Macroeconomic & Geopolitical

Fear Itself

March 2020 – 3 min read
Why are markets so wild? Just listen to the voices in your head.

"This is crazy. The news coverage is just scaring everyone."

"Except, now they say it may have been here undetected for weeks!"

"It's not much worse than the flu."

"But, when was the last time I washed my hands?"

"At last! Governments are finally beginning to react."

"Fifty basis points? What do they know that we don’t?”

Most of the time, investors can stare studiously at their screens, fiddle at length with their spreadsheets and make a reasoned judgment to buy or sell based on data, analysis and a hunch. 

But as the coronavirus headlines multiply, money managers must contend with much noisier voices rattling around in their heads. First, they must try to understand new dynamics around contagion and mortality rates to project just how far the disease may spread. Second, they must assess how much damage mounting fears of the disease will feed through to growth and earnings. Third, and hardest of all, they have their own emotions to keep in check.

Why shouldn’t I make that trip to New York? Will they really cancel the Olympics? Don't all those masks look ridiculous? Why did my local drugstore just run out?

The first set of analyses is difficult enough. Epidemiologists have rough precedents from SARS (Severe Acute Respiratory Syndrome) and Zika and even the 1918 Spanish Influenza, but they don't really know how quickly this new disease will spread. Developing countries like Iran don't have the public health infrastructure to contain it. Developed countries like Italy can't shut down major cities even if that seemed like the wise choice.

Still, as awareness spreads and government coordination picks up, it's possible to see through to the other side. Already the number of new cases in China is falling, and it seems reasonable to expect decent forecasts for other parts of the world, too.

"This is one of those moments in markets when the news and data and price monitors spill off the screen like a bad 3-D movie and mix seamlessly with shreds of personal worries."

Assessing the economic shock is trickier, since it depends on the assumptions—and success—of the health professionals. Nevertheless, it’s possible to unpack the most important moving parts. The disease itself and the measures to contain it delivered a clear shock to the Chinese economy, which has been supporting about a third of the world's growth. PMI data for February sank to record lows on both official and unofficial measures. Factories are slowly returning to work but may not resume full operations until well into the spring. In Korea and Japan, most of the cases so far have been concentrated and traceable, so we may soon have a sense of the impact there, too. 

Economically, there will also be ripple effects through global supply chains. Apple swiftly reduced its revenue guidance while other firms suspended guidance altogether. You can't sell a car without all the parts. You can't sell a pair of shoes without the shoes. These will be difficult to measure, but analysts have already begun to lower earnings estimates.

The combined impact of these supply shocks will also feed through to demand. Again, there is no formula for adjusting these assumptions, but anyone who was expecting corporate capital expenditure to bounce back in the wake of the trade truce between Washington and Beijing will need to think again. The ever-resilient and optimistic American consumer may even waver if the meeting cancellations and market gyrations continue to fuel worries. This will likely require an adjustment to growth estimates. 

Pricing in this new reality is hardly precise, but it has clearly begun and it is what professional investors are paid to do. What is so much harder, however, is to keep their own emotions in check as they stare at all these projections.

This is one of those moments in markets when the news and data and price monitors spill off the screen like a bad 3-D movie and mix seamlessly with shreds of personal worries. 

“Why did I agree to meet at this crowded restaurant anyway? Are they really closing schools in New York? When was the last time someone cleaned this keyboard?”

Franklin Roosevelt famously warned Americans during the Great Depression that the "only thing we have to fear is fear itself." Of course, in financial markets it is sometimes eminently logical to panic when everyone else is running for safety. 

But fear, as Roosevelt went on to say, can be “nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance.” A successful investment strategy will involve seeing through the coronavirus contagion and containment trends before everyone else and making a more realistic estimate of the economic and financial damage. 

It will also mean finding a way to moderate—and mediate—those voices in your head.

Christopher Smart, PhD, CFA

Chief Global Strategist & Head of the Barings Investment Institute

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