Just how virulent and just what the final mortality rate of the coronavirus remains unknown. The reports we have seen suggest this is a global pandemic. The fatality rates from COVID-19 are higher than the current influenza strains. However, the fatality rates are still relatively low and are tilted towards the parts of the population that are already weakened by age or pre-existing medical conditions. 

 

The fatality rate of the common flu is estimated at 0.1%. Initial estimates for fatality rates of COVID-19 are likely to be less reliable due to the difficulty in determining infection rates. However, we have seen estimates from 0.5% in South Korea to 0.8% in China.

Vaccines and drugs to treat COVID-19 symptoms are estimated to be anywhere from 3 to 12 months away. However, once there is certainty around a medical development, we would expect the response to move from containment to mitigation. In the same way as currently happens with the common flu.

To give some perspective to the severity of COVID-19, the World Health Organisation at the start of March reported some 87,000 cases of COVID-19 globally with a tick under 3,000 reported deaths. Fatalities from the common flu during the current flu season solely in the US has exceeded 12,000 deaths and the 2017/18 year exceeded 61,000 deaths. A statistic we may be more familiar with, road crashes, will account for over 37,000 deaths in the US each year.

Are these numbers large? The 2017 global population was 7.5 billion and in the same year 17.79 million deaths were recorded from cardiovascular disease, 2.51 million from dementia, 1.24 million from road accidents, 295 thousand from drowning and 126,000 died from hepatitis. These numbers blur the horrific toll on human life, but it is useful to demonstrate that the loss of life from COVID-19 is at this point in time, relatively minor.

A key lesson learnt from the SARS outbreak in 2003 was the need for containment of the infections to reduce the contagion effect. History may show that this strategy remains the best course of action to restrict the loss of human life, however it is this very response that is at the heart of current market volatility and economic instability.

Shutting down entire cities has restricted the manufacturing heartland of the Wuhan province in China. We are already seeing shocks to the supply chain as the extensive factory closures and travel bans of China take effect. Of Australia’s total exports, over 30% goes to China and 25% of Australia’s manufacturing imports are from China. This is many times more than it was only a decade ago and even at this early point in the epidemic the Australian economy can expect to experience a negative economic shock from the containment policies of Chinese authorities.

With the virus spreading globally and the key preventative response continuing to be containment, these supply side shocks will reverberate around the globe for some time. While not noticeable yet, we should recognise that today’s supply side shock will readily morph into tomorrow’s loss of demand. 

 

The rationale for considering the current supply shock reducing future demand is compelling. Consumer behaviour requires us to continue to seek those items that are truly necessary. However, these items only make up a small component of total consumption in most western societies. This is why the regular “one day only” sales strategies do so well. Consumers buy things they don’t really need and impulsive purchasing patterns are recognised as the norm. If consumers are restricted from their purchasing patterns, demand will fall. 

As we have seen in previous corrections, fear of the unknown leads to an exodus from equities and a flow of capital to the safety of bonds. This movement is currently in full swing. Demand for the Australian 10-year bond has pushed it to an all-time historical low of 0.68% as at the end of February and has shown increased volatility in trade every day since.

The economic shock is sufficient that we can expect a fiscal and monetary response. A fiscal response is where the Government will push money into specific sectors that are experiencing negative shocks. Examples historically have been the building sector when the GST was introduced and drought aid for farming communities more recently.

Governments can simply give money to its citizens with the goal of increasing demand as happened in 2008 in Australia or as happened in Hong Kong earlier this month when authorities disbursed HK $10,000 to every Hong Kong permanent resident aged 18 or above.

  

A monetary response is when the Central bank adjusts interest rates (lower). The consequences of this is explained later in this newsletter. Both are attempts at increasing demand. Neither method is known to successfully support supply.

Probably the most important person to lead this shift is the US federal Chair Jerome Powell and he has already hinted at further reduction in US interest rates. We can expect further stimulus packages to be announced over the coming days and weeks across the globe.

With increased liquidity it may be that this material correction turns into a major buying opportunity for longer term investors. Of course, the timing of shifts in market sentiment is impossible to predict but the longer-term outcome may well be more positive than the market is currently indicating.

Our response to current events is to stay calm and let the active investment approach of our selected managers play out. There are going to be opportunities to buy companies at discounted prices. We can expect increased volatility until the market reaches some level of confidence that the outbreak is containable.