The risks posed by the coronavirus spooked markets in a major way last week, with the S&P/TSX Composite down 8.9%, the Nasdaq Composite down 10.5%, the S&P 500 down 11.5%, and the Dow Jones Industrial Average down 12.4%. Despite the drastic moves, there is still a great deal of uncertainty about what the epidemic means for the global economy. Below is a summary of what we have learned so far about its potential impact.
First things first: China has basically shut down. The following chart shows that the number of trips taken in the country has dwindled to a fraction of what they were this time last year.
Combined with fewer trips, factories have also drastically scaled back their activity. The following map shows the concentration of nitrogen dioxide (NO2) in the air over China both before and after the quarantine efforts. The gas is emitted by motor vehicles, power plants, and industrial facilities. As this map suggests, none of those three emitters is operating anywhere near normal capacity.
Source: NASA Earth Observatory
To put the scale of China’s shutdown in perspective, it has been estimated that 40 billion work hours were skipped because Chinese workers stayed home following the Lunar New Year. That’s equal to all U.S. workers taking two-months off work.1
This plummeting Chinese business productivity has already had a negative impact on global supply chains. It has been estimated that 60% of the scheduled cargo ship departures from Asia to either Europe or the U.S. were canceled during the first three weeks of February.2 Supply chain delays of this significance will take quite some time to be resolved even once productivity returns to normal in China.
We’re hesitant to try to quantify what kind of impact the epidemic will have on economic activity, because so little is yet known about the science of the virus itself. We have seen many economists make predictions about best-, base-, and worst-case scenarios, but the fact remains that all of these predictions are pure guesswork at this stage.
What about the virus itself?
To illustrate these unknowns, we’ll highlight a recent interview Goldman Sachs Global Investment Research did with Dr. Barry Bloom, a public health professor at Harvard University. The bulk of the public’s fear seems to be based on the epidemic’s fatality rate: the coronavirus fatality rate is currently estimated to be above 3% versus 0.1% for the seasonal flu. However, Dr. Bloom provided a more nuanced analysis of this calculation:
“The case-fatality rate estimates, or the percent of infected people who die, doesn’t provide any information about how lethal this virus is at this point. That’s because those estimates basically reflect the percent of hospitalized people who die from the disease. In the case of SARS, this was around 10% and a relatively accurate reflection of the disease’s virulence because virtually everybody infected had severe symptoms. But with this virus, which can be asymptomatic, we don’t know the total number of people infected; so the case-fatality rate’s denominator is unknown.”
On when the virus will peak:
“It’s very hard for scientists to make evidence-based predictions on that. We couldn’t have predicted that the quarantine around the Wuhan area would have resulted in such a rapid decline in cases; the classic epidemiology model suggested that the number of cases would have declined around the middle of March, at the earliest.”
On whether the arrival of summer in the Northern Hemisphere will slow the virus’ spread:
“That has been the case for influenza, which moves seasonally. And SARS wound down over the summer. But it is not at all predictable whether this infection will be seasonally controlled. There’s good evidence that coronaviruses don’t do well in warm, humid weather, and that they thrive in cold, dry weather. But is that because of the climate, or because people are huddled closer together in the wintertime? It’s not clear. A couple of small studies on parts of China versus places like Hong Kong that are in a tropical belt show no evidence that weather differences between these regions have been a big determinant in the viral spread. But we just don’t know.”
Goldman Sachs Global Investment Research also conducted an interview with Dr. Michael Osterholm, the director of the Center for Infectious Disease Research and Policy at the University of Minnesota. Here is Dr. Osterholm talking about whether we are facing a global pandemic:
“At this point, it’s not clear what the future holds. However, we do know several facts. First, this virus is easily transmitted, much like the influenza virus. Over 80% of cases are mild or asymptomatic, and there appears to be clear evidence from several clusters of cases that even asymptomatic people can transmit the virus to others. That is concerning, because it means that the public health measures we traditionally use, like quarantine or isolation, will be ineffective. […] Should it continue to unfold in this manner, that would make it a global pandemic.”
On whether it’s an encouraging sign that the number of new infections in China is slowing:
“I don’t take much comfort in that. Remember that much of China has been under an extremely severe population lockdown, well beyond a standard isolation or even quarantine from a public health standpoint. And even despite that, we’re still seeing new cases, which is a testament to this virus’ infectiousness. When China loosens its population control efforts to restart its economy and people go back to work and gather in crowds again, we could easily see a major rebound in the number of cases in the ensuing 4-6 weeks. We saw something similar in Toronto during the 2003 SARS outbreak. An outbreak in April was brought under control, but then two unknown cases reignited the spread in May, which became the more severe part of the outbreak. The lesson from that was don’t celebrate the end of this prematurely.”
On whether we should expect the number of international cases to rise:
“More cases are very likely. To see why, take a look at what happened in Wuhan. The virus emerged there in late November at the latest, and no one in the medical community picked up any activity until the end of December—a month later. The best data we have so far suggests that each infected person not in protective isolation infects about two other people on average; that compares to 1.2-1.4 people for regular influenza, and about 1.8 people for pandemic influenza. Using an incubation period of around 6 days, in the first 24 days, or four generations of the virus there are 31 total new cases per every individual initially infected. Over the next four generations, there are a total of 480 cases. At that point, you might start picking up something, but, if 80% of these cases are mild, not a lot of cases would be detected by the medical system. After the tenth generation, there are 1,548 total cases. If 5% of these are severe, you really start picking this up, but that’s already ten generations, or 60 days, out. Every country in which the virus is introduced around the world will go through a similar pattern in which the disease goes undetected for the first month or two. And once the virus is detected, it will take time to see a buildup in the number of cases. So that is why we are just beginning to see a rise in international cases, and why we can expect more to come.”
On whether a vaccine, if discovered, would help:
“In terms of stopping this outbreak, I have no hope a vaccine will play any role. There’s no way we’re going to have a vaccine tested for safety, effectiveness, approved by a regulatory agency, manufactured and administered to the public any time short of more than a year, or even several years.”
To loosely paraphrase the doctors’ commentary, “We don’t know.” Yet the markets will still open every day, and investors must make decisions about how to allocate capital in this uncertain environment. This will likely be a recipe for increased volatility over the coming weeks and months, as the markets react to each piece of incremental news about the virus.
What it means for the markets
Speaking of reacting, after selling-off during the week of February 24th, equities began to rally on the afternoon of Friday, February 28th. They continued to head higher on Monday, March 2nd, with major North American indices up 5% that day. What happened? Central banks around the world all started talking about interest rate cuts, and the markets started listening. To quantify, the next chart shows how the odds of the Bank of Canada cutting rates tomorrow, on Wednesday, March 4th, increased rapidly over the aforementioned two days that equities rallied.
The biggest risk we see – with respect to central banks’ rate cuts – is what will happen after the cuts are made. Short-term rates are already near 0%, so there’s only so much lower they can go. That means there is only so much more fuel a lower borrowing rate can provide to the equity market rally. So what do central banks do if they cut to 0% and the coronavirus gets worse? Quantitative easing? Negative near-term rates? It’s not like looser monetary policy will convince a sick person to go in to work. It’s a risky time for investors to believe that central banks will continue to protect the downside of their equity valuations.
So far during this period of increased volatility we haven’t been selling equities. But we haven’t been buying equities either. Despite the rapid decrease in the S&P 500, it has still only reversed back to where it was in October – that’s not exactly bargain-basement territory for valuations. If the selloff continues, however, we would expect more bargains to present themselves. We have been cautious about equity valuations for quite some time, having positioned our portfolios accordingly with elevated cash balances and inverse ETF positions. If and when the time comes, we will be ready to act.
We were putting the final touches on this blog post and just about ready to upload it when central banks again took centre stage. On Tuesday morning the Fed announced an emergency 0.5% rate cut. This was the Fed’s first emergency cut (a rate cut that occurs outside of a scheduled meeting) since October 2008. The markets initially rallied on the news, with the Dow Jones Industrial Average popping 2.5%. However, this rally was short-lived, with markets giving back most of these gains within 30 minutes. We stress that it is very early days for the market to digest this news, but we do find it interesting that a surprise 50 bps rate cut from the Fed did not provide another boost to equity markets.
1Source: Johns Hopkins, Goldman Sachs Global Investment Research
2Source: Jeff Currie, Head of Global Commodities Research, Goldman Sachs Global Investment Research