COVID-19'S STOCK MARKET HISTORY LESSON

Global stock markets plunged again this week as the COVID-19 outbreak continues to spread.

While in no way diminishing the human loss and suffering caused by this virus, for any investor, trader, or anyone with a retirement account, the financial outcome of this is also significant. That said, we can try to learn from the past about what to expect in the markets. Let’s look at how markets performed during prior epidemics — SARS, the swine flu and the Spanish flu.

SARS

How did SARS affect global equity markets. Below is a plot of worldwide SARS cases from the World Health Organization with the pre- and post-peak coloring:

Here is how the S&P 500 performed as SARS peaked:

In this case, the early onset of SARS cases coincided with a 10% market decline over the course of three months. However, this decline started to reverse before SARS even finished peaking.

If you look the MSCI Emerging Markets (EM) index over this time period, you see a similar story:

The sell-off in markets related to SARS were reversed in a short time period and recovery ensued.

SWINE FLU

Another modern epidemic to look at is the 2009 swine flu:

Unfortunately, the relationship between swine flu’s peak and world equity markets is the weakest among the modern epidemics:

As you can see, there is a decline immediately after the peak in swine flu cases, but that decline is the smallest we have seen so far, and, also, doesn’t last. Emerging markets reacted in a similar way:

Both SARS and the swine flu coincided with minor declines in global equity markets (5% to -10% range) that quickly recovered.

If we assume that coronavirus will be similar in deadliness to SARS or swine flu, then I wouldn’t worry about the long term impact on the stock market.

But it looks as if coronavirus will end up being worse than these other modern epidemics.

Unfortunately, given the limited number of epidemics we have seen in modern times, we don’t have lot of data to work with. However, one pandemic is telling.

SPANISH FLU

Unlike the other epidemics discussed, and unfortunately like COVID-19, the Spanish flue was a global killer. Between 1918 and 1920, it infected over 500 million people (~27% of Earth’s population) and killed over 50 million of them.

It’s hard to imagine this many people dying considering that Swine flu killed about 12,000 people and SARS killed fewer than 1,000 people.

This chart shows Spanish flu per-capita deaths in the U.K. while the virus was active:

Overlaying this same coloring with the Dow Jones Index during this time period, we can see that the market sold off about 10% shortly after the peak:

However, unlike the modern epidemics, the market stayed depressed for a few months post-peak.

This suggests that market participants thought that things could get worse. It is also possible that these depressed prices had nothing to do with the Spanish flu whatsoever. We can’t know with certainty.

But think about what this tells us: A global pandemic that killed 3% of the Earth’s population only sent markets down 10% over a period of four months. This is a stunning result. The worst virus since the bubonic plague and markets go through a normal correction?

It is unlikely that COVID-19 will be anywhere near as catastrophic as the Spanish flu because of our greatly improved medical knowledge over the past century. But the markets are acting as if it will be far more devastating. We have yet to see a peak in COVID-19 cases and the major markets are already down between 20-30%. Many individual stocks are already down 30-60%.

Why might this be the case? The economic cost of COVID-19 is likely to be higher than prior epidemics as we take larger preventive measures to stop the virus from spreading. These measures are causing massive layoffs and a dramatic contraction of economic activity.

If history is any guide, however, COVID-19 is likely to cause a temporary downturn in the market. Once COVID-19 cases peak, the market will begin to recover its losses, the economy will recover and humanity will march on.