Why the Stock Market Cares So Much About the Coronavirus

February 5, 2020 12:28 pm

Derek M. Amey

Partner & Portfolio Manager

For the last few weeks, it feels like the stock market has been responding positively and negatively to every new piece of information around the coronavirus. This article is not meant to diminish the impact this disease has on human life, but rather focus on why the market seems to care so much. Why does it seem like the market will rise and fall whenever a new piece of news is released about it?

The market is struggling to balance the knowns and the unknowns as it pertains to the economic impact of this virus. There are certain sectors of the global economy that are immediately and logically affected; they include:

Airline Stocks
As with all health scares in the past, airline stocks were one of the first sectors of the stock market to sell off. Travel bans were imposed, and so the flight cancellations have an immediate impact on revenues to the airlines. As China continues to struggle to contain the virus, airlines will be challenged by two issues:

  • How long will the travel ban last?
  • How many trips, both business and personal, have been and will be cancelled?

The longer this virus remains unconstrained, the longer the bans will go on and ultimately more and more travel plans will be cancelled.

Hotel Stocks
If people aren’t going to be travelling as much, then they also won’t be using hotels. Many of the American hotel companies (Marriot, Hilton, etc.) derive a lot of business from the Chinese market. There is also the reverse issue, that Chinese residents are currently prevented from traveling and many may decide to cancel their own plans as a precautionary move. But it won’t just be hotels operating in China that will see bookings cancelled- expect major tourist destinations around the globe to be impacted as the ban continues. As with airline profits, the longer this goes on, the more hotel chains will see rooms sit empty and profits will be negatively affected.

Casino Stocks
It may be unknown to many Americans, but Las Vegas is no longer the global capital of gambling. Back in 2006, revenue earned from gambling in Macau China overtook those of the Las Vegas Strip, and its growth has continued to outpace Vegas since that time. In fact, according to a recent Wall Street Journal article, Macau generated five times the revenue of Las Vegas in 2018. As such, almost every major US casino company has operations in Macau. This morning the Chinese government issued a 15-day lockdown of Macau casinos, ordering them to close down their businesses. To make matters worse for the casinos, January 25th was the Chinese New Year and Macau is typically a popular holiday destination.

Restaurants
By now it should be obvious why restaurant profits will be under pressure if travel has been banned. Starbucks has over 4,000 stores in China. McDonald’s has almost 3,000. Yum Brands (think KFC, Pizza Hut and Taco Bell) has over 8,000 restaurants in China. All of these stores will be impacted in some way due to coronavirus, in fact Starbucks has already said over 50% of their stores in China have been closed and will remain closed for the near future.

The Unknowns:
“People used to say, ‘When the US sneezes, the world catches a cold. Now, we’re gonna find out about China. China just sneezed. We have to find out if it’s a sniffle, a cold or a really serious pandemic” – CEO of Basic Fun Toys, which imports 92% of its products from China

That quote is a good synopsis on what the stock market is struggling to quantify. The inference that the CEO is making is that history has shown that when the US economy starts to struggle, even if momentarily, the rest of the globe typically experiences a real slowdown economically. Global economic growth is heavily tied to US economic growth, more than any other country. Never has a Chinese economic slowdown ever impacted the rest of the globe’s economic growth. The fear with this virus is that perhaps this is different and that the Chinese economy has now reached a size where as China goes, the rest of the globe will as well. The question, for which right now there is no answer, is global growth now as reliant on China’s economic health as it has been with the US?

Many business and Wall Street analysts are using the SARS outbreak in late 2002 as a guidebook for the outcome of the current coronavirus. Ultimately the economic impact of the SARS outbreak was limited, and the Chinese economy quickly rebounded from the affects. The potential mistake of using SARS as a guide is due to the size and the speed at which the current virus is growing. SARS ended up affecting just over 8,000 people in nine-month period. Currently the coronavirus has impacted over 20,000 people in as little as 3 months, with currently no signs of slowing down. If this pace of growth of the disease continues for a few more weeks, it should be obvious to everyone by then that comparing this to SARS is a mistake.

The primary reason why using SARS could be a mistake is due to how large the Chinese economy has become. The Chinese economy is now four times the size it was back in 2002. They had seven more times the amount of international air travelers in and out of China in 2018 than they did in 2002. Finally, China ships almost three times the number of containers today than it did back when SARS hit. Supply-chain management, and the impact of delayed or missed deliveries of Chinese goods could have a major global economic impact. Due to the known Chinese New Year, many companies had stocked up in preparation of a holiday shutdown in China. However, these supplies will not last long and with 50 Million Chinese residents under lockdown, the harder it will be to restart shipping goods once the ban is lifted. One report we read said that as many as 450 importers use suppliers from the heavily affected Hubei province, with electronic manufacturers and automakers making up the predominant businesses importing from that region.

As stated, the longer this virus’s impact drags on the greater impact it will have on global growth and on the US stock market. As of now, investors seem to believe that the base case is that the Chinese response has been swift enough and aggressive enough to stop this from becoming a worldwide issue. There may be challenges to contain it within the Hubei province, but the travel bans and the forced shutdowns of companies is doing the job of stopping the spread beyond the country. In fact, here in the US as of this writing, we’ve only seen 11 cases and no deaths which is amazing considering how interconnected the globe is these days.  The base case also seems to be that supply-chain issues are currently not insurmountable. Companies have supply on hand, and others will adapt and find other places to import their goods until the Chinese economy is at full strength again. A few weeks of disruption is one thing for the market to digest, but weeks turning into months is something all together different. As with all fears of the unknown, only time will tell whether they are warranted or not. For societal reasons we hope that investors are correct and that the issue will not have a long-lasting impact on lives and or the global economy, but we will just have to wait and see.

 

 

Derek Amey serves as Partner and Portfolio Manager at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail him at damey@strategicpoint.com.

The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Derek’s opinions and comments expressed on this site are his own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.