Investors should be worried about the economic impact of the coronavirus. But they should be equally concerned about the psychological impact of the outbreak.
For at least some people, the virus appears to be crystallizing a wider set of anxieties around stock prices. If you are convinced the market is due for a correction because of excessively high valuations, or think the global economy rests on an artificially engineered low interest rate bubble, the outbreak offers a ready-made focus for your anxieties. The danger is that these fears will become a self-fulfilling prophecy.
There are already flickers of panic selling. In Toronto, the S&P/TSX Composite fell 2.19 per cent on Tuesday, its biggest one-day decline in four years, to close at 17,177.37. In New York, the S&P 500 slid 3.03 per cent. It has lost a total of US$2.138-trillion in market value over the past four trading days, according to market analyst Howard Silverblatt at S&P Global Inc.
For now, it bears repeating that observers such as the International Monetary Fund are still not certain how long or deep the negative effects from the virus will be. Rather than sounding the alarm, IMF managing director Kristalina Georgieva told the Wall Street Journal she is worried countries may overreact to the virus threat and shutter their economies.
This doesn’t mean countries should ignore health precautions. It just means the world has dealt successfully with viruses in the past. Public-health authorities understand the actions that have to be taken and can usually take them without disrupting activity for more than a few weeks.
According to the virus dashboard run by Johns Hopkins University, the growth rate of coronavirus cases has already slowed markedly in China, suggesting that strong containment measures are having the desired effect. While the disease is spreading outside of China, the absolute number of confirmed cases is still not large – less than 400 in Italy, for instance, where several towns are in quarantine, and under a dozen in Canada.
So why the near panic on Bay Street and Wall Street this week? In part, it is because the disease is moving closer to home. The U.S.-based Centers for Disease Control and Protection spurred a new wave of selling on Tuesday when it warned Americans to prepare for the arrival of the disease in their own communities.
The fear also seems to reflect a widespread skepticism of current market valuations. U.S. stocks, in particular, look unusually overvalued by some popular gauges. For instance, the cyclically adjusted price-to-earnings ratio, or CAPE, compares current stock prices with their underlying earnings over the past decade. By its reckoning, the S&P 500 is now more expensive than at any time since the height of the dot-com bubble in the late 1990s.
A highly valued market is vulnerable to the ripple effects from Chinese quarantine measures. The Asian giant accounts for roughly a quarter of world manufacturing and any disruption in its output – even a limited, temporary one – rattles global supply chains, depriving other manufacturers of necessary components and ingredients.
To make matters worse, central banks in much of the developed world have only limited room to stimulate their economies to offset the impact of a virus-related slowdown. In a dramatic demonstration of how low interest rates have sunk, the yield on the 10-year U.S. Treasury bond – the go-to haven for many investors – hit its lowest level on record on Tuesday, as people scrambled for safety.
After years in which policy makers cut interest rates to support their economies, there is “very little room to cut rates further if something goes wrong,” Paul Krugman, the Nobel-winning economist, warned on Tuesday. “And the coronavirus looks like something.”
Perhaps so. It is worthwhile emphasizing, though, that markets have been exceptionally fickle in their response to the virus outbreak. The S&P 500 index of big U.S. stocks swooned in late January, then recovered strongly earlier this month, before falling again in recent days.
Maybe the real lesson here is not to trust the market’s diagnosis. The next couple of weeks will tell us far more about how serious the coronavirus outbreak will be on a global scale. Until then, the short-term outlook for the global economy remains nothing more than a guess.
The one thing that is certain is that the virus offers a blank canvas for all types of scary notions. Scott Minerd, chief investment officer at Guggenheim Partners in New York, wrote a note earlier this month in which he argued the new coronavirus “is much more deadly than SARS and if not contained threatens to become a global pandemic.” He pointed out the last pandemic, the Spanish influenza of 1918, killed 50 million people.
Other analysts argue the virus will spell an end to globalization and force a major re-engineering of global supply chains. Still others worry it will lead to political upheaval in China.
Those are all vivid tales of things that could possibly go wrong. But investors should keep in mind they are all based on speculation. Until the ultimate path of the virus is clear, betting on the short-term direction of the market is a gamble on the unknown.
Ian McGugan