February 28, 2020
Mark Minchin

Understanding the Coronavirus

As most readers will know, Coronavirus (now known as COVID-19) started in the Wuhan province in China. Prima facie, you could be forgiven for believing that the virus isn’t remarkable. Most people who get the virus only suffer relatively mild “cold and flu like” symptoms and then they get better. The fatality rate is only around 2%, so whilst many die, the vast majority – some 98% of people who contract the virus, make a relatively quick and full recovery. 

By way of comparison, the first avian flu that was discovered in 1997 in Hong Kong, now known as H5N1, had a fatality rate of 60%. If you got it, then chances were you’d die. 

Whilst Coronavirus sounds, on these grounds, less sinister than some other viruses such as the high profile H5N1, Ebola, SARS or MERS, it is precisely this lower fatality rate that makes Coronavirus potentially more dangerous and more likely to become a pandemic. 

Whilst H5N1 was horrific in its fatality rate, it has only killed 455 people. Similarly, SARS and MERS each killed fewer than 1,000 people.  The Coronavirus on the other hand, has already killed some 2,800 people and appears to be crossing borders rapidly.

With its potent mix of characteristics, the virus is unlike most that capture popular attention: It is deadly, but not too deadly. Perhaps most dangerously, the virus sometimes causes no symptoms at all. 

What about a Vaccine?

Whilst genetic sequencing is now extremely fast, the making of vaccines is still as much art as science. It involves finding a viral sequence that will reliably cause a protective immune-system memory, but not trigger an acute inflammatory response that would itself cause symptoms. While the influenza vaccine cannot cause the flu, it can cause flu-like symptoms. Hitting this sweet spot requires testing, first in lab models and animals, and eventually in people. 

During the SARS outbreak in 2003, researchers moved from obtaining the genomic sequence of the virus and into a phase 1 clinical trial of a vaccine in 20 months. These days, this process can be compressed even further. And in the case of the Coronavirus, given the significant global implications, one would assume vaccine development may be faster again. Nevertheless, experts suggest it is likely to be 12- 24 months before a vaccine will be in the market (and that would be an unprecedented achievement). 

The world has responded with unprecedented speed and mobilization of resources. The new virus was identified extremely quickly. Its genome was sequenced by Chinese scientists and shared around the world within weeks. The global scientific community has shared genomic and clinical data at unprecedented rates. Work on a vaccine is well under way. The Chinese government enacted dramatic containment measures, and the World Health Organization declared an emergency of international concern. All of this happened in a fraction of the time it took to even identify H5N1 in 1997. 

Notwithstanding the swift response, the outbreak continues to spread. Whilst 95% of the cases to date are in mainland China, spikes are occurring in other countries, including South Korea, Iran, Italy, Singapore, Taiwan, Thailand and Japan and some scientists sense the outcome is that it will ultimately not be containable. 

If containment efforts fail and this indeed becomes a pandemic, scientists suggest there are two likely ways that the outbreak could end: 

  1. either enough people will develop immunity — either through infection or vaccination — that the virus will stop transmitting and is eliminated, or
  2. the virus will continue to circulate and establish itself as a new seasonal respiratory virus (much like the flu).

Another possibility is that COVID-19 (Coronavirus) will mutate in a potentially beneficial way, making it more difficult for the virus to infect people. Back in 2002, a similar coronavirus in the Guangdong province of southern China first hopped to humans from animals and caused an outbreak of an infection that became known as severe acute respiratory syndrome (SARS).

SARS spread to 26 other countries, including Canada, sparking fear that the disease would become widespread in North America. But the outbreak ended up petering out, in part due to good public health containment, but also because SARS randomly mutated — as viruses commonly do — and became much more severe but harder to transmit to humans.

The Economic Impact

There are clearly going to be health and social impacts from the Virus, but our priority here is to consider the economic and market impact. 

The economic impact needs to be measured in terms of the potential for an ongoing emergency, the closing of borders, the disruption to supply chains, the reduction of trade, possible public unrest in some countries and the postponement of tourism – all for a period – not indefinitely. 

Economists suggest that the intense period of disruption will take place only while the World tries to contain the virus. This won’t go on indefinitely. Before too long, we will know which way this outbreak is heading: uncontained or containment. 

Either outcome is likely to result in factories, schools, borders, reopening within months. If the World can’t contain it, people will simply have to go back to work. Some will get sick, most won’t – sort of like a severe flu season, but either way the show will go on. 

Best & Worst Case for Global Markets

The question then is: How long will it take before normality will return and how much disruption will there be?

Typically, when we consider macro events such as Coronavirus we look back in history for a similar event to see what the implications were last time. In this case, the most similar event was the SARS outbreak in 2003. That outbreak had many similarities, but also many differences. 

Analysis suggests that the SARS crisis cost the world economy a total of about $40 billion. However, the threat passed relatively quickly, and the economic recovery was V-shaped. That is, growth was depressed for a quarter, but then rebounded hard for the subsequent four quarters as the virus dissipated. Stock markets weren’t severely impacted. 

It is already clear that the Coronavirus is likely to be much more impactful than SARS was. 

Circumstances were very different back then. In 2003, China was booming — with real GDP surging by 10% (China is targeting 6% for 2020) — and the world economy was growing by 4.3% (compared to 2.9% now).

Furthermore, in 2003 China was a far less significant part of the world economy (3% of global GDP) compared with today (17% of global GDP). Back then, factories were mostly churning out low-cost goods like T-shirts and sneakers for customers around the world. 

Today, although China’s factories still produce a mind-bending array of simple, low-value products like clothing and plastic goods, they have gone on to achieve dominance in more advanced and lucrative pursuits like smartphones, computers and auto parts. 

Today China is an essential part of the global supply chain, producing components needed by factories all over the World. Some estimates suggest that 25% of the components of all manufactured goods are sourced from China. In many cases these component parts can’t be sourced from anywhere else.

While the “shock” of Coronavirus is likely to be relatively short lived. Perhaps what is more important is the underlying economic trend. The world economy was weak, and weakening when the Coronavirus struck. Thus, the V-shaped recovery that followed SARS will be hard to replicate — especially with monetary and fiscal authorities in the U.S., Japan, and Europe having such little ammunition at their disposal (ie rates are already at extremely low levels leaving comparatively little room for significant stimulus).

What should investors do?

A key thing all investors need to understand with economics and markets is that they aren’t the same. Predicting what is going to happen to economic growth is one thing but looking to the second derivative – predicting movements in markets –-is altogether a much lower probability game. 

Even if we were to correctly forecast the economic impact of Coronavirus, that alone will not ensure success in predicting future movements in market prices. 

The disconnect between economic growth and stock market returns is well documented (they have precious little correlation). The disconnect exists because markets are ever mindful of current events and predictions. So, if your own fears and forecasts for economic activity are in line with the prevailing view – then chances are the market has already priced that view in. There is a saying: “Today’s news was factored into yesterday’s price”. 

This week is a good example of just how quickly markets assimilate news into prices. Hour by hour as news of the Coronavirus’s spread through the World has emerged, market prices have recalibrated to incorporate the new reality – an increasing likelihood of global pandemic. 

This is precisely why, at any given point, it is difficult to determine exactly how much of the current risks we fear are already “built into” prices. 

A portion of the ongoing news flow is typically in-line with market expectation – these announcements are likely to be largely in the price already; other announcements however, may come as a partial or complete surprise to markets – it is these that aren’t accounted for in the price and cause markets to jump one way or another. 

Obviously, it is the surprise or unpredictable news that is the news that it would be so helpful to know ahead of time – but these are also the data points that are precisely the hardest to second guess.

For instance, possible future headlines in the coming weeks and months could read: 

  • “Virus mutates to become less infectious” or
  • “Virus mutates to become more dangerous” or
  • “Researchers stumble upon breakthrough Vaccine” or
  • “Vaccine proves elusive for researchers” or
  • “Virus recedes as Northern summer begins”

Determining which headlines will break and when is incredibly difficult. On the other hand, there are some relevant things which we can predict with comparatively higher confidence. For instance –  

  • The current Coronavirus outbreak will come to an end.
  • Economic growth and company profits will suffer for a period and then recover.
  • Share markets will experience heightened volatility (both up and down days) whilst uncertainty persists.
  • Markets will ultimately recover and continue to deliver sound long term returns for investors over the long term.

If you are a long-term investor, with a well-considered investment strategy, you shouldn’t need to make changes to your portfolio strategy now. 

Investors who play the speculative game of trying to get “all in” or “all out” are playing a dangerous game of Russian roulette with their savings. These people so often forget that markets can have big “up days” – as well as “down days” in times like these. 

If you already work with us here at Minchin Moore, you can be assured that we have been consistently taking profits on your shares as they have risen in recent years and we have used those harvested profits to top up the defensive portions of your portfolio (cash, bonds and for some – alternatives). 

Note: whilst last week saw shares fall some 10%, bonds (which are seen as a flight to safety) have traded sharply higher with the US 10 government bond yield falling -31 bps to 1.16% and the Australian 10 year government bond falling -12 bps to 0.82% (falling bond yields represent a rise in bond prices). 

This movement in bond prices has partially sheltered investors with diversified portfolios. An average Balanced Portfolio (60% growth and 40% defensive), fell slightly less than 4% during the week. 

It is also worth noting that returns leading up to the correction have been strong. Here are some of the index  returns from 1st of January 2019 to 20 February 2020 (immediately before last week’s slide) followed by last week’s drawdown:

  • ASX 200 Index  22.1% (last week’s drawdown -10.1%)
  • Aust Small Caps  25.5% (last week’s drawdown -11.6%)
  • S&P 500 35.1% (last week’s drawdown -12.8%)
  • NASDAQ 45.7% (last week’s drawdown -12.7%)

Should share markets continue to slide, Minchin Moore clients will likely see their next regular portfolio rebalance involve the opposite set of transactions to that which we performed in their last rebalance. That is, we will be taking profits from bonds and buying equities. This systematic process ensures we are always selling high and buying low – managing and evening out your risks.

If you are feeling anxious or uncomfortable about your investments – that’s natural. We all share these common human emotions in times like these. But remember that we planned for this kind of “disturbance” all along. Now is not the time to make impulsive decisions. A better plan is to stick with your strategy and talk with your adviser. 

The information in this article is of a general nature. It does not take your specific needs or circumstances into consideration, so you should look at your own financial position, objectives and requirements and seek financial advice before making any financial decisions.

Portfolio declines since the COVID-19 sell-off began

In this edition of Insights we look at what’s really behind the volatility and give investors a sense of how their diversified portfolios have been travelling through this roller coaster period.

March 10, 2020