Will the Coronavirus Outbreak Lead to a Market Breakdown?

by Jeffrey Kleintop, Senior Vice President and Chief Global Investment Strategist, Charles Schwab & Co., Inc.

Key Points

• While it is impossible to predict the extent a virus can spread and have greater consequences than past epidemics, history indicates that the global economy and markets have been relatively immune to the effects of past epidemics.
• A key reason is that global health organizations are prepared for outbreaks and effective when mobilized. Combining these efforts with widespread public awareness and adoption of effective safety measures eventually limits the spread of the virus and its economic impact.
• Individuals travelling to Asia may be wise to take some precautions against contracting the coronavirus, but investors may have little need to take action if their portfolios are diversified and aligned with their long-term plan.

The markets are reacting to daily updates on the spread of the nCov2019 virus, yet it may take a couple of months to begin to assess the actual impact. While the cost is likely to be in the tens of billions from the preventative measures alone, developments over the next few weeks may provide data needed to assess the full toll on the economy and markets.

A long history

While there is always the chance that the next outbreak could have greater consequences, the global economy and markets have been relatively immune to the effects of past viral epidemics—even when the global economy was especially vulnerable to a shock. A short-term dip in stocks tended to be followed by the continuation of the upward trend.

Immune: world epidemics and global stock market performance

Note: MSCI World Index scale is reflected in the left vertical axis.

Source: Charles Schwab, Factset data as of 1/21/2020. Past performance is no guarantee of future results.

A look at three recent examples:

• In early 2003, SARS only briefly added to the pressures on global stock markets at a time when the global economy was emerging from recession and wary over the invasion of Iraq. The impact was felt most acutely in Asia, where the outbreak was most concentrated. Airlines were also affected as travel declined. The World Bank estimated SARS reduced global GDP by $33 billion. That may seem like a lot, but for perspective the seasonal flu costs an annual $10 billion in lost output just in the United States, according to the Department of Health and Human Services.
• In June 2006, as the Federal Reserve hiked rates for the 17th meeting in a row, Avian flu (H5N1) garnered much attention. Polls at the time found that one-third to one-half of respondents were at least somewhat concerned about an Avian flu outbreak in the United States. As human-to-human transmission of the lethal virus was confirmed, the outbreak had a short-term effect on the markets, but stocks continued to climb to all-time highs later in the year as those concerns faded.

Stocks rose as bird flu cases mounted

Source: Charles Schwab, Bloomberg data as of 1/24/2020. Past performance is no guarantee of future results.

• In April 2009, the U.S. Centers for Disease Control and Prevention announced that the Swine Flu (H1N1) that spread from its apparent origin in Mexico to the United States cannot be contained. The World Health Organization indicated this new strain of flu had the potential to become a pandemic. The Obama administration declared a public health emergency. However, markets failed to react to this news and the potential shock it might pose to the fragile global economy that was just beginning to recover from the financial crisis.

Stocks rose as swine flu cases mounted

Source: Charles Schwab, Bloomberg data as of 1/24/2020. Past performance is no guarantee of future results.

What happens next?

If the spread of the nCoV2019 virus tracks a pattern similar to those tracked in the past by the World Health Organization, the number of confirmed cases will rise sharply for eight to ten weeks, then the infection rate will likely start to taper off into the spring months. Travel may return, along with consumer spending, setting up for an economic rebound in the second quarter similar to the timeline for SARS in 2003, as you can see in the chart below. The sharper the downturn, the sharper the rebound that may be in store. Stocks would be likely respond as they have done in the past given the short-term and limited impact on the global economy.

SARS: “V”-shaped rebound in retail sales

Source: Charles Schwab, Factset data as of 1/26/2020.

Is it different this time?

Of course, we need to be careful about making simple comparisons to the past because these viruses are all unique, China is much more integrated into the global economy today, and the ability to quickly diagnose the virus and the widespread public awareness and adoption of effective safety measures is different from the past. If this virus deviates from the historical pattern, new cases may continue to accelerate past March and spread widely in and outside of China. The economic cost of lost production due to widespread shutdowns and the resources devoted to the crisis would have the potential to trigger a recession in the global economy already vulnerable to a shock due to last year’s trade-driven slowdown.

January’s stock market gains have already been eliminated. Investors, to the best of their knowledge, have gauged the potential impacts of the outbreak on various parts of the market—focusing most intently on travel and commodity-related industries. The market reaction may be exacerbated by investor sentiment that is more stretched (optimistic) than during most prior pandemics. Also, the re-inversion of the yield curve (when the 10 year Treasury yield falls below the 3 month yield) may also bring recession fears to the forefront of investors’ minds given its historical record as a recession signal. As an offset to these concerns, any related tightening of financial conditions could be met with additional rate cuts by the Federal Reserve—an action not taken during past pandemics.

What to do

While it is impossible to predict the extent a virus can spread and have greater consequences than past epidemics, history indicates that the global economy and markets have been relatively immune to the effects of past epidemics. A key reason is that global health organizations are prepared for outbreaks and effective when mobilized. Combining these efforts with widespread public awareness and adoption of effective safety measures eventually limits the spread of the virus and its economic impact. Individuals travelling to Asia may be wise to take some precautions against contracting the coronavirus, but investors may have little need to take action if their portfolios are diversified and aligned with their long-term plan.

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