The Corona Virus outbreak in China is alarming. We are not experts on the virus itself, nor on the human impact, but one of the more concerning aspects about the outbreaks is that they're unprecedented and even infectious disease experts won't know the full extent of the danger until its containment is established. In that light, rather than attempting to pinpoint the likely extent of the virus, we'll take a look at historical data to establish some reference points for how markets might react.

 

Markets have been quick to react so far, although fixed income assets outside of Asia have held up fairly well. The S&P 500 is down less than 3%, and corporate credit spreads have barely budged from their near-record lows.

 

Of course, the reaction in China – where 99% of the outbreaks have occurred and people are dealing not only with the virus itself but prolonged and unprecedented travel restrictions – has been more severe, with the Shanghai Shenzhen CSI 300 Index down 10% even after today’s bounce back.

 

Market reactions in past outbreaks have been largely focused on the disruptions to travel and global supply chains, rather than the tragic deaths themselves. The spread of Ebola in 2014 was devastating, and tested the social fabric of many West African communities; it was also an extremely deadly disease, killing over 10,000 people despite fewer than 30,000 cases. However, because the mechanism of Ebola’s spread was easier to contain (through bodily fluids of an infected individual, rather than airborne particles), markets didn’t panic because the chance of a global breakout was slim.

So far, the reaction to coronavirus has been considerably closer to that of SARS, which makes sense given the similarities regarding the contagiousness and mortality of the new coronavirus.

 

Source: Bloomberg

Although thousands of new cases continue to pop up every day, there are even some early signs that markets are beginning to believe that economic damage will be limited. A basket of equities that have been identified as particularly sensitive to coronavirus has recently reversed half of the losses incurred so far.

 

This all begs the question – what is, or could be, different this time around? One risk is to fall in the trap of thinking that the economic implications won’t extend beyond China. The importance of China to the global economy is many times higher today than it was for SARS, and global supply chains are more dependent on the country than they’ve ever been. in 2003, China accounted for 8.7% of global GDP vs. 19.3% in 2019. Here's a breakdown of other sectors:

China's Annual Consumption as a % of Global Consumption

Source: Barclay's, Macrobond Financial, Danske Bank

 

 

Ultimately, the risk to markets depends on the extent of the spread of the virus, as the relatively low mortality rate of 2019-nCoV (~2%) is well established at this point. On the one hand, this virus is considerably more contagious than SARS (can be spread for days or even weeks before showing symptoms), and the opportunity for a truly global pandemic are higher this time around. New confirmed infections are in many cases virus transfers that occurred last week or earlier, meaning the data is always playing catch-up as to the extent of the proliferation. On the other hand, the global health community is far better prepared today for these events, and the information flow out of China has been far more open and helpful than it was for SARS.

 

However, perhaps an underappreciated risk this time around is simply the reduced ammunition in market or central bank toolboxes to deal with the coronavirus. A combination of central banks having few levers left to pull alongside very elevated valuations in equities and credit means that we believe investors should be particularly aware of events that could affect these valuations to the downside. The current market reaction appears to be a prudent repricing of the very plausible tail-risk of a highly disruptive global pandemic.

 

Although there can be no definitive answer about the ultimate extent of the disease until after the fact, the one key metric we’ll be watching to estimate the high-water mark of the spread will be the growth rate of new infections. If that growth rate doesn't continue to fall meaningfully, we would then look at a potential repricing of markets and adjust our recommendations.

 

As things are unfolding now we recommend maintaining neutral weightings to equity in your portfolio, and we continue monitor the situation for any further developments.