The market's viral resistance
Why have markets remained resilient despite the continued threat of the coronavirus? And as investors, how should we react to this surprisingly positive sentiment?
2019-nCoV has tragically now claimed more than 900 lives, and our thoughts are with all those who are suffering and affected. The coronavirus is not so much a measurable single risk as a fog of uncertainty. So how, as investors, do we assess its potential impact?
We started by building a simple but intuitive framework for how similar past outbreaks impacted the GDP of affected countries. Our dedicated team of economists delivered two independent approaches in just 24 hours.
In the first, the team conducted a cross-country analysis based on the experience of SARS in 2003 to compare infection rates and the impact on economic growth. The second was a bottom-up estimate of 2019-nCoV’s impact based on the economic contribution of the individual provinces locked down.
Taking both together, our research suggested that although this incidence of the coronavirus is worse than the SARS outbreak, the very decisive response from the authorities in China and global awareness should prevent a global pandemic.
However, the epidemiologists are still in the early stages of understanding this disease. Markets are monitoring the levels of new infections closely: these appear to have stabilised in recent days and remain relatively low outside China, but some experts believe the true number of cases in Hubei is already several times larger. This could have implications for the mortality rate, assuming deaths are not as severely under-reported.
Prepare, don’t predict
Faced with a fast-changing situation, such work gives us the foundations from which to assess the key sensitivities and to question assumptions. Alongside the economic analysis, we must also remember that financial markets are influenced by sentiment that is less rooted in fact.
Investors are not virologists and so there’s a very real risk of a fake narrative taking hold. Despite it being very early days in our understanding of the virus, we are starting to see some quite strong views emerging in the media and market commentary. We believe this is partly due to behavioural biases like the availability cascade, whereby a collective belief gains more and more plausibility through its public repetition.
As the narrative swings one way or the other, we’ll focus on finding credible sources that fact check it. For example, comparisons of the virus to a bad case of flu are challenged by the The Lancet, which reported that 11% of early cases in Wuhan Jinyintan Hospital died of organ failure and 75% had pneumonia in both lungs – far more serious than is common with the flu. Other excellent sources on the virus’s development include Johns Hopkins and the EU.
The sheer amount of information available to investors on a daily basis, and the pace with which the market environment can change, are just two of the reasons why it is so important to have a structured investment process to combat our natural instincts.
Viewing information in a consistent manner over time minimises the chance that we fall prey to certain biases, as does viewing the market through multiple lenses. That is why we keep our eyes on both the fundamental economic analysis and the prevailing market sentiment.
It’s difficult for us to short equities or buy government bonds based entirely on one factor, and at the moment we’re struggling to find support elsewhere. Sentiment appears neutral, with virus risks tempering encouraging US data, and lower bond yields and oil prices will both support growth. That said, if the current narrative becomes more extreme in either direction, we’ll look for opportunities to lean against it.