The World Health Organization reports (as of March 13, 2020) that there have been 132,758 cases of COVID-19, with 4,955 deaths. The virus has spread to 123 countries. It certainly looks scary, and it is scary for those directly affected. But consider:
- The United States Centers for Disease Control (CDC) estimates that so far this season there have been at least 36 million flu illnesses, 370,000 hospitalizations and 22,000 deaths from flu in the United States alone (from the Weekly US Influenza Surveillance Report for the week ending March 7, 2020). This represents increases of 7 million illnesses, 90,000 hospitalizations and 6,000 deaths from the report just 3 weeks before.
- The US Insurance Institute for Highway Safety reports that in 2018, “there were 33,654 fatal motor vehicle crashes in the United States in 2018 and 36,560 deaths. This resulted in 11.2 deaths per 100,000 people and 1.13 deaths per 100 million miles traveled.”
In contemporary life, the flu is an annoyance, and fatal motor vehicle crashes represent an unfortunate but remote possibility that casts a mere shadow on our daily lives (unless, unfortunately, we or a friend or family member is a victim).
The response to severe acute respiratory syndrome coronavirus 2 or SARS-CoV-2 and Coronavirus disease or COVID-19 – the illness it causes – has been more dramatic, though the numbers to date are much smaller. We have closed schools and cancelled large gatherings, including concerts, conventions, faith-based events and sporting events. “Social distancing”, the deliberate creation of physical space between individuals who may spread infectious diseases, represents a seismic shift in our social lives.
Financial markets have also reacted, with the S&P 500 down more than 25% (as of March 16th) from its peak a month ago.
Why the difference? How do we live with the risks of flu and automobile crashes, while concerns about COVID-19 have led to significant changes in our daily lives and large stock market impact?
From a medical and disease management perspective, an extraordinary reaction is essential:
- The disease now is more dangerous than flu:
- It is very contagious.
- It can be fatal to large swaths of the population, including older people and those with compromised immune systems.
- We have no pharmaceutical treatments and no vaccine.
- The disease threatens to overwhelm our healthcare system.
- Unchecked, we could see an exponential growth in the number of severely ill patients.
- Severely ill patients require medical resources such as isolation rooms and ventilators.
- If there are a lot of severely ill patients at once, we won’t have enough medical resources for all of them.
- The large social response is designed to slow the progress of the disease so that our healthcare system can cope.
Does the investment market’s reaction to COVID-19 make sense?
It’s impossible to say.
- The economic effects are unknown.
- There will be significant economic losses associated with event cancellations and other restrictions on economic activity.
- Those losses will increase as those social restrictions are extended.
- There will be losses due to illness and death – work won’t get done, and both consumers and businesses will purchase fewer products and services.
- However, it does seem likely that our beliefs about Covid-19 are skewed by “availability bias,” our human tendency to over-react to information that is more readily available. In the US, deaths due to the flu or automobile crashes rarely make the “front page” of major news providers, while COVID-19 has been a top story for more than 2 months straight.
I believe that humanity will eventually learn to live and continue to prosper in the presence of COVID-19. We have survived and thrived despite the existence of measles, smallpox, polio, and Spanish flu, not to mention HIV, Ebola, SARS and MERS and countless other challenges. We will reach a point where the disease is manageable. We may have antiviral treatments and a vaccine, or perhaps just more acquired immunity. Social distancing will no longer be required, and life will seem “normal” again.
However, how long it will take for life to return to “normal” (that is, the new normal including COVID-19) is unknown. Nor do we know what the path to that new normal will be.
The path matters socially and economically, not just medically as discussed above.
The economic events that we have cancelled and continue to cancel represent unrecoverable losses – the airplane seats that fly empty today, the hotel rooms unfilled tonight, the days of idle conference centers, arenas, concert halls and museums are gone forever. Similarly, the people who might have worked during those cancelled economic events are suffering and will suffer losses – they will not earn their wages.
The important economic question is how large those losses will be, and how long they will last. If it takes a long time for the new post-novel coronavirus/COVID-19 environment to emerge, the losses could be very large. I believe that this also is an important medical question as well. If the economic losses are large and hard to sustain, there will be pressure to reduce them, even at the cost of increasing the number of people who become sick.
Economic impact translates directly to investment impact.
At first blush a 20% decline in the stock market would appear to be an over-reaction. After all, a stock’s value represents the present value of a company’s earnings. It seems difficult to believe that the average public company will suffer a 20% reduction in its profits for the rest of time due to the disruptions we are now experiencing.
However, one never knows for certain the causes of market movements. It “seems” obvious that worries about COVID-19 are solely responsible for the market decline, but the financial markets respond to innumerable sources and items of information. For example, it could be that the economic impact of COVID-19 has forced investors to revise downward their beliefs about the fundamental strength of the world economy.
At this point, we can say only that the current level of the stock market incorporates all information available about future returns. In particular, the market has factored in the best estimate of economic losses due to the novel coronavirus. No one has a better one.
Regardless of the uncertainty of the overall market impact, it is tempting to try to identify winners and losers among industries and companies. For example, in the current environment, companies in leisure industries look like losers, while health care companies seem like natural winners. However, some leisure company may develop a clever way to benefit economically from the crisis (popup isolation units?) while not every drug development company will be able to develop effective treatments or a vaccine. And again, the market has already factored in the world’s best estimate of the coronavirus impact on each company’s stock. Diversified investing is the time-tested approach to ensuring that we benefit from winning investments while limiting exposure to the losers.
What should you do? Or not do?
If you have stock market exposure, it is because you believe you will benefit from future returns and you can afford the risk. COVID-19 has not fundamentally changed the risk/reward structure of the stock market. Only changes in your personal circumstances should dictate adjustments to your investment posture. For example, if your earnings prospects for the next few months have become less certain, your lifetime risk may have risen, and you may wish to adjust your stock exposure.
As a society, we are enormously fortunate to have the financial markets we have. They allow us to adapt much more smoothly to the constantly changing risks and opportunities of our world. Business owners who can share their risks with investors can bear more risk and offer more access to the products and services consumers enjoy. Investors have decided the investment returns they enjoy compensate them for the upsetting stock price fluctuations they must endure.