The Wuhan-coronavirus and the financial modelling of unknown unknowns
Montreal, January 30, 2020
In 1951, American author George Stewart was awarded the first International Fantasy award for his novel, Earth Abides. The novel told the story of a student working on an ecology research project in a remote mountain region who returns to the city to find that civilization has collapsed due to a deadly virus outbreak. Many years later, Stephen King drew inspiration from Stewart’s novel and took the idea further in the Stand (1990), which depicts an epic battle amongst survivors of a global epidemic that decimated over 99% of the world’s population. Movie studios also jumped on the bandwagon and created thrillers in which the antagonist was an elusive deadly virus or bacteria, rather than a monster or a deranged individual of some sort. This led to the not too fabulous Outbreak (1995) and the much more successful 28 Days After (2002).
Since then, the world has been attuned to the threat that a global pandemic could unleash. This is why the presence of a new strain of coronavirus in China (Wuhan, in the Hubei province, to be precise), has many wondering whether this outbreak could be worse than the SARS episode of (2003) as the coronavirus is in the same family. If this is the case, the outbreak could have an adverse impact on global economic growth and force policy makers to revisit their policies.
What do we know about the Wuhan coronavirus?
The virus was first reported in late December 2019. It remains unclear, as of January 30th, whether transmission originally occurred by touching or by eating an as yet unidentified animal but we do know that the virus is being transmitted from human to human through close contact and that transmission is possible prior to the first symptoms showing. Officials indicate that approximately 7,700 cases have been reported. Most are in China although the virus has crossed the border as its presence has been confirmed elsewhere in Asia and at least five cases have been confirmed in the United States.
Preliminarily, the good news is that while the virus is highly contagious, potentially even more than the SARS, it is not as fatal. To this point, the Wuhan’s coronavirus is responsible for 170 fatalities, which translates into a mortality rate of roughly 2% based on the number of confirmed cases. This is roughly half the mortality rate of the SARS (10%). It is also much lower than that of the MERS (Middle Eastern Respiratory Syndrome) which killed over 30% of the 2,450 affected in the Arabian Peninsula in 2012.
How have authorities responded?
While the disease is similar to the SARS virus, the response of the Chinese authorities has been markedly different this time around. In 2002, China concealed the virus from the rest of the world and from its own population for many months. The press was prevented to report on it. This time around, China alerted the World Health Organization (“WHO”) within days after having identified the first case of a pneumonia of unknown cause and posted the virus’ gene sequence in the open domain immediately after having isolated it. On January 22nd, in spite of the upcoming China new year, as the disease was spreading rapidly, the government announced a quarantine, cancelling outgoing flights and trains from Wuhan, and suspending public transportation in Wuhan, effectively stranding 11 million people and a further 50 million elsewhere. As such, while some argue that the Chinese authorities could have acted more quickly, there was no cover-up attempt this time around.
On its end, the WHO held an emergency meeting to determine whether the coronavirus should be classified as a public health emergency of international concern (“PHEIC”), a decision not to be taken lightly. It decided against it. The WHO labelled 5 diseases PHEICs in the past decade. Those were the H1N1 (2009), the Poliovirus (2014), the Ebola (2014 and 2019) and Zika (2016). The latest data on the speed of propagation of the disease lead some experts, including former FDA head Scott Gottlieb, to argue that the WHO might reverse its decision shortly. In effect, as illness is less severe, many people falling sick may have dismissed symptoms as regular flu symptoms. As such, many more people could be affected. It is just impossible to tell.
What about the economic impact?
If the Chinese authorities succeed in containing and quashing the disease, the economic toll should be short lived and muted. In the interim though, we expect commodities and commodity-related stocks, which have declined modestly, to remain volatile. The Yuan should also show signs of weakness, as would China–centric travel and leisure related names such as airliners hotel operators and retailers. What blurs the picture is that the outbreak coincides with the China new year, a two-week period during which the country nearly shut down entirely. Because of that, it may take a while before we have more clarity.
On the other hand, the economic cost could be more significant should the transmission potency of the virus turn out to be underestimated or that the virus itself mutates and turns deadlier. On that note, our desire is not to sound like a bad omen but many Canadians born two generations ago lost a family member to the Spanish Influenza outbreak of 1918 or know someone who has. 55,000 Canadians died and a further 50 million globally, or 2,5% of the world population. The creation of the Canadian Ministry of Health in 1919 is a legacy that we can directly attribute to the Spanish Influenza. But what few remember is that there were multiple waves of Influenza. The first one, in the spring of 1918, was relatively benign. But in the fall of that same year, the virus mutated and it is then that it became lethal.
Should clients adopt a more defensive asset mix stance, at least temporarily, in response to the virus outbreak?
We believe that the markets are generally decent discounting mechanisms, quick at taking into consideration any new information that surfaces. It does not appear to be different this time around. Until the second half of last week, financial markets were continuing on their upward trajectory. Then the news of the coronavirus outbreak hit mainstream and markets shivered but based on the initial reaction, a mild decline, consensus is that the novel-coronavirus is not as damaging as the SARS, and certainly not as bad as the Spanish Influenza episode of 1918. That said, this interpretation might evolve rapidly.
Every day, cohorts of pundits and prognosticators talk about the various risks that they think will affect the financial markets. The list typically includes potential conflicts arising between countries, changes in macro patterns such as growth, employment or inflation or changes in sentiment or liquidity. All fall into the category of known unknowns. Those are generally easier to quantify and more easily incorporated in a portfolio construction framework. What we’re talking here, the prospect of a severe global pandemic, like the prospect of a grave natural catastrophe, are unknown unknowns. Our view is that unknown unknowns are so improbable that they should not be considered for modelling purposes. However, once we become aware of their existence, we think it is prudent to monitor them and determine if they are likely going to cause a worsening of existing conditions as they evolve, or, on the contrary, improve, or stabilize. In the current situation, as we are not epidemiologists or virologists, we simply do not have enough information to tell. As such, we do not think that a major adjustment to portfolio asset mix is warranted.
Dimitri Douaire, M. Sc., CFA
Co-Chief Investment Officer