Since the beginning of the Novel Coronavirus outbreak, a wave of pessimism has hit the markets all over the world, especially those geographically exposed to the epidemic epicentre. The Shanghai Stock Exchange has seen the worst performance since the break of the trade war with the USA and the concerns among investors have been rising in the last few days. Looking at the other financial centres across the world, the market reactions have been less violent, although the fear of a global pandemic has kept the stock prices under pressure, there has been some bear days and the VIX has seen a sharp increase after the January lows.
Switching the focus on the macroeconomic conjuncture, the economic forecasts are not promising. In fact, according to an S&P survey, the outbreak is likely to cut the Chinese annual growth by the 0.7%, leading to a 0.3% slowing down in the global growth. However, the impact on both USA and EU economy will be slight, with GDP growth reductions in a range of 0.1-0.2 percent and major cuts only in the Asian area.
Therefore, the obvious question: how should investors deal with this situation?
The watchword in uncertain periods such this is caution.
Since we don’t have enough details about the evolution of the disease, it’s too early to take a view on the markets. In fact, if on the one hand it would seem logical to embrace the short vision as the economic outlook appears to whisper, on the other hand there is the possibility that China will soon manage the situation. Since the fundamental growth drivers would still be intact, the growth path could take its course and there would be no longer reason for being short.
Even if we assume that prices on the market follow a Geometric Brownian Motion – and therefore there’s no correlation between historic and future prices (stochastic independence) – some indications about the future course may be drawn by looking at what happened in the markets during the SARS epidemic in 2003. Certainly, the macro-context was completely different, back then. China was growing at a fast pace (9.1% on a yearly basis) and the world interconnections were at an embryonic stage compared with today. Looking at the market reaction during that outbreak, we can see that, after a few months of uncertainty and high volatility, once China found a way to contain the disease, the markets went back to normal, meaning that, even in the worst case scenario (in terms of GDP reduction), there is no reason to be pessimistic, especially in the long run.
The suggestion for investors is therefore to be patient, monitoring the evolving situation on a daily basis and hoping that a way to contain the outbreak will be found soon. The markets will celebrate, and we will sigh with relief.