A virus-stricken ship, with more than 3,500 on board, prepares to dock in California. Saudi Arabia unleashes all-out war on the price of oil. Italy announces a lockdown around Milan, the nation’s economic engine. Wall Street analysts worry about signs of distress in the corporate funding markets.
Those are just some of the factors that investors need to weigh as they head into another trading week under the shadow of COVID-19.
The pathogen that emerged in central China last December has spread with remarkable speed to about 100 countries across six continents and is highly contagious. The virus strain isn’t terribly lethal at the individual level, but could be for humanity at large if it infected, say, a third of the world’s population like the great pandemic of 1918.
So if you’re a financial professional, or merely looking after your own retirement savings, how do you price in chaos? It’s hard to imagine an economic or trading model that can fully capture the dynamics of a shape-shifting and wealth-destroying virus like this. There are too many economic actors – consumers, chief executive officers and heads of states – each making individual decisions at the micro-level that add up to mayhem at the macro-level.
The uncertainty has contributed to heightened volatility and a savage sell-off that’s wiped out about $7 trillion in market value in about 2.5 weeks. The S&P 500, down 8% on the year, has fallen roughly as much as it did in its last six corrections.
In the Middle East, where some exchanges trade on Sunday, market participants “are finding it difficult to cope with all these variables that have been happening over the past 10 days,” said Mohammed Ali Yasin, the chief strategy officer at Al Dhabi Capital Ltd. in Abu Dhabi. “That’s why we see this panic-selling across the board taking certain markets to lows not seen even during the financial crisis.”
There are some similarities with the early phases of financial crisis of 2008, but one key difference is that it’s still difficult to quantify just how much damage the coronavirus could do – nobody is quite sure what’s needed to resolve the situation. The fear factor looms larger this time.
The crisis of 12 years ago triggered the biggest economic downturn since the Great Depression. An overheated housing market crashed while banks had bundled bad loans with good and sold them to investors, some of whom were clueless about the real risk. Wall Street wizards came up risky products like synthetic collateralized debt obligations that amplified the market shock. Really bad idea it turned out.
Yet at least it was a crisis with variables that market participants understood. Some money pros like Michael Burry and John Paulson, of “The Big Short” fame, and plenty of other money pros, connected the dots quickly and made a killing along the way.
This crisis seems way different. Even scientists are still trying to unlock the secrets of the novel coronavirus, known officially as SARS-CoV-2. How will it behave in warmer weather? Will it mutate into something even more worrisome? Will the world really have to wait for an effective vaccine until 2021, as experts such as Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases, insist?
In the U.S., a disastrous rollout of diagnostic test kits and conflicting comments by President Donald Trump and top public health officials about the severity of the epidemic have left investors and the general public struggling to asses the risk.
While China has slowed the infection rate with an iron-fist approach of strictly enforcing lockdowns on travel in Hubei province, of which the outbreak epicenter of Wuhan is the capital, there is still a risk of secondary infections as President Xi Jinping’s government tries to reboot the economy. As things stand now, the world’s second-biggest economy is facing a massive economic shock in the first quarter of 2020.
With so many unknowns surrounding the trajectory of the epidemic, pretending to have a definitive read takes real bravado. More cautiously, the team at Bloomberg Economics came up with four scenarios, ranging for quick bounce-back scenario to recessions in the U.S., euro-area and Japan, the slowest growth on record in China, and a total of $2.7 trillion in lost output – equivalent to the entire GDP of the U.K.
But some doubt a U.S. recession is a real possibility just yet. “With a lot of unknowns out there, the market will be more volatile and will pull back a bit but it doesn’t necessarily mean a recession,” Frank Ingarra, head trader at Greenwich, Connecticut-based NorthCoast Asset Management LLC, said in a phone interview. “Things could wrap up really quick and we could resume a bull market.”
Aside from the human toll of the virus, SARS-CoV-2 is also a wealth destroyer, now hitting three key components of the world economy: consumption, trade, and investment. On top of that, the virus has stormed on the global scene very late into the business cycle and current bull market.
Even before the age of the new coronavirus dawned, global trade had fallen last year for the first time since 2009 because of a tariff war between the U.S. and China and a manufacturing recession. After setting a record on Feb. 19, it took all of six days for the S&P 500 Index to tumble more than 10% and into a correction.
Then there’s this: The virus is the latest challenge to idea of efficient financial markets, the notion that at any point in time, the price of a security reflects its intrinsic value; that at some level the market are guided by rationality and can accurately capture where things stand with companies and the global economy.
That may be true in periods of relative calm, perhaps less so right now. Trouble is, nobody knows how far this virus will run and how severely it will damage the global economy. That makes it very hard to model indeed.
With assistance from Lu Wang, Vildana Hajric, Filipe Pacheco and Katherine Greifeld.
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