The past couple of weeks, the world has been busy worrying about the coronavirus. Investors are no exception. Global markets have reacted negatively to the outbreak of the disease, although its spread is largely limited to China and contaminated patients in other countries are held in quarantine. But if the virus is mostly under control, why do the markets react so heavily?
What happened on the markets?
In the United States, markets seem to be concerned. The Dow Jones and the S&P 500 both lost 1.6% on Monday. Travel-related businesses were hit particularly hard. Most Asian markets were closed on Monday, but the Japanese Nikkei also dropped by more than 2%. Closer to home, the European Stoxx 600 tumbled, losing 2% as well. Bond prices, on the other hand, soared which indicates that investors fled from the stock market to the safety of government debt. The price of gold, considered a safe haven, also increased slightly. It is clear that financial markets are worried about the consequences of the coronavirus. But what explains this fear?
The direct impact of the disease on the global economy seems to be limited. The deaths of dozens are a tragedy on their own, but unlikely to make the economy turn south. Also, the reduced economic activity by the 2500+ contaminated people are unlikely to have significant economic effects. Thus, what makes markets so nervous about the virus? The keyword, we all know, is uncertainty. And if there are one thing investors do not like, it is uncertainty. One of the worries is that China will not be able to contain the virus as hundreds of millions are traveling to their families to celebrate Chinese New Year. The lockdown that China has placed on some metropoles, including Wuhan, are likely to affect the travel industry somewhat. However, global economic damage is largely overestimated.
The keyword, we all know, is uncertainty.
The same occurred in 2003, when the financial industry was worried about the spread of SARS. This virus also belonged to the corona family and killed 774 people. Financial markets reacted largely the same as to the current virus. However, the situation today is different from back then. 17 years ago, the Chinese government largely attempted to cover up the outbreak of the disease. Today, the Chinese Government is more open about the virus and cooperates with other countries which give them the opportunity to prepare efficiently. Furthermore, the recent virus is way less contagious and also less likely to make lethal casualties. Finally, the lockdowns in place today were not instituted at the time the SARS virus broke out. All this indicates that the current crisis is more controlled than the SARS outbreak. Still, markets tend not to learn from the past and uncertainty continues to play investor’s minds. Another lesson learned from the SARS virus is that markets quickly realized that the economic damage was not as bad as it seemed at and recovered quickly.
Markets tend not to learn from the past.
The way forward
Markets tend to overshoot, both positively and negatively, in reaction to external events. There is reason to assume that this time is no different. Markets have reached high peaks globally and a small correction should not come as a surprise. At the same time, the consequences of the disease are likely overstated. The virus does not spread as fast as the media would have you believe, and a serious pandemic is not likely to occur. Once the panic has subdued, markets will focus again on what really matters to stock prices, which are the underlying fundamentals. As these will remain largely unaffected, markets are likely to rebound.