Nature is no match for liquidity
While it is too early to predict how deadly the Coronavirus might become, the explosion of new cases and its relatively high death rates (~2%-3% vs usual influenza of less than 0.1%) are unnerving the markets. Also, unlike SARS, China is today far more important at both the forefront of global supply chains and consumption, and has a far greater impact on the global economy. The rush for safety in financial markets and erosion in growth expectations is already flattening interest rate curves, reinforcing US dollar strength (as a safe-haven currency) and sapping global sentiment. Indeed, if it becomes evident that we are failing to contain this epidemic and/or virus becomes more deadly, it could lead to a global reset, not dissimilar to influenza epidemic of 1918-19.
However, at this juncture, the evidence does not support such extreme outcomes, and instead it seems closer to SARS or MERS experience of sharp but relatively short-lived shocks. If the epidemic is contained, even if it persists for the next 12 months, it will be the global monetary and fiscal policies that will determine the depth of the contraction in markets and the extent of asset price volatility.
If we ‘dig’ into the SARS (severe acute respiratory syndrome) example between 15th January and 11th March 2003 the S&P500 was down -13.7% over that period. At market close on Friday 31st January 2020 we were only down -3.13% from the index’s all-time highs. Similarly, the NZX50 gross index was down -7.00% during SARS and we are now down a mere -1.5% from our highs.
This can be interpreted in two ways, firstly this is just the beginning and history tells us that markets can fall considerably further if the Coronavirus persists. Secondly, markets have become more sanguine when it comes to these types of left field type events.
Central banks globally continue to focus on financial stability, and to that end asset prices driven by liquidity and cost of capital. There is a growing expectation already for rate cuts in China and a larger infrastructure spend.
A common error over the last decade by strategists and economists was to assume that public sectors will allow business cycles or nature to take their course. Quite the contrary, central banks are far more intrusive, and the free markets essentially no longer exist. The good news therefore is that the downside of asset prices is protected. The bad news is that conventional strategies no longer work. While some sectors (e.g. tourism, retail etc) will be more affected, unless the world is facing an Armageddon, biology is no match for ample liquidity and low cost of capital.