Three Coronavirus Effects on the Economy, One Direct and Two "Indirect"
Updated: Jul 19, 2020
I wanted to say a bit more about Coronavirus and the equity markets to embellish my post from yesterday. Some of this might be repeating what I've already said, but not a lot (hopefully).
There is so much unknown about the Coronavirus aside from the fact it is spreading like wildfire, and this is causing investors in risky asset classes like stocks to run for cover. Even if the virus is eventually contained - which it certainly will be after it runs its course - the damage it is inflicting on the global economy and investor psychology is very real. I see three reasons, all valid, leading to this downward spiral in global equities.
1. Direct economic effects: This is crystal clear – where the Coronavirus has high penetration rates, governments are encouraging people to stay at home (rather than go to work or school), not to travel, etc., all of which has the effect of dampening economic activity. As I mentioned in yesterday’s post, the IMF in any event already revised global economic growth down late last year before Coronavirus even surfaced. Nearly every large economy in the world has faced steadily declining growth over the last 8-10 quarters, and the appearance of Coronavirus will just exacerbate the downward trend. If you want to take a more macro sector approach, airlines, cruise ship companies, travel companies, international transport / logistics companies, companies dependent on a meaningful amount of their sales or supplies from China, and so on should suffer the most. Meanwhile, those companies that are less reliant on Chinese sales or supplies, travel, international activity generally, etc. should arguably be less affected (albeit it will be difficult for any company to avoid being touched in some way by this calamity). Some biotech or pharmaceutical companies that might be chasing vaccines or other remedies for Coronavirus, or that make facemasks, etc., could actually benefit.
2. Indirect effect 1 – The Wealth Effect: The “wealth effect” is simple and well-established economic theory – if people feel poorer, they tend to reduce consumption even though the reality is that - so long as they are not selling into this drop - they are experiencing unrealised paper losses. Nevertheless, these sorts of harsh sell-offs - when they show up in your brokerage account, your pension fund, your IRA and / or your 401-k – can be demoralising. It just doesn’t feel good to have your stock portfolio worth 10% less today than it did one week ago, so people adjust their sentiment accordingly. They are less optimistic and will possibly reduce consumption (or reduce/ defer investment if they run a business). The consumer “wealth effect” will reduce global economic growth further in 2020 - this is as certain as the Titanic sinking after it hit the iceberg!
3. Indirect effect 2 – Indiscriminate Selling: These sorts of sell-off’s can take on lives of their own, as investors indiscriminately dump stocks (or index funds) to shield themselves from further losses. An investor’s risk tolerance is a matter of personal taste, as well as the timing and need for liquidity. The downward spiral of a vicious cycle like this, originating with an unexpected occurrence like Coronavirus, will find a bottom, but it is impossible to say where that might be. Of course, most media sources are covering this 24/7 (or so it seems), and no good news has surfaced, at least yet. I do expect some stocks to find their bottom as astute long-term investors identify attractive fundamental value and load up on specific stocks at much lower prices than the (often) record-high prices experienced earlier this year.
Personally, I have little doubt that markets will overshoot on the downside, but where the floor might be is hard to tell. Buying shares of fundamentally strong companies on the way down can be dangerous, but it is certainly better than buying the same names at higher prices. Find your comfort zone, and let’s all hope we bottom out soon as equity prices eventually come into line with the new economic reality, which will be slower global growth (albeit how much slower is hard to know just yet).