Is the Stock Market Immune to Epidemics?

The news of a new deadly virus dominated news headlines over the last two weeks. To some of us in financial markets this was a wakeup call, reminding us that risks to financial assets are not only political in nature. As many readers can confirm, over the past few years political noise has dominated news and was chief among the risks to financial assets. Now investors are concerned about the economic impact the coronavirus may have on the global economy and ultimately on investors’ sentiment and markets. The aim of this article is to show how markets have reacted since the outbreak was reported, and to explain how markets have reacted in the past following similar outbreaks.

While this virus is not new to the medical field, it took centre stage only recently following a first case reported in the Chinese city of Wuhan, on December 31, 2019. The news was reminiscent of other epidemics which took the lives of many in the past 15 years. To name a few, anyone in his late twenties can remember SARS, Swine Flu and Ebola. There were many others and a recent research shows that there were at least 10 epidemics since 2003. Scientists and the World Health Organisations do their best to contain such viruses and send continuous messages to the public to ease the spread of the epidemic. In fact, people are being encouraged to avoid close contact with sick people and to avoid food markets, where it is alleged the virus was first contracted.

The coronavirus shocked the business community in China, as the Lunar New Year gets under way. This is a very busy period for the Chinese, as travelling and consumption reach a peak. Some Chinese cities risk being locked with no to minimal travelling. Last Saturday, Hong Kong, which homes 7.3 million people, has declared a state of emergency and schools will remain closed until February 17. All the leader’s official visits to main land China have been cancelled. In addition, the city announced that flights and high speed train journeys between the city and Wuhan will come to a halt.

This could have various economic consequences, chief among which, a sharp decline in consumption. Many events related to the New Year Lunar season were called off and the official Lunar New Year celebrations in Hong Kong have been cancelled. In addition, last week Beijing had shut down parts of the Great Wall of China. As a result this will restrict 46 million people from travelling. This kind of news did not go down well with investors, as markets declined on the back of a drag on profitability if the virus persists and no immediate solution is found.

The severity of the virus determines the magnitude of the market’s reaction. As is often the case with any negative news, investors reaction initially is to price-in the worst case scenario and selling pressure will induce prices of risky assets to decline. Global investors are concerned because the epidemic can have economic consequences well beyond China. Let us not forget how interconnected the world has become and how easily people and products can be transported from one part of the world to another. On Monday and Tuesday this week, equity markets tumbled, as investors feared the worse. However, sentiment improved mid-week, as concerns surrounding the epidemic eased.

Yet, if we take a slightly longer view not all is doom and gloom for financial markets. Recent research by Charles Schwab looks at the last 13 epidemic outbreaks since June 1981. The research looks at global market returns, by measuring the performance of the MSCI World Index, after the first month, 3-months and 6-months from the outbreak.

After the first month, the global equity index, which measures the performance of large and mid-cap companies in 23 developed countries, generated an average return of 0.44% when taking into account all 13 epidemics. After the first month, the worst decline was recorded in 2018 when the Ebola virus broke in October. Then the world market index lost 7.4%. Almost three years before, global equity markets lost 6% when the Zika virus broke.

On the other hand when SARS and Swine Flu broke, in April 2003 and April 2009 respectively, equity markets were not concerned at all. One month after the SARS epidemic made headlines, global stock markets gained 8.6% while they gained nearly 11% one month after Swine Flu left its first casualties.

The same research also shows that after three and six months, the MSCI World Index gained 3% and 8.5% respectively.

Certain sectors are more vulnerable to news related to the epidemic. Airlines, travel agents, hoteliers, retail companies and other cyclical sectors are expected to be among the most volatile if no solution is found shortly. On the other hand, we have already seen a surge in demand for high quality sovereign bonds, as the yield on the 10-year US Treasury declined (prices increase) to a three-month low of 1.61% last Monday. Gold futures also increased.

Given the levels markets are trading at, this kind of negative news may encourage some investors to lock in their gains and exit their positions. The less clarity financial markets have in the next few days and weeks, the more investors will grow nervous about their investment positions. We may witness an increase in equity markets’ volatility if the epidemic makes further headlines. However, based on market returns after previous epidemics, and if history is any guide to the future, investors should not stay away from financial markets when volatility increases, but they should avoid food markets in China, for the time being.

Gabriel Mansueto is Head of Investment Advisors at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or email [email protected]