Coronavirus — How Might It Affect Financial Markets?

In early February, U.S. investors had largely considered the coronavirus problem to be contained in China, with maybe some spillover to nearby countries due to travel (like the Diamond Princess docked in Tokyo).

That sentiment was shaken last week as more cases began to pop up in other countries, even as it appeared that new infections inside China had levelled off. News of clusters of community exposure – that is, new cases of the virus without obvious direct links back to China or travel in China – rattled investor confidence and sparked a significant sell-off in stocks over the past few days.

Initial Expectations

The hope on Wall Street had been that the spread of Coronavirus, while bad for China, would be largely contained to China. Additionally, there would be some impact to manufacturing in China, and thus global supply chains, but that this wouldn’t last long and that companies would adjust their plans and recover quickly.

It has become increasingly clear that this expectation was overly optimistic. For example, if an auto manufacturer needs parts that are only made in Wuhan, the epicenter of the Chinese epidemic, then it cannot simply shift that manufacturing work somewhere else. They will eventually, but this will take time and will disrupt production and consumption for several months as supply chains for both component parts and finished goods are adjusted.

Revised Thinking

The news over the weekend of additional clusters of the disease outside China (Italy, Iran and South Korea) has forced a rethinking of Wall Street’s earlier, optimistic assessment. Initially, consensus estimates suggested that the disease would shave a couple of percentage points off Chinese growth, and maybe reduce global growth by up to a half a percent but wouldn’t have much impact beyond that. With a spread beyond China’s borders looking increasingly possible, investors have begun to take a closer look at other models to assess the potential impact.

What would happen if the outbreak does spread to the U.S.?  With economic growth expected to be less than 2% this year, it wouldn’t take much of a shock to tip the economy into a mild recession. The impact on economic activity in the US will depend on the scope and severity of the outbreak. It’s also possible that if economic activity slows in both Europe and Asia, the resulting impact could affect the U.S. economy as well.  

Global economic activity is definitely going to be affected by the outbreak and its repercussions within China. The probability of a recession here has likely increased in the past few weeks. Reduced economic activity (regardless of how or why that occurs) will mean reduced earnings for corporations. Disrupted supply chains also means higher input costs and lower profits for affected companies. This is the impact that investors are looking at as they try to model how the disease could affect company bottom lines, and thus stock prices.

At this point, we need to emphasize something. A recession will come eventually; they always do. A coronavirus outbreak could be the catalyst that starts it, but neither are guaranteed in the short run. It’s not even certain the U.S. will experience an outbreak. Investors have simply changed their projections to include a higher risk of that outcome occurring, meaning they are less willing to pay the current high prices for stocks that may be earning less in the future.

Impact on Investment Portfolios

While a more negative-than-expected scenario could cause stocks to drop even more, it’s not a reason to panic. Stock market investing rewards investors over the longer term for staying patient in the face of shorter-term setbacks. It’s also the reason why we build diversified, balanced portfolios that include bonds and other income investments. Bond prices have soared over the past few days as panicked investors have sold stocks and bought bonds, driving bond prices higher and yields lower. If the coronavirus outbreak intensifies, we would expect this to continue.

With that in mind, our plan is to hold tight and stick to our long-term investment strategy. Ups and downs are part of investing, and we assume they will happen periodically.  We are closely monitoring the markets and plan to rebalance investment portfolios as market dips happen.

Non-Investment Considerations

Aside from the impact on investment portfolios, a wider spread of Coronavirus here at home could have an impact on your health. We encourage everyone to consider your preparations for a larger presence of the disease in your community.

One of the best resources we’ve read yet is this article in the Washington Post.

The advice they were given (by epidemiologists) is to take the kinds of precautions you would always take during cold and flu season:

• Wash your hands regularly
• Cover your nose and mouth when you cough or sneeze
• When you’re sick, stay at home from school or work
• Drink lots of fluids
• Don’t touch your eyes, nose or mouth

Another thing the experts have stressed is having a plan for an emergency. Here in California, where wildfires and earthquakes are relatively common, that shouldn’t be a big stretch. Do you have an emergency kit with batteries, a flashlight, solar blanket, water purification tablets, etc.? The American Red Cross has some great resources for general emergency preparedness.

A critical element of emergency planning is to prepare for contingencies. If you have school aged children, what will you do if schools are closed for a few days or weeks? Or if public transportation is shut down? If you are planning to travel, did you purchase travel insurance that could help cover the cost of an unplanned disruption? Are you able to work from home if that becomes necessary?

One of the reasons that outbreaks like this affect the economy is that people change their behavior. For example, if there is an increased chance of contracting a serious disease, experts recommend avoiding public places where there might be more exposure. Perhaps spending more time at home doing things like streaming Netflix instead of going out to the theater or out to dinner.

As always, we welcome your questions and are always willing to have discussions with you about this topic and any other topics affecting your finances. We are grateful for the opportunity to be your trusted advisors.