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Mar 02, 2020

Market Uncertainty over Coronavirus

Bill Miller

The rising concerns over coronavirus led to significant market turmoil over the past week. Fear and uncertainty abound over the current and future implications. Here is a current perspective from members of our team:

Bill Miller, CFA

As with all or almost all investment questions, the answer is “it depends.” I had thought that the risks in the market since the Federal Reserve (the Fed) began easing were political and not economic and that 2020 growth would be better than 2019 and the path of least resistance for stocks was higher. Put differently, I thought the risks to stocks were not endogenous (earnings, inflation, Fed raising rates, etc), but were exogenous (US or global politics, terrorist events, pandemics, etc).

The virus is one of those exogenous events that feeds back into and creates endogenous risks. There are too many unknowns at this point to have a lot of conviction, but the ferocity of this sell-off and the explosion of volatility is more consistent with bottoms than with the beginning of a bear market, which in my opinion would require a major global supply shock, which is possible depending on how government officials and companies behave as the virus spreads, but so far looks to be fairly mild.

The Fed is a key part of the picture. As General MacArthur famously said, every military disaster in history can be summed up in two words: “too late.” Same with every economic disaster. If the Fed acts forcefully and aggressively, even if the virus gets a whole lot worse, a recession and bear market can be averted, in my opinion. I disagree with those who say the Fed is mostly out of bullets and even a 75 basis point (bps) cut will not do anything because growth is not being inhibited because rates are too high. The Eurozone crisis in 2011, a far greater long-term threat to financial stability and the global economy than the virus is or is likely to be, ended not with the ECB doing anything, but with Mario Draghi saying they would do “whatever it takes” to preserve the euro. It was about restoring confidence, not about a specific policy lever. A similar statement by Jerome Powell about doing whatever it takes to offset the economic effects of the virus and keep the expansion going would go a long way to ending the panic selling. I see no risks in the Fed cutting 50bps or higher near term—inflation expectations are falling not rising—and a lot of risks if they do nothing or do too little too late.

The key to me in thinking about the impact of the virus is the number of active cases, i.e. those currently being treated, not the number of new cases, which is what is constantly being reported. Those who have been cured or who have died are not contagious, so if active cases are falling, as they are, that means there are fewer people who can infect others. Active cases peaked on February 17 at 58,747 and currently stand at 42,632. Of course, a rapid global spread could turn that number around, but so far so good.

It takes a lot of emotion to sustain a panic, and that requires the negative news continuing to outrun the market’s discounting of that news. I would put the lows somewhere close to the 2018 decline from the peak, so 20+% or so, or about 8% more if the news does not improve or if the Fed does nothing. I would guess it might take another week to get there, but I would not be surprised if the lows were Monday or Tuesday. The Chinese market went down 14% on this virus and made a V recovery. I would not rule out something similar in the US.

But it depends…

Samantha McLemore, CFA

I did a lot of reading over the weekend on the coronavirus and past possible precedents. Like my experience many times on “doing the work”, my conclusions verify what Bill said at the recent Forbes/SHOOK conference. The market panic may be overdone relative to the biological impact, but not necessarily to the human panic impact. From a biological perspective, there’s good news and bad news.

The bad news is that it will be impossible to contain the virus. Many individuals are asymptomatic or have mild illness yet they are contagious. Sources such as Harvard epidemiologist Marc Lipsitch and Johns Hopkins University Center for Health Security expert Dr. Amesh Adalja say containment efforts are futile and estimate that 40-70% of the population will be infected with this coronavirus. But the good news coming out recently is that fatality rate estimates keep declining. Initial reports out of Wuhan China pegged deaths at roughly ~2-4% of those infected. That is horrible. The devastating 1918 Spanish flu pandemic had a 2.5% fatality rate. But experts agree this is a huge overestimation because of a “severity skew” in the reporting (only the most severe cases seek medical treatment and get tested). This morning on CNBC Dr. Matt McCarthy, an infectious disease physician, estimated the ultimate fatality rate at 0.2-0.4%, a fraction of the current reporting. This is only 2-4x a bad flu season. Dr. Adalja said that he believed it would ultimately be in-line with a bad flu season, + or – 0.1%. We dealt with a bad flu season just last winter.

Dr. Adalja compared this coronavirus to the H1N1 flu pandemic of 2009 that infected 60M people worldwide. Society paid some attention to that outbreak, but the world was much more occupied with the financial crisis then. There were flu pandemics in 1957 and 1968 with fatality rates around 0.5%, which is higher than the current estimates of this virus – both originated in China. With the 1957 Asian flu, which hit the US in June that year, the SPX peaked roughly when the virus hit and declined ~20-21% to the trough in October. The 1968 Hong Kong flu hit the US in December 1968 (after a big run-up in markets from the lows in March). The market peaked at that time and declined ~17-18% making a double low in July and December 1969. Again, both of those flu pandemics appear to be worse biologically than the estimates of this one.

The S&P 500 has already declined 15.8% from the peak on February 19th to the low Friday – we experienced the fastest 10% decline in the past 50 years! The rapidity with which events are discounted keeps accelerating. This was a huge and painful shock, but it can also enable a quicker recovery. The 1957 and 1968 flu pandemics appear to be worse than this one and averaged a decline of ~19%. We are already within spitting distance of that. From a biological perspective, you could make a decent argument the lows are in.

Additionally, some interesting research I read highlighted that these flu shocks have had a positive impact on economic growth over the following decade, which makes sense if the economy bounces back to trendline growth from a temporary slowdown. The bigger question is how much do governments and people panic as the facts come out and people realize they will likely get this virus?

Dr. Adalja spent a good amount of time talking about the futility in canceling events and halting travel. But he said many decisions are made locally. These decisions can be based more on fear than facts. On CNBC they mentioned that at a gathering in Detroit, they polled the audience. People were not worried because they didn’t think they’d get the virus. When the case counts are reported, how will behavior change? Imagine if there was daily reporting on flu cases and deaths. The answers matter for the economic implications.

Overall, the impact of coronavirus will be large just due to the math of large numbers of infected people and significant fatality risk, even if that risk appears much lower than it did last week.

The market, though, can price risks when there’s clarity – it’s uncertainty it hates. As more data comes out, the market can get a better sense of the biological risk, which is tragic but appears manageable.

For long-term investors who remain patient and rational, now appears to be an attractive buying opportunity. The market seems to be sniffing this out today.

Any views expressed are subject to change at any time, and Miller Value Partners disclaims any responsibility to update such views. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. Past performance is no guarantee of future results, and there is no guarantee dividends will be paid or continued. Content may not be reprinted, republished or used in any manner without written consent from Miller Value Partners.

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