The Market Is Trying to Put a Price on the Coronavirus Outbreak

(Bloomberg Businessweek) -- Past performance, money managers warn us in countless marketing documents, is no guarantee of future results. Yet when a threat emerges to the value of investment portfolios, Wall Street’s market pundits rush to find an analogous past event.

So as the number of patients with the coronavirus swiftly grew into the thousands over the past week in China, analysts’ time machines landed back in 2003. That was the year that severe acute respiratory syndrome spread from China to the rest of the world, eventually infecting about 8,100 people and causing 774 fatalities. The cold takeaway for Wall Street? That turned out to be a great year for stocks. Despite some turbulence caused by SARS, the S&P 500 rallied 26% and the MSCI China Index surged 81% that year.

As a result, the latest outbreak looks like just another buy-the-dip moment for many investors. And that very well may end up being the right response. But comparisons of the two viruses aside, the health of markets and the economy at the moment couldn’t be any more different from 2003. And that makes predictions of future performance based on these past results all the more perilous.

When the SARS outbreak started—in November 2002, to be precise—the S&P 500 had just finished a 49% plunge as it worked through the excesses of the dot-com bubble and the uncertainties of a post-Sept. 11 world. When the coronavirus began making headlines earlier this month, the index was at a record high after a 42% surge since Dec. 24, 2018. Similarly, at the time the SARS news hit, the Conference Board’s index of consumer confidence had almost completed its fall from 145 at the height of the dot-com boom in early 2000 to 61 in March 2003. The reading for this January was buoyant at almost 132.

That ebullient confidence at the start of this year could also be seen in the valuations investors were willing to pay for stocks. The price-to-earnings ratio for the S&P 500 jumped from about 16 at its low in December 2018 to 22 at its pre-coronavirus high in mid-January.

In short, when SARS broke out, the market was starting to figure into stock prices the notion that things couldn’t get much worse after one of the nastiest bear markets in history. This time around, it was pricing in an abundance of hope to justify the rally that had just occurred. The narrative from the bulls was that the ever-dependable U.S. consumer and dominant U.S. services industries would continue to keep the economy and markets chugging along, while the smaller manufacturing sector would begin to recover from the effect of a trade war with China, thus doing its part to boost growth.

“Investors are hungry for evidence that this global recovery, driven out of China, is actually happening,” Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, told Bloomberg TV on Jan. 27. “So there’s this hope trade that’s been going on all year. And my question is, are we threatening that hope trade with what’s going on with this virus?”

That the virus is a direct threat to consumer behavior—not only in China but potentially everywhere it touches—explains why markets responded so negatively to its discovery in the U.S. and the growing number of cases inside and outside China, causing the S&P 500 to tumble 2.5% starting on Friday, Jan. 24 though the following Monday. About 90% of the stocks in the index fell over those two sessions. Some of the worst-hit shares told the story of an interconnected global economy, already at risk of being fractured by the trade war, now at risk of becoming even more disconnected: American Airlines Group and other carriers, Royal Caribbean Cruises Ltd. and Carnival Corp., energy companies such as Halliburton Co. Falling oil prices and a rally in safe-haven bonds, which pushed down their yields, signaled a widespread economic concern that went beyond the stock market.

China’s efforts to contain the virus, as well as nervousness among its citizens, effectively shut down not only the factories of Wuhan, where the outbreak began, but also large swaths of the domestic consumer economy, which accounts for a much bigger share of gross domestic product than it did in the days of SARS. Shanghai Disneyland was closed, for example, as were thousands of movie theaters.

Regardless of how swiftly markets recover from the coronavirus, and despite the recent trade tensions, the interdependence of the U.S. and Chinese consumer economies is only likely to grow. This won’t be the last time a risk like this emerges.

The type of forced quarantining imposed in China is unlikely to be replicated in the U.S. or Europe. That doesn’t necessarily mean other economies around the world won’t take a hit if more virus patients start turning up. Although much of U.S. commerce has shifted onto the internet this century, a huge driver of employment growth over the past decade has involved work that requires face-to-face contact. Retailers have added 1.5 million jobs in the past 10 years, with almost 16 million now employed at stores. Bars and restaurants, which have added 3 million jobs, employ more than 12 million. Fear of the coronavirus, well-founded or not, could thin the crowds at restaurants, malls, theaters, stadiums, and other temples of the consumer economy. And that could quickly be reflected in jobless claims and employment data that have held firm in the face of trade and other worries.

“What we’re seeing reflected in things like bond yields and oil prices is the very real possibility that, at least in the short term, we see a hit to economic growth,” Liz Ann Sonders, chief investment strategist at Charles Schwab, told Bloomberg TV on Jan. 28. “A rerating of growth in the very near term, at least just specific to coronavirus, is justifiable.” How big that rerating will end up being is yet to be seen, and investors could very well look past this the way they look past weak economic data amid an especially harsh winter. However, the fading of the coronavirus is much harder to predict than a spring thaw.

Michael Antonelli, a market strategist at Robert W. Baird & Co., compares investors to the crew of the Titanic, who put great effort into spotting icebergs on the horizon—only to miss the big one. “I read countless outlooks to start the year talking about the election, manufacturing weakness, debt, interest rates, earnings, etc., which are all known icebergs,” he wrote in a blog post. “Did a single strategist write about a viral outbreak originating in the 6th-largest city in China posing a threat to a tentative global economic recovery? Of course not, but that’s TRUE risk.”

With only a handful of coronavirus cases in the U.S. and Europe confirmed, equity traders piled back into the market on Tuesday after the two-day sell-off. About half the losses in benchmark indexes were recouped. Was this just another opportunity to buy the dip and get some stocks at a relative bargain? Could be. But make no mistake: Right now, no one knows exactly how big this iceberg is.

To contact the editor responsible for this story: Pat Regnier at pregnier3@bloomberg.net

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