As of Feb. 14, 2020, the stock market doesn’t appear worried about the coronavirus outbreak.
This applies not just to the U.S. market — where the S&P 500, Dow Jones industrial average and Nasdaq composite touched all-time highs this week — but to markets around the world.
The MSCI World ETF, which represents the global stock market and trades under the symbol URTH — like the planet Earth, get it? — touched all-time highs this week, too.
Meanwhile the MSCI Emerging Markets ETF, symbol EEM, did not hit all-time highs, but did manage to register a V-shaped bottom pattern, surging back strongly from a freefall decline to climb back above its 50-day moving average.
Even FXI, the iShares China large cap ETF, saw a major bounce this week that looks like a v-bottom.
Given this data in the form of price action, which represents the real-time behavior of buyers and sellers, one might think the coronavirus danger has passed.
That would be false. The coronavirus is still a threat, not just to public health but to equity markets. And the period of greatest danger still lies ahead.
As a point of housekeeping, it isn’t called “coronavirus” anymore. The virus was officially renamed COVID-19, which sounds worse (like a label you would see on a toxic biohazard canister).
There are a few reasons the market’s “relax, no worries” verdict can’t be trusted:
- Markets have never had a great track record in dealing with binary events (where the competing possibilities are extreme).
- A “sigh of relief” stance in hopes the worst is over puts markets at their most vulnerable if a second wave of COVID-19 infections hits.
- With the rise of “super spreaders” and high infection rates in warm climates like Singapore, the data on the ground is looking worse, not better.
- An increasing body of evidence suggests China has been underreporting the scope and scale of the outbreak, possibly by an order of magnitude.
The “binary event” problem is related to the fact that markets express opinions through price, and there is no good way to reconcile extreme outcomes under the banner of one price.
Say, for example, a publicly traded biotech company has gone $100 million into debt to develop a single drug that now awaits FDA approval.
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If the drug is approved, the company should be worth at least $500 million via patent rights. If the drug is rejected, the company is bankrupt and worth zero. What is the proper stock price a day before the verdict? There isn’t a simple answer.
In similar fashion, there is no way to split the difference between optimists and pessimists when it comes to an extreme event. If money managers are biased to the optimistic side, prices will reflect that.
If a new round of pessimistic news comes in, the market may then adjust violently downward, which is exactly what happens on occasion when new information changes the prior view.
This is why, with fast-moving events like the spread of COVID-19, it makes sense to be aware of actual events unfolding on the ground.
In general terms, the higher the probability that exists of game-changing information coming in to disrupt the consensus view, the greater the potential for a violent price dislocation as the market adjusts.
That is why, even though the market feels complacent right now, new data points are worrisome.
Take the rise of COVID-19 cases in Singapore, for example. As of late Thursday (Feb. 13), Singapore had 58 reported cases, one of the highest rates outside China.
Singapore’s temperature headed into the weekend was 79 degrees Fahrenheit with 88% humidity.
This is problematic because one of the “don’t worry” arguments for COVID-19 was that it bore resemblance to the traditional winter flu, and likely fared better in cold and dry-ish winter conditions, and would thus fade in the spring months as temperatures and humidity levels rose.
If Singapore can see a notable rise in cases — and their health minister expects the number to climb — that argument goes out the window, because it shows COVID-19 can spread in summer-like climates.
Then, too, there are worrisome reports of “super spreaders.” A super spreader is an individual who is asymptomatic, meaning they show no symptoms of COVID-19, and aren’t aware they even have it, yet infect others in their day-to-day travels.
A British man, now under quarantine in a London hospital, is believed to have infected 11 people in his travels home, with a stop in France on the way, after attending a Singapore business conference.
It’s also a concern that the data out of China could be completely bogus.
While the Chinese government continues to elevate the numbers each day, the reported rate of infection could be off by an order of magnitude.
According to Barron’s, a finance publication, the stats out of China are “too perfect” to be real, which suggests they are fake. As Barron’s reported:
“…the number of deaths reported appeared to correspond to a simple mathematical formula to a very high accuracy, according to a quantitative-finance specialist who ran a regression of the data for Barron’s. A near-perfect 99.99% of variance is explained by the equation, this person said, referring to a statistical measure known as r-squared. That’s a fancy way of saying that the data updating the number of deaths was almost perfectly predictable. ’This never happens with real data, which is always noisy,” the person said.’ ”
If China’s government is managing the numbers, they are almost certainly revising the totals downward to avoid further panic and adjusting them upward only to maintain a semblance of reality.
As such, given that we don’t know the half-life of COVID-19 — the speed at which it dies off — or the number of “super spreaders” still out there, we really don’t know much about the scope of this threat at all.
Then, too, the civil unrest impacts within China are another giant X-factor. As we have written, the scope of this crisis could rock the Chinese Communist Party or even bring down President Xi Jinping. That isn’t a likelihood, but it’s a real possibility.
Even as this update is broadcast, new data points are rolling in. The continent of Africa now has its first case, with the Egyptian health ministry reporting a case of COVID-19.
Elsewhere in the world, the social media giant Facebook just cancelled its global marketing summit that was planned for March in San Francisco. The Mobile World Congress, the largest smartphone conference in Europe, has also been canceled. Cancellations of significant business events appear to be multiplying as fast as the virus itself.
The bottom line is: We still have no idea how serious this outbreak is, and the market’s price-based complacency verdict is premature. This isn’t Chicken Little, sky-is-falling type talk, but a simple awareness of facts on the ground.
Investor awareness here is comparable to owning a beach house with a hurricane sighted off the coast. Whether the hurricane has an 80% chance of landing on your property or just an 8% chance, you want to be prepared.