Epidemics can rattle markets, and as fund managers we need to know what is worth reacting to and what is a product of the 24-hour news cycle. Here, we share some learnings, as the World Health Organisation (WHO) continues to call for false information to be squashed.
In the age of information, it can be easy for investors and advisers alike to be swayed or distracted by articles, statements and opinions which lack evidence, rigour and analysis. Certain headlines can be frightening and foster an air of anxiety.
Our role as guardians of clients’ capital means we apply refined filters to assess incoming information and guide our investment decisions. We have models to help us separate signal from noise during the regular flow of economic data, however navigating ad hoc events, for which there may not be a ready-made model, is another critical aspect of portfolio management.
The situation unfolding with the Coronavirus is, above all, a human tragedy. For investment managers, who have a responsibility to be a steady hand during this time, it represents an ad hoc event to interpret and manage with caution. We share some of our thinking on the Coronavirus below, with insight to our thinking and processes during events of this nature.
1. Monitoring scale and severity
The scale of an epidemic is an important factor in analysing market impact, but you first need to determine what to measure. In the case of an epidemic, mortality rates hit our fear impulse hardest. However for financial markets the significance of an event like this boils down to the level of disruption caused to regular flow of goods and people.
By way of example, over 11,000 people sadly fell victim to the Ebola outbreak in West Africa in 2014. In contrast, the Coronavirus has resulted in around 2700 deaths, to-date, yet the level of disruption caused to the global economy has been more severe because of differences in population density and the impact to global supply chains.
While the mainstream media will emphasise the mortality rate, and the undeniable human tragedy this situation entails, an investment managers lens must include various other factors. Ultimately, we are trying to measure the level of disruption caused to the economy; a function of the scale of the response required to contain the epidemic (e.g. flight cancellations) and the likely time to containment.
Furthermore, when we frame the situation in terms of disruption, events like the 2010 Icelandic volcano eruption, where nearly half of global air traffic was halted over an 8-day period, can be factored into and enhance our analysis.
2. Understanding context and the knock-on effect
The economic context also sets the scene for how harshly an event can impact markets. Further, it has large bearing on how lengthy the recovery phase will be.
In the case of SARS, GDP in China fell by over 2% in the June quarter of 2003. The economic backdrop wasn’t particularly helpful at the time – the global economy was still feeling the effects of early 2000s recession which saw the collapse of Enron, bursting of the Tech bubble and the September 11 terrorist attacks.
While the situation isn’t quite as dire this time around, the virus has arrived at a time where great hope has been placed on emerging markets’ ability to rebound from an 18-month long US-China trade war. China was set to play an important role in this rebound story and, critically, its share of global GDP has increased nearly three-fold since the 2003 SARS outbreak.
Equity market watchers will also be acutely aware of the markets sensitivity to US-China trade relations, and the Coronavirus raises new questions about China’s ability to meet its obligations under the recently signed Phase One trade deal when it agreed to buy large quantities of US goods in exchange for tariff relief. Compounding the issue is the looming US Presidential election where Trump may not be in the position or mood to offer the type of leniency China requires to avert a more dramatic slowdown.
In recent days, we’ve seen the number of new cases in China moderate while the number of new cases outside of China has been increasing. For some market participants, this is being viewed as cause for relative optimism for Chinese stocks versus other regions. In the context of global trade, however, one has to consider whether there is any actual difference or benefit to China, which goes from not being able to sell goods to the world, to much of the world (potentially) not being able to buy China’s goods as stricter quarantine measures are adopted.
3. Adding a grain of salt
There have been some fairly wild conspiracy theories circulating since the onset of the Coronavirus, which the World Health Organisation (WHO) has called out as damaging and unnecessarily fear provoking.
They’ve also been compelled to address some specific myths in an online fact sheet – including that eating garlic, covering your body in sesame oil, and even exposure to cold weather can help protect against the virus.
There are also a number of more sinister headlines and theories in circulation. One of these is that the virus was a biological warfare experiment gone wrong and the passing of the doctor that discovered the virus was part of an elaborate cover up. Absurd as some of these stories may seem, they do have the ability to impact an investors mindset and undermine the level of trust in the official reporting.
Here, a little situational awareness and rational thought can provide a timely filter for investment decisions.
Over the past 16 months, China’s hog population has decreased by approximately one-third as a result of African Swine Flu, resulting in an 110% increase in the price of pork. Under these circumstances it is reasonable to assume some behavioural shifts by the Chinese consumer, i.e. an increase in demand for substitute meats which may have unintentionally created the conditions for an uncommon virus. It is also reasonable to assume that the doctor that sadly passed away was working tirelessly to help contain the virus, which compromised his immune system.
A portfolio manager deals in probabilities and thinking along these lines can be a vital debunking tool which allow you move on quickly to other things.
By and large we are closely monitoring sources like the WHO, while taking note of studies from other credible institutions, such as the London School of Hygiene and Tropical Medicine and the Imperial College London as they become available.
"At the WHO we're not just battling the virus, we're also battling the trolls and conspiracy theories that undermine our response," WHO Director General Dr Tedros Adhanom Ghebreyesus said. In that statement, he endorsed a headline from The Guardian reading “Misinformation on the Coronavirus might be the most contagious thing about it.”
4. Keeping calm
As our chief economist, Dr Shane Oliver, often reminds us: our worst-case fears are just that – worst-case fears. Our senior economist, Diana Mousina, has also pointed out how fears of a Spanish flu type of situation – which was in 1918 and killed about 50 million people – is highly unlikely.
With that said, there is also no denying that the situation has deteriorated following outbreaks in South Korea, Italy, and Iran, to name a few, with focus now shifting to the United States. The ASX 200 and S&P500 indices have suffered some of the most dramatic weekly falls on record, falling 10% and 12% respectively from recent highs, as the contagion threatens to reach pandemic status. For many investors, there will be few better opportunities to practice the art of keeping calm.
The conversations we are having now include the likely time to containment for the cases outside of China and the ability of fiscal programs (or intentions) being announced by various governments to stabilise growth. For example, on Wednesday, Hong Kong announced a spending package granting each resident the equivalent of A$2000. South Korea also announced a program targeting small businesses struggling to pay wages, which we would argue is a more direct and timely form of stimulus.
So while there is no doubting the severity of the Coronavirus; the disruption it has already caused and could cause were the situation to deteriorate further, an investment manager must remain grounded by probabilities and rational thought because a steady hand is imperative during times of crisis.
With the benefit of a tried and true investment process and an ability to identify the facts that matter, we can get on with doing what we do best: growing and guarding our client’s capital.
Subscribe below to Insitutional Edition to receive my latest articlesBrad Creighton, Dynamic Markets - Portfolio Strategist
1 National Bureau of Statistics China, Bloomberg 2020
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