Feb 13, 2020

Health Scare

In January, the outbreak of the coronavirus caused volatility in the stock markets. Our in-house research team takes a deeper look into the impact of the virus and compares it to past epidemics to help make informed investment decisions. 

January Recap

  • Coronavirus is spreading fast, causing volatility in stock markets.
  • Past epidemics have sent markets lower for relatively short periods before rebounding.
  • The Bank of Canada does an about-face and is now open to rate cuts.

 

Health Scare

January started out with a bang. Global markets moved higher as the U.S. and China officially signed a phase-one trade truce. Investors were also hopeful that rate cuts enacted by many central banks around the world in 2019 would start to stimulate the global economy. Three weeks into the month, the S&P/TSX and S&P 500 were both up around 3% in Canadian dollar terms. A truly spectacular start to the year.

 

Of course, the biggest risks in life are often those that are unforeseen.

The same holds true for capital markets. As the coronavirus started to become headline news, the markets started to retreat and many global markets ended January in negative territory, while bonds outperformed (Figure 1). Therefore, what is the coronavirus and how do we analyze the situation to make informed investment decisions?

 

Figure 1

Line chart showing the volatility in the S&P 500, S&P/TSX and Canadian Universe Bond

Source: Bloomberg

 

There are actually seven coronaviruses that affect humans. The most well known is SARS which broke out in 2002 and 2003. The strain today is called 2019-nCoV or novel coronavirus and originated in China. These viruses typically affect the respiratory system and can spread quickly. As of this writing there are roughly 20,000 cases and close to 400 deaths worldwide. Major Chinese cities have been quarantined and travel bans are in place.

 

From an investment point of view, it is impossible to know exactly what will happen with an outbreak such as this, but we can look back on prior epidemics such as SARS, Swine Flu and Zika to gauge the impact. Typically, the disease spreads quickly, new cases arise, and the outbreak is the lead story in the media. Markets are negatively affected across the board but hurt the most in the countries most affected, in this case China. Health officials get a handle on the situation, the number of new cases starts to decline and the markets and economy rebound. Will this time be different or will it play out the same?

 

It is likely that this outbreak will have a more severe impact on the global economy than something like SARS, primarily since China is a much bigger player on the world stage than it was almost twenty years ago. Ultimately, the end result will likely be the same with a more volatile market in short to mid-term, depending on severity, followed by an economic rebound. We will be monitoring this situation very closely. In our view, this could create some compelling opportunities to deploy capital as some investors overreact to the short term.

 

From a Canadian perspective, the impact of coronavirus could mean a rate cut or two. After leaving rates unchanged in 2019, the Bank of Canada took a more dovish tone in January by indicating an openness to cutting rates in 2020 should the economy remain sluggish. This announcement occurred just before the coronavirus became a household word. The virus will certainly increase the chances of a cut being the next move on rates.