Is the Coronavirus a Black Swan Event that Will Cause the Next Recession?

The deadly Coronavirus has now spread to more than 60 countries around the world and infected more than 85,000 people, killing nearly 3,000. The virus began in China, which is where overwhelmingly most of the infections and deaths have occurred, but several other countries have recently seen dramatic spikes in infections.

The virus, which was initially diagnosed in December 2019, has proven difficult to contain. However, based on reports from China, the spread of the virus can be slowed, only after what some would consider ‘extreme’ measures. Those measures in China where quarantine orders of the general public, school closures, and businesses shutting down daily operations. These steps have appeared to help the spread of the virus in China, but have taken their toll on the world economies.

During the last week of February, the Dow Jones Industrial Average fell 3,500 points or more than 12%. That is the largest one-week point loss ever for the index, while the percentage decline is the biggest we have experienced since the 2008 financial crisis.

So why did the US markets react the way it did?

The main reason is uncertainty. Right now, we don’t know how bad this virus will affect not only world populations but world economies. There are analyst’s already predicting growth models of mild economies contraction in the first quarter of the year and possibly flat gross domestic product growth for the year. Major corporations such as Apple, Microsoft, and Disney, just to name a few of the bigger ones, have also said earnings will be negatively affected this quarter and possibly for the year due to the Coronavirus outbreak.

Apple, Microsoft, and other technology companies are already seeing supply chain issues due to the quarantine orders in China and manufacturing facilities in the country, shutting down operations for a period of time. These supply chain issues and earning warnings would be another big reason the markets sold off. Stock market prices are based on past and predicted future earnings. If earnings are expected to fall, then stocks will also fall.

The more prominent companies mentioned above are also seen as ‘bell weather’ companies. Meaning they are big and powerful companies, and if Apple thinks there is going to be an issue, there will probably be issues for smaller companies that don’t have the ‘pull’ to get product the same way Apple or Microsoft may.

Furthermore, if we begin seeing supply chain issues from manufacturing plants in China, that could be just the first dominion to fall. If companies don’t have products to sell, then they may not need as many employees working. This could cause layoffs. People laid off from work can’t pay their bills and debts or buy other products. Then the chain reaction follows, and we see more layoffs because other businesses are now being affected by lower sales, not because they can’t get product, but because they don’t have as many customers.

When it comes to debt payments not being made, higher default rates then make lenders tighten their belts and lend less money. That further slows the economy and puts more businesses at risk of reducing jobs, which in turn just further feeds the process.

Of course, all of this is on the more extreme side of what outcome we could see from the Coronavirus. World Health Organization Director-General Tedros Adhanom Ghebreyesus recently said that “Global markets … should calm down and try to see the reality.” He was speaking about the fact that this is not yet a true global pandemic. That the virus while still spreading is not yet reached, in-mass, all parts of the world. He went further, saying, “We need to go into the numbers, we need to go into the facts, and do the right thing instead of panicking. Panic and fear is the worst.”

Ghebreyesus finally stated, “Based on the facts on the ground, containment is possible. But the window of opportunity for containing it is narrowing. So we need to be preparing side by side for a pandemic. Containment works. But at the same time, we cannot be sure. This thing could change direction and be worse. That’s why we prepare for the worst.”

The stock market is a forward-looking entity. We price stocks based on what we think their earnings and growth rates in the future will be. The decline during the last week of February was a hint that market participants thought earnings and growth rates were going to get worse than previously expected in the future. But no one, not market participants, not health officials, know how bad things could get.

Which like WHO Director-General Ghebreyesus stated, we could contain this virus, but at the same time, we should be prepared that it does get worse. If the Coronavirus is contained and businesses get back to operating, as usual, this decline will be just that, a small correction that lasts a few weeks or months, before stocks move even higher than they were before. In that case, no need to sell, just ride this out. But if it gets worse and it looks like we are heading for a much larger decline and more serious impact on world economies, than you may want to start selling. Which is what you should be ‘preparing’ to do now. You should know now what you should sell and what you should keep if things get worse.

To find out what industries will be hit the hardest by a Coronavirus Pandemic check back soon for part 2 of this series in which I discuss what ETFs you don’t want to own if things get worse. In part 3, I will discuss a few ETFs that will help you ride out a market downturn.

Matt Thalman
INO.com Contributor - ETFs
Follow me on Twitter @mthalman5513

Disclosure: This contributor did not hold a position in any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.