By David Bailin
Chief Investment Officer
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The coronavirus could become a pandemic. As we keep monitoring closely, we consider potential economic and market outcomes.
The COVID-19 (Coronavirus) outbreak appears to be nearing pandemic status. A new surge in Coronavirus infections outside of China materially raises the likelihood of a far wider, and potentially more lengthy, global economic shock. Even though the World Health Organization (WHO) has not yet made a declaration to that effect, we believe recent outbreaks outside of China, including Italy, Korea, Japan and Iran, are likely to cause it to make a declaration soon. The fact that new outbreaks do not have definitive sources and the lengthy time of gestation of the disease without symptoms suggests “quarantines” and other normal measures to contain COVID-19 may fail.
If infections continue more widely in coming days, economic disruptions seen in China will occur more widely. As other nations face similar health issues, factory closures and slowdowns will accelerate. These will exacerbate supply chain interruptions and cause near term earnings impacts currently unforeseen by markets.
The COVID-19 virus is more lethal than the 2009/10 swine flu pandemic that killed an estimated 575,000 globally (0.3% morbidity). Thankfully, the COVID-19 virus is much less lethal than the Spanish Flu of 1918-20 that killed 40 million people globally.
According to Harvard epidemiological models, the death toll from COVID-19 globally may reach 3 to 6 million people over a period of up to 18 months. That dwarfs the 2,500 deaths reported so far and underscores the large delta between reported news and third-party estimates. While in any given year there are about 55 million deaths from all causes, to the extent the estimates are accurate, such COVID-19 related deaths would represent the second largest number from any global health crisis of the past 100 years. Note that the estimated 3 to 6 million fatalities assume that no timely and effective vaccines and treatments are found.
The tragic human toll from COVID-19 will not be the primary channel of economic disruption. Government travel restrictions, quarantines, supply chain disruptions and changes in individual behavior are the sources of short-term economic impact. For example, air traffic, tourism, retail activity, theater attendance and restaurant receipts may drop precipitously in impacted areas. Major purchases like autos and electronics may be delayed. These demand shocks will occur even as supply chains lengthen and the availability of merchandise may be impaired for a time.
Preparations to fight global pandemic risks have intensified in the nearly two decades since the SARS epidemic. Along with far greater information, the stronger precautions taken by governments and business would tend to intensify any global economic shock. Further, we believe that a global shock would be more intense than any regional one. For example, a net decline in travel and tourism from a global pandemic exceeds reductions in travel spending in which only a particular region is avoided.
Over the next few days, we will assess potential impacts from this increasingly probable outcome. We would expect that “safe haven” assets like US Treasuries, gold and the US dollar will continue to see inflows and higher prices. We would, similarly, expect to see equity markets in affected countries decline in response to the degree of the spread of the virus. Eventually, if evidence of a global pandemic becomes clear, there may be a major “risk off” move in markets globally. Negative “multipliers” from trade-sector losses may occur. Unlike regional shocks, currencies may not provide an adjustment channel in a global pandemic. Marginal creditors may experience acute stress that may have to be addressed by significant changes in macroeconomic policy.
For investors, risk hedging over the near-term is growing strongly in appeal even as hedging costs rise. In addition to maintaining our long-term portfolio diversification, we may also take added steps to adjust for a potential global health crisis. Our existing overweight positions in US Treasuries and gold may be augmented at the expense of equities.
News on the virus deserves an open-minded reassessment in coming days as facts are reported. That said, we do not advise overt market timing for Core portfolios. While the probability of a major pandemic has risen dramatically and is now more likely to be confirmed, the sources of disruption – largely efforts to stem infection – makes the primary economic impact temporary in nature. As seen in previous global and regional health epidemics, economies typically rebound sharply when the health threat itself has passed – see “Germs of Steel”. Such a disruption is materially different than vulnerabilities from traditional sources of economic boom and bust - see Expensive Defensives.
The comments and data presented above reflect information gathered on 2/23/2020 from Professor Marc Lipsitch, Professor of Epidemiology and Director of the Center for Communicable Disease Dynamics at the Harvard T.H. Chan School of Public Health.