Coronavirus Black Swan

In the past two weeks the Coronavirus has been picking up steam globally and causing production concerns for companies around the world. The question for investors remains, is this enough to truly put the global economy in trouble.


Looking to history, we know that SARS ended up being contained and didn’t cause a problem. Before SARS, the largest outbreak was the Hong Kong Flu in 1968 which caused such a stir that Wes still remembers it despite being a little kid at the time. This strain of Flu killed 1 million people worldwide in a matter of months. Over that timeframe the S&P saw its largest drop of 10.11% top to bottom in March 1968. Obviously, we’re much more globalized now, but despite the death toll, the global economy pressed on.


As far as real economic impacts today, the biggest is obviously in China where growth estimates are being pulled back by as much as 0.4% for the first quarter. The International monetary fund claims this could shave .1 percentage points from global GDP alone. However, they also state that a quick recovery would be likely.


That doesn’t sound so bad on its own, but if you look at the stock market, you’d think hostile aliens had just landed in Washington D.C.


So, the big question is, is the market overreacting or is there something more to this drop?  


As a first point to that extent here is an excerpt from a letter from Commonwealth’s CFO Brad McMillan on the subject:


“Signs of a Slowdown in China


While the risk to your health may be small, that may not be the case for your investments. The epidemic has already caused real economic damage in China, and it is likely to keep doing so for at least the first half of the year. The same case seems likely for South Korea. These two countries are key manufacturing hubs. Any slowdown there could easily migrate to other countries through component shortages, crippling supply chains around the world. Again, there are signs in the electronics and auto industries that the slowdown is already happening, which will be a drag on growth. This risk is largely behind the recent pullback in global markets.


Here, the key will be whether the disease is contained—which would still be a shock to the system but would be normalized fairly quickly—or whether it continues to spread. Right now, based on Chinese data, the first scenario looks more likely. If so, Chinese production should recover in the next six months, with the economic effects passing even more quickly. It might help to think of this situation like a hurricane, where there is significant damage that passes quickly. Stock markets, which typically react quickly on the downside, can bounce back equally quickly. Should the virus be contained, it would be a mistake to react to the current headlines. We have seen this situation before—the drop and bounce back—with other recent geopolitical events.”


We felt that Brad hit the nail on the head in his letter which acknowledged that there would certainly be economic impact on the supply chain side, but that things should rebound when the spread of the virus slows and fears abate.


Also, looking to the bond markets, which are usually smarter than stocks, there is no major blowout in pricing there, usually indicating that the fears don’t run deep enough to think companies are in danger of being able to pay off their debt.


This selloff has certainly happened quickly, but that doesn’t mean it’s going to be any more severe than any other. The next quickest correction happened in February of 2018 and while 2018 wasn’t a great year, it was a far cry from the great depression when it was all said and done.


All in all, we certainly agree that this week has been more than a little scary but keeping both events in perspective we can keep our heads and get through this.


First, we have contained coronaviruses before effectively and this isn’t affecting near as many people as the flu does every year.


Second, although this is disrupting supply chains in the short term, containment of the virus and restoration of these supply chains will likely calm the markets as quickly as it worried them.