The Coronavirus and How It Has Impacted Markets

Hello everyone, this is Everett Millman and welcome back to Breaking the Dollar. These next two episodes, I'm going to be taking a look at some topics that are kind of outside the normal realm of finance, but they are still having a major effect on the global markets. So first, I'm going to walk through sort of what has already happened on the ground. What is the situation? I will recap that. And then I'll explore some of the possible economic implications of this, because that is the question on everyone's mind. Is this going to have a major effect or is this just kind of a blip on the radar that will be gone in a matter of days or weeks?

By and large, that seems to be the consensus. So far, the equity markets in particular, the US stock market have really shrugged off the coronavirus, like it is not going to be a big deal. It's not going to have a long lasting effect. And so far, stocks have merrily climbed higher and higher, despite the body count of the coronavirus also climbing. So far, the best statistics we have about the virus show that over 40,000 people have been infected and more than 1,000 have already passed away from this disease.

Now there have been quite a few arguments I've seen that compare these numbers to how many people get sick and die from the common flu each year. As its name implies, the flu is a much more common ailment. Yes, it affects many, many millions of people and more people die from the flu than have died from this coronavirus. Unfortunately, this reassuring comparison is a bit of an apples to orange comparison. When you're looking at mortality rates, so how many people actually die after contracting the flu, it's around 1/10th of 1%. By comparison, the coronavirus is already killing 2.5% of the people who catch it. So that is 25 times more deadly. Moreover, it is extremely likely that these numbers are underreporting how widespread the coronavirus actually is. As I've said on this program before, I myself am not a conspiracy theorist. However, I do keep an open mind and it does make sense for government authorities in China and elsewhere to underreport how severe the problem is. It is in their interest not to have people panic. There is no doubt that fear and paranoia are part of this story. And those kinds of emotions or sentiments do have an effect on the market.

So for example, the timing of the outbreak of the coronavirus was particularly bad for China because they were in the midst of celebrating the Chinese Lunar New Year. This holiday is somewhat comparable to the big seasonal spending that we see during Christmas time in the West. During the Lunar New Year, people go shopping, they travel, they engage in tourism. It is a really huge economic event. And since the coronavirus hit, really none of that has been happening. Tens of millions of people are basically locked in their homes right now in China in order to try and quarantine them from further spreading the virus. That means millions of people not going to their jobs, not going to work, not using public transportation, not going out to spend money. As a result, many businesses are closed. Many factories in China have been temporarily shuttered. All of that has a huge effect economically. Already, this is causing a pretty big drop in productivity. And there are estimates that this could shave two percentage points off of China's GDP during the first quarter. That is a huge loss of output and productivity.

Moreover, it's brought trade almost to a halt. The fear and uncertainty surrounding this health emergency is definitely making trade partners wary of importing anything from China right now. One of the effects of that is that China is seeing the fastest inflation of its food prices in more than a decade. Because of the nature of how a sickness like this spreads, it's affecting basically every sector and every industry. And when you look at tourism, the casinos in Macau, which is a special economic zone controlled by China, have all had to shut down operations. That's leaving a lot of profit on the table. Another effect I want to emphasize is that this is having a global impact. So we have already seen oil prices pull back significantly. We've seen copper prices down big, and that is in large measure because China is such an important part of the world's economy.

When you look back historically at the last time we had a major outbreak like this in China, the best example to compare to was the SARS epidemic around 2003. Since that time, China has increased its share of global GDP fourfold. That means four times higher. We live in a different world now where European markets, especially, are very dependent on what's going on with China's economy. And to bring back the comparison of SARS, the coronavirus has already killed more people than died in the entire SARS epidemic. So I think it's definitely a sign of complacency that Western markets have really shrugged off the threat of the coronavirus thus far. Because the impact of a Chinese market that is essentially frozen is going to be pretty far reaching. The coronavirus is a perfect example of a concept called a black swan. And that is a term used in finance to describe something that is an unexpected and unpredictable economic shock. So something that has a very negative effect on markets.

Of course, I should point out that I am not a pathologist. I am not an epidemiologist, but it is clear to see that there are some major uncertainties that still remain with the coronavirus. To say that it has already been completely contained is definitely a bit overly optimistic. The World Health Organization recently estimated that there could be a vaccine for this virus within 18 months. Not that everyone who contracts the virus doesn't recover, but still that is a long time to wait for a cure. We also don't have a clear sense of how long the incubation period is for this virus. In other words, we don't know how long it takes before someone shows symptoms. So imagine how many hundreds of thousands of people could be walking around infected, but they don't know yet because they haven't shown any symptoms. The indications are that the coronavirus does have a very long incubation period. So that makes this issue even more pressing. In order to combat this situation, China has already injected some more stimulus into its markets to try and keep everyone calm and the United States government has offered $100 million in aid to the Chinese government. So there has been some reaction from authorities.

However, this popular argument that the fears of the coronavirus are exaggerated and that it will be a short lived issue seem to be ignoring what was already going on on the ground with the Chinese economy. So we know that it was already slowing down before this virus hit. And of course, you had the trade war negotiations going on. One of the overlooked effects of this problem is that the Chinese delegation is now using the coronavirus as a reason to ask for more concessions from the US and the trade negotiations. They are basically claiming that dealing with this virus is diverting resources and they simply won't be able to meet many of the requirements for how many products they agreed to purchase from the United States because they are dealing with trying to contain the virus. In my opinion, that is a major issue that nobody is really talking about. It's especially odd that markets haven't had any kind of negative reaction, at least in the stock market. I say that that is strange because of how sensitive the stock market was to every headline about the progress of the trade war. This is something that certainly throws a wrench into that process so you would think it would cause a little bit more of a reaction.

Another point is that not only will the impacts on China's economy be global, but the virus itself is increasingly becoming a global phenomenon. At least two dozen countries have already reported cases of the coronavirus and that includes many of the world's largest economies. So that means Japan, Germany, the United States, etc. Keep in mind that both Japan and Germany, the third and fourth largest economies in the world respectively, were already dealing with recessionary conditions. I don't see how this doesn't make that situation already worse. Of course, to reiterate, many ports in China are closed. Trade and commerce between countries in that region of Asia simply isn't happening out of fear over the virus. The longer that goes on, the worse it will get. Additionally, this idea that there is a risk of overemphasizing how bad it is or causing too much fear. Although that makes some sense, it really doesn't hold water if you consider that the fears are well placed. The information on the ground backs up reasons for people to be worried. Really it amplifies all of the existing economic problems and tensions that we were already seeing in the world.

So when it comes to what you can do or what you should be doing as an investor, the only advice is to stay aware of the situation. As I said, this really does fit the definition of a black swan. It's something that you could not have predicted, so there really is no preparation at this point that would have helped you. But to simply bury your head in the sand and pretend that this isn't a problem or it will simply blow over, I think is the wrong approach. That is the most dangerous thing that investors can do. Even though the stock market has, as I said, largely shrugged this off. It's undeniable that this is causing a pretty big disruption in China. What's about the only product that has seen higher sales is those surgical masks that you see people wearing to try and protect themselves from catching any kind of virus. Other than that, there's really only negative after effects. So I don't think we have seen all of the consequences from the coronavirus and we will have to continue to monitor the situation until there is a cure or vaccine.

But anyway, I think that is about enough doom and gloom for one episode, so we will move on to our mailbag and check a question from the listeners. This week's question comes from, apologize if I butcher this, from Jabu Lani in Pretoria, and they ask, why has gold risen in price if the dollar has gotten stronger? That is a very astute observation and it is true that not just in 2020, but going back to the second half of 2019, both gold and the dollar have moved higher together. Some would say that this is unusual situation because generally, as the value of any currency goes up, the prices of commodities in effect tend to come down. A stronger dollar means it takes less dollars to buy the same amount of something.

Now although that general principle is true, particularly for commodities, this is what makes gold unique. It is a non-correlated asset. That means it does not share any strong relationship to the price of pretty much anything else. So in my experience, it is not terribly unusual that gold and the dollar could move in the same direction, at least for some period of time, because the price movements of gold generally don't correlate strongly with anything in the markets. That is what makes it such a useful hedge and safe haven for your portfolio. So that is sort of the philosophical reason of why this is possible with the dollar and gold, but to address why I think this is happening now, it is because both the US dollar and gold, along with US Treasuries, are generally seen as safe havens. So because large institutions are kind of stocking up on those safe havens, both gold and the dollar have benefited at the same time.

That wraps up this week's episode. As always, I appreciate everyone listening. Thank you so much for tuning in. Be sure to check out next week's episode where I will be looking at how the current presidential campaign in the US is affecting or will affect markets. That should be a timely and exciting one, so be sure to check it out.