Musings on Markets Wed, 26 Feb 2020 13:55:00 GMT language
Start at the source
This crisis has an uncommon source, insofar as it is one of the few that is not man-made (at least based upon what we know now) and is thus more difficult to predict, in terms of how it will play out. As a novice in infectious diseases, here is what I know at the moment:
- The virus (COVID-19) had its origins in China, though what caused it to spread into the human population is still unclear and rife with conspiracy theories. In an attempt to keep the populace from panicking and to give the impress of being in control, the Chinese government initially went into crisis mode, trying to control the information that is being made public and that has created both confusion and skepticism about official claims.
- Within China, the virus has had its biggest impact in the Wuhan province, but it has affected other parts, though there is still not clear by how much or how many. The count, which is obviously a moving target, is that there are more than 80,000 cases of the virus, with more than 2700 fatalities so far. The latest reports from China is that new infections are falling, and if true, this would suggest that the spread is being controlled.
- The most immediate spread has been to the neighboring Asian countries, with Singapore being an early casualty and South Korea a recent-add on. It has jumped borders and is showing up in more distant parts of the world, mostly in occasional cases. Over the weekend, though, the Italian government set alarm bells ringing with an announcement of a large cluster of cases in the country, which suggests that earlier assessments that the virus was not easily communicable may need to be rethought, and it was this news that seems to have precipitated this week’s sell off. On February 25, the CDS warned Americans that the disease could make significant inroads in the United States and suggested that states prepare cautionary measures.
- There is no cure or vaccine yet for the virus, but the mortality rate from the virus seems to vary across the population, with the very young and the very old being the most likely to die from it, and across geographies, with more deaths in Asia than in Europe or the United States. The overall mortality rate is low ( about 3%), but it is higher for people who are hospitalized with complications.
There is no denying that the last week has been a rocky one for investors, and a 1800-point drop for the Dow over two days (February 24 &25) is bound to add to the sense of foreboding. Since the first casualty of a crisis is perspective, it may be worth stepping back and looking at the market through wider lens. After the drop yesterday (February 24), the S&P 500 was at 3225.89, slightly above where it started this month (February 2020) at. In short, investors in the index were back where they were 18 trading days ago. Bringing in February 25 into the picture does put you below that level, but it still way above what it was a year ago:
- Drop in 2020 Earnings: This is the number that will reflect how you see Corona Virus affect the collective earnings on stocks in 2020. This will include not only earnings declines caused by lower revenues growth at companies like United Airlines, but also the earnings decline caused by higher costs faced by companies due to virus related problems (supply chain breakdowns). The wider the swath of companies that are affected, the bigger will be the earnings effect. As to how big this effect will be on overall earnings, we can only guess, given where we are in this process. To provide some perspective, the 2008 banking crisis caused an earnings implosion, with earnings dropping almost 40% in 2008, from 2007, but the World Trade Center attacks in September 2001 barely made an impact on overall S&P 500 earnings in the last quarter of 2001.
- Drop in long term Earnings: In previous crises, where consumers and workers stayed home, either for health reasons or because of fear, the business that was lost as a result of the peril was made up for, when it passed. If consumption is just deferred or delayed, the growth in subsequent quarters will be higher, to compensate for the lost business in the crisis quarter. If consumption is lost, the drop in earnings in the crisis quarter will never be made up.
- Spreadsheet to value Corona Virus Effects on S&P 500 (February 25, 2020)