Markets may be underestimating coronavirus costs: this is what I am doing

Sell on rumour, buy on news. Does this principle hold up in 2020, when rumour and speculation about the coronavirus is rife?

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The human consequences of the coronavirus virus are tragic and of primary importance. However, the significant economic consequences should not be ignored. 

The fatality rate of the coronavirus appears to be around 2%, compared to 9.6% for SARS, 34% for MERS, and 50% for Ebola.

However, the coronavirus is spreading rapidly — by 30% a day, according to Kambiz Kazemi of Toronto-based investment management firm La Financière Constance. He projects that by the end of this week there could be over 80,000 cases.

That is terrifying. If the 30%-per-day growth rate is accurate, and holds up, then most of the world’s population could potentially be infected by the end of March. Of course, this is highly unlikely for the simple reason that authorities are taking steps to curb the spread. For example, already 10,000 scheduled flights within and from China have been cancelled.

Comparisons with past diseases outbreaks don’t help much. The SARS epidemic, for example, occurred when the Chinese economy was much smaller than it is today. Back then, China’s economy was growing super-fast, and SARS merely slowed the growth down a bit for one quarter. By contrast, at the end of 2019, the Chinese economy suffered its weakest quarterly growth rate in 27 years.

Exponential change

At the moment, there is so much we don’t know about the coronavirus – no one knows how quickly it will be contained, how widespread it will become, or what the economic impact will be. We do know that a 30%-per-day growth rate is an example of exponential change

Companies that rely on China for their manufacturing are especially vulnerable. The types of products that are frequently manufactured in China include smartphones and pharmaceuticals. Around 15% of all drugs are made in China.

A decline in the number of Chinese holidaymakers, if only for a few weeks, will also have a massive impact on tourist industries including airlines and hotel chains. If global authorities react to the threat the virus poses by cutting down on international travel beyond China, then the economic impact will be much greater.

At worst, we could see a worldwide travel ban on the scale of the one currently in place in the Wuhan province. Sectors which are struggling as it is, such as retail, may be pushed over the edge. However, online shopping may become even more popular.

It is well known that the markets hate uncertainty— and yet, so far, I would say that the market reaction has been remarkably sanguine — Chinese stocks have fallen sharply, but as I write these words, the FTSE 100 is up on the morning’s opening price.

This makes me wonder whether some people have done their maths. Humans don’t instinctively understand the implications of exponential change, and the spread of the coronavirus is certainly following an exponential trajectory. That is why I think the markets are underestimating the potential cost – they have not priced in the effect of exponential change. 

Over the next few days and weeks, our understanding of what the coronavirus means will improve massively.

I think there is a good chance that as this understanding grows and the implications of an exponential growth rate in the spread of the virus sinks in, we will see sharp market falls, maybe very soon. 

At some point, however, as hard facts replace theories, as news replaces rumour, or maybe as a cure or vaccine emerges, the Chinese economy will begin to recover, and markets will surge. The opportunity for investors will emerge at the moment this happens, so I would wait for that moment before buying. In the meantime, an online retailer such as Boohoo may be worth considering

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Michael Baxter has no position in any of the shares mentioned. The Motley Fool UK has recommended boohoo group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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