazon of China) and Tencent (an online gaming and social media company).
From January through the end of February, shares of Tencent outperformed Alibaba by six percentage points. While Chinese consumers did buy more online from Alibaba, their purchases tended to be in lower-value household goods, rather than pricier, higher-margin items.
Tencent, on the other hand, saw large increases in consumer spending, as bored Chinese citizens under quarantine looked for ways to pass the time.
When choosing winners and losers in the US stock market, it’s not enough to group companies into “tech vs. non-tech.” Instead, smart investors need to identify companies where the underlying profits (not just demand) will do well in the long-run.
4. Coronavirus Black Swan Potential
Finally, the coronavirus has Black Swan potential.
Nassim Nicholas Taleb coined the term “Black Swan” to describe the financial crisis of 2008. It describes events that fulfill three criteria.
1. Rarity. A surprise event beyond the realm of reasonable expectations
2. Impact. An influence beyond anything anticipated
3. Retrospective predictability. People see the event as entirely predictable in retrospect.
Mr. Taleb based the term “Black Swan” on Europe in the 1600s. At the time, no European had ever seen a Black Swan and therefore had no reason to believe Black Swans existed. However, Black Swans DID exist in the Far East. It was only after explorers found Black Swans in the late 1600s and early 1700s did Europeans realize their existence.
Similarly, we have never quite seen a modern-day version of the 1918 Spanish flu pandemic. It’s impossible to comprehend the range of possible outcomes, yet any result may seem predictable in retrospect
What if the Coronavirus spreads through the government?
As a thought experiment, imagine that one person in Congress somehow gets infected with the Coronavirus. As recent history has shown, Coronavirus carriers can be infectious for days before showing any symptoms. So imagine, for a moment, that a third of Congress members become infected before people realize it’s spread.
I’m not suggesting that this will happen. But if it did, what would happen if 10% of the 1/3 infected members of Congress become incapacitated? Mathematically, 18 of the 535 members of Congress may become unable to carry out their duties.
Other political impacts
The US economy and stock market, a well-known predictor of presidential outcomes, could impact the 2020 elections. Further declines in the stock market may hurt President Trump’s potential for reelection.
COVID-19 might have an additional impact: a stifling of political rallies and voter turnout. This could have an undue effect on campaigns built on energizing a voter base.
The ultimate Black Swan event
Even though the coronavirus has just a 2-5% mortality rate, investors shouldn’t rule out the possibility of mass panic.
But can we predict what will happen as of today? Not really.
That’s what makes the Coronavirus such a potential Black Swan event.
Conclusion: So What Should Investors Do?
It’s still too early to know the full impact of the Coronavirus on the US economy and stock market. But current indications point to a heightened need for concern.
Most likely: Coronavirus continues to spread
As the Coronavirus continues to spread, the US will likely institute significant containment efforts. Expect temporary school closures, cancelation of public gatherings, and self-imposed quarantines. These actions will be necessary to slow the spread of the Coronavirus, but they will also significantly suppress economic demand in the short-run. The market has not yet priced the full extent of knock-on effects.
Less likely: full-blown panic
Whether these measures turn into full-blown panic remains to be seen. It’s still unlikely, but as experience has shown, a hyperactive news cycle makes it a possibility. The moment we see large-scale panic is the time when investors should start seriously worrying and potentially selling stock. It’s good to be invested for the long-term, but not in the face of extreme panic.
Moral: Don’t buy in too early
It’s unlikely that the US stock market will see a V-shaped recovery. The impact from the Coronavirus will last several months at least, if not until the end of the ear. There’s a lot more turbulence ahead, and I highly recommend investors remain vigilant.
Good luck investing. We’re going to need it.
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