One month ago, I published a note (please see my previous blog post) explaining why I thought that the Coronavirus would not leave the markets unscathed. Although markets largely shook off the growing risks for the first weeks of February, last week saw the worst fall in stock prices since the financial crisis as it became clear to investors that COVID19 has an increasing probability of becoming a global pandemic, following increasing infection rates in other developed economies, specifically South Korea, Hong Kong, Japan and Italy.

 

Why the market sell-off may continue

As mentioned in my note last month, the sell-off is likely to be intensive because “this outbreak is occurring when market valuations are at historical highs and interest rates at historic lows. High stock valuations can result in large stock market drops when there is a negative change in investor’s earnings expectations. Although central banks can help support the economy and stock markets by reducing interest rates, given that interest rates are already low, it is questionable how effective lowering rates further will be.”

 

Unfortunately, angst from the rapid spread of COVID19 may continue as investors over the weekend learned that:

 

It will be difficult to grasp what the full impact of the disruption to the global supply chain will be after China’s factory activity shrank at its fastest rate on record through February and the largest shipping port in North America, the Port of Los Angeles, announced that it is projecting a 25% drop in container volumes in February. In other words, 1 in 4 imported goods just suddenly stopped coming. https://www.wsj.com/articles/port-of-los-angeles-sees-coronavirus-impact-sharply-reducing-imports-11582648931

The US reported its first COVID death and researchers who studied two cases of Coronavirus say that the virus may have been spreading for weeks. - https://www.nytimes.com/2020/03/01/health/coronavirus-washington-spread.html

Reports so far suggest that anywhere between 5%-20% of those infected suffer from severe pneumonia which can only be treated in a hospital for around 14 days. Until a vaccine is found and proven effective (a process which is likely to take a year or more), it is becoming increasingly likely that governments will resort to cancelling major events, put infected areas under quarantine and lockdowns, shut down schools and ask employers to reduce activity to decrease the chances of workers spreading the virus, leading to an additional unanticipated economic shock. The reasoning behind the necessity of these drastic measures is that do not have anywhere close to enough hospital beds to treat the likely influx of patients that will need intensive care as a result of the severe pneumonia. For instance, according to the AHA there are 924,107 hospital beds in the US or 37 million bed-days/yr. There are 330 million people in the US. The estimate has been ~40% of the population will be infected. That is 132 million. If only 5% of those infected suffer from severe pneumonia, the low-end of most estimates, the US would need 92 million bed-days to effectively treat everyone, which is 30 times more than currently available. It is simply unfeasible. Therefore, drastic measures may be necessary in order to reduce the intensity of an outbreak, flatten out the epidemic curve and therefore reduce the strain on the health system.

The situation in Canada is unfortunately not any better.

 

Inflation could spike as a result of a supply shock

In Economics 101, we learn the basics of how the balance between supply and demand affects employment and pricing. When supply suddenly decreases due to an external shock (like the one we are experiencing), the likely result is higher prices (and probably higher unemployment). The reasoning is intuitive. Supply chain disruptions may lead to shortages, which will likely increase the price consumers are willing to pay for the remaining goods. The longer the shortages last, the increased chance that employers will have to layoff redundant employees. Therefore, the speed of restoring the global economy back to normal levels will be key to avoiding this scenario.

 

Eyes on Canada – Increased inflation and lower economic activity would put significant pressure on indebted Canadian households

Canadians will be entering this period of economic instability with extremely low levels of disposable income. Any significant increase in consumer prices or higher unemployment would be a blow for many living paycheck to paycheck. Both coming simultaneously could be devastating.

Share of Household Income Left for Discretionary Purchases

 

My sincere empathy goes out to all those who have suffered or who may suffer from this mysterious virus.

 

I remain available to take any questions and/or help review your portfolio to help assess how it may be affected from these events -please feel free to contact me.