The global spread of the coronavirus has sown panic in the financial markets. At times like these, it is more than ever important to look at things not through alarming headlines but through the known facts and numbers.
The known and proven fact is that in China, the epidemic that started spreading rapidly in December reached its peak towards the end of January. At the peak, the number of new coronavirus patients in Hubei, where the epidemic started, was 3,000 daily, and it was 900 daily in all the other provinces of China combined. At the end of last week, the number of new patients in Hubei was less than 100 daily, and in the rest of China it had fallen to single-digit numbers.
How did the Chinese cut the number of those falling ill with the coronavirus so dramatically? At the focus of the epidemic, chiefly in the capital of the Hubei province, Wuhan, they instituted drastic measures. The local authorities imposed an almost complete lockdown. Elsewhere in China, the steps taken were similar to those now being taken in the West: monitoring of patients, isolation of those who have come into contact with them, restrictions on gatherings of people.
According to the head of the World Health Organization delegation that returned from China last week, these measures have proved extremely effective in reducing the incidence of the disease in all of China's 30 provinces. Similar measures have already led to a drop in the number of new patients in the other focus of the pandemic, South Korea. At the peak, at the end of February, there were 800 new patients there daily. The latest figure is less than 400.
This demonstrates that it is possible to gain control over the spread of the coronavirus within a fairly short time, through measures that any normal country can introduce, and that most of them already have. In this respect, the situation in the US, the world's economic superpower, is somewhat worrying. The impression at the moment is that the authorities there have responded tardily and confusedly to the spread of the virus. Nevertheless, there is no doubt that the US is capable of doing all that is necessary to stop the pandemic, and presumably this is what will happen in that country too.
Severe blow to growth, but short term
The Chinese economy has already started to return to normal activity. In other places around the world, the crisis is still in its initial stages, and the disruptions are growing. Nevertheless, if in each of China's provinces the period from the peak of the pandemic to a return to routine was about a month, it can be assumed that a similar scenario will play out elsewhere.
Of course each event is unique, and there can be no certainty that it will be similar to previous ones. All the same, it's worth recalling that severe economic damage as a result of natural disaster, war, or disease in the current century has in most cases been short lived, and that the subsequent recovery has generally been very rapid. Here are some examples:
- Economic growth in Israel fell sharply in the third quarter of 2006, during the period of the Second Lebanon War, when half the economy was paralyzed for a month, but rapidly returned to a high rate afterwards.
- A sharp fall in growth after the earthquake and the damage to the nuclear reactor at Fukushima in Japan turned into a sharp jump after two quarters, with the support of incentives from the Japanese government.
- The earthquake and tidal wave that hit several Asian countries hard in 2005 and caused the deaths of over 200,000 people led to severe retardation of growth in the Indonesian economy. Within a year, however, that economy returned to the growth rate it had shown before the event.
- The decline in air travel in China during the period of the SARS outbreak in 2003 was reversed within six months.
If the spread of the coronavirus around the world and associated events last longer, the economic risk will of course rise. Company insolvencies and worker layoffs will be liable to turn the situation into a severe financial crisis. In this respect, the sharp fall in the price of oil that we have seen in the past few days raises the risk to energy companies, especially US energy companies, which in any case are in a delicate financial situation, with high leverage. But analysis of the situation leads to the conclusion that this is not the main possible scenario.
What holds for non-financial sectors is true of the financial markets as well. There are many examples of the way in which, when the markets change direction, the sharper and swifter the decline, the sharper and swifter the correction.
In 2002, stock markets and government bond markets plunged by high double-digit percentages, but in 2003 they rose even more powerfully. It was the same with the drop in 2008, which was followed by a sharp upward correction in 2009 and 2010.
The same happened in 2015, when sharp declines in China caused declines in all the stock markets, which corrected upwards within two-three months. In January 2016, world stock markets fell by 15-20%, but corrected all the declines by April that year. The most significant recent example is December 2018, when there were sharp falls that were recovered, and much more than that, in 2019.
Markets in a panic, alarming headlines
Statistically, the chances of losing on stocks in such situations over a period of a year are very low. The markets are in a panic, the headlines are alarming, and rumors throw the markets into sharp fluctuations.
But even in this instance, it's important to look beyond the headlines. The VIX index, known as "the fear index" on US exchanges, is above 40. In the past 30 years, there have been 168 days on which the VIX was above 40 at the close of trading. Only in the case of seven of these 168 days was the S&P 500 stock index lower a year later. In all the other cases, anyone who bought shares when the VIX was above 40 gained an average of 31% after a year.
An important investment rule is that if there are strong statistics, they should be relied upon more than experts.
Already, the gap between the expected return on the S&P 500, calculated according to the companies' projected profits, and the yield on 10-year US Treasury bonds, has grown to one of the widest seen in a decade. The gap between the S&P 500 dividend yield and the 10-year T-bond yield is the widest it has ever been.
In addition, we are already seeing, and we shall continue to see, intensive action by governments all over the world. They are will relax fiscal limits and inject significant amounts to support economic recovery. The governments of Germany, Italy, Hong Kong, New Zealand, and Israel as well, have already announced measures of this kind. All this of course means expanding or creating fiscal deficits.
Treatment not in the hands of central banks
Some sixteen central banks have cut their interest rates since the beginning of the month. In the US and Canada the rate was cut by 0.5%, in Australia by 0.25%, and now the Bank of England has cut its rate by 0.5% to 0.25%, the lowest rate in its history.
The market is pricing in a further rate cut by the Federal Reserve next week of 0.5%, and even possibly 0.75%. Experience in recent years shows that the Federal Reserve does what is expected of it, which means that within a week the interest rate in the US economy can be expected to fall to 0.5-0.75%.
It could be that the Federal Reserve will also announce a return to purchases of government bonds and even of mortgage-backed securities ("quantitative easing"). In Europe, the central bank has limited room for action, and interest rate contracts are pricing in a 0.1% interest rate cut by the European Central Bank on March 12.
Interest rate cuts are, however, not a very effective way of dealing with the kind of event happening now. At any rate, that is what investors in the US appear to think, to judge from their negative reaction to the Federal Reserve's interest rate cut last week. By contrast, the market responded positively to the US House of Representatives' approval of a special budget amounting to $7.8 billion for dealing with the coronavirus. This shows that the US government should promote a broad program of fiscal incentives, rather than pressure the Federal Reserve to cut interest rates further.
It's much easier to cut interest rates than to raise them. It took the Federal Reserve three years to raise its rate to 2.5%, and it is now rapidly using up ammunition it is likely to need in the future, to little advantage.
Israel's advantage - amid panic
The authorities in Israel have implemented measures recommended by the World Health Organization for dealing with the coronavirus, and have even exceeded them in strictness. The entry gates to Israel are known and controlled, which is unlike the situation in Europe and the US. The experience of China and South Korea therefore indicates that the pandemic is likely to be halted in Israel fairly quickly.
From an economic point of view, the Israeli industry liable to suffer the heaviest blow is tourism. Even on the most optimistic scenario, tourists will not return to Israel fast, and Israelis will also take time to be convinced that it's safe to travel abroad.
According to OECD figures, the tourism industry represents about 2.8% of Israeli GDP, and directly employs about 3.6% of the working population, while those employed indirectly raise the proportion to 6%. The tourism industry is of less importance in Israel than the average for the OECD. The countries that will be hardest hit by the fall in global tourism are Austria, France, Greece, Hungary, Italy, Mexico, New Zealand, and Portugal.
If we estimate that incoming tourism in Israel will be down by 80% for three months, the hit to Israeli GDP will be 0.3-0.4%. The tourists who don't come during this period will probably not come afterwards either, so the loss of product will be permanent. If Israelis also fear to go on vacation in Israel during this period, the hit will be double.
As far as the stock market is concerned, there is no reason that Israel should be different from the rest of the world. All in all, the economic situation in Israel is fairly good, and if things calm down globally, the Israeli stock market should also recover rapidly. As usual, when panic reigns, the public jettisons investments hastily. The falls in corporate bond in Israel have been far sharper than in the US or Europe so far. This is the result of mass withdrawals from mutual funds specializing in this instrument. As a result, the extra yield on corporate bonds over government bonds, known as the spread, has risen to levels that in the past decade have generally been regarded as attractive.
On the other hand, Israel government bonds, the prices of which have risen sharply in recent months, look less attractive for investment. The political deadlock and the inability to deal with the problem of the fiscal deficit, the low interest rate, which leaves little room for further cuts, and the low absolute yield on government bonds, do not amount to an especially enticing combination.
It is doubtful whether even in a negative scenario Israeli government bonds will demonstrate characteristics of a safe haven for investors such as US government bonds provide.
To sum up, past experience teaches us that in periods such as the one we are now going through, it's important to exercise judgement, to look at events with a long perspective, and to stick to the facts, not the headlines. These are guidelines that should help in avoiding mistakes that later will only be a source of regret.
Zvi Stepak is a founder and director of investment house Meitav Dash, and Alex Zabezhinsky is the firm's chief economist. This article should not be taken as a recommendation to buy, sell or hold securities, and each reader should obtain professional advice taking into account on his or her particular situation before taking any action affecting their finances.
Published by Globes, Israel business news - en.globes.co.il - on March 11, 2020
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