The Emergence of a Black Swan

As January appeared to be another month of extraordinary performance for different asset classes around the world, investors were suddenly hit by a black swan: the definition for a rare and unexpected event in the world of finance. This event was related to the Corona-virus epidemic in China. In the space of a week, this infectious disease has expanded from the city of Wuhan to other countries around the world such as Thailand, Japan, South Korea, US, and Germany, intensifying fears that a viral outbreak in China will deliver a setback to the outlook for worldwide economic growth. In this context, it would be relevant to analyze what could be the potential financial and economic impact of this black swan event, based on past epidemic or pandemic events. 

A pandemic is defined as an epidemic occurring over an extensive area, including different countries, and usually affecting a large number of people. Since 1900, three pandemics (1918, 1957, and 1968) and several “pandemic threats” have taken place. The most significant pandemic was the Spanish influenza in 1918. According to calculations of that time, it was estimated that over 20 million people died, and between 20% to 40% of the worldwide population became ill. US suffered around 500 thousand deaths from flu and the S&P 500 index fell by 24.7% during 1918. 

In 1957 the East Asian flu pandemic was first reported in Singapore. The estimated number of deaths was 1.1 million worldwide and 116 thousand in US, while the US GDP fell -0.7% in 1958. However, the performance of financial markets was not as harmful as the previous pandemic episode. Thus, the S&P 500 rose 24% in 1957, while the UK equity market fell 5.8%. The pandemic of 1968 was first detected in Hong Kong and caused around 1 million deaths worldwide in that time, while the US GDP grew 4.9%. Similarly, the S&P index rose 12.5%, while the UK equity index rose 5.8%. According to recent literature, the expected annual losses from pandemic risk would be between US$60 Bn. per year (Commission on a Global Health Risk Framework, 2016) and US$500 Bn. per year (Fan et al.,2017). 

One of the most critical “pandemic threats” was the SARS (Severe Acute Respiratory Syndrome) virus, which spread across South East Asia and Canada during 2002 and was recognized as pandemic one year later in Vietnam. After Chinese authorities reported the outbreak of SARS to the World Health Organization (WHO) in 2003, the MSCI China index decoupled from its global peers. The SARS epidemic of 2003 is the most similar to what the world confronts now with the coronavirus. According to a report made by the International Air Transport Association (IATA), the world GDP suffered a 0.1% hit due to the SARS outbreak. 

This adverse context during 2002-2003 benefited pharmaceutical stocks while tourism and travel-related stocks, airlines, luxury, and consumer goods suffered severe losses. This pattern is similar to what investors have seen in markets in the last two weeks. Thus, Chinese drugmakers and facemask manufacturers were among those industries with higher performance in the equity market.

How long can this outbreak last?  If we look at the most recent experience, the outbreak of MERS (Middle East Respiratory Syndrome) in South Korea in 2015 began to come under control after three weeks, with the last death occurring a little more than a month later. However, it is essential to mention that coronavirus has become an epidemic more quickly than SARS did and has already found its way to countries as dispersed as US, Germany, Canada, and Australia.

In terms of economic and financial impact, no early recovery signals are coming from financial markets in Asia (see graph below). Moreover, this event is happening at the beginning of the Lunar New Year, which will make things even more difficult for the Chinese authorities to contain the virus. Furthermore, the Chinese government has recently decided to extend the holiday, which means fewer working days. Hence, it should not be a surprise if, in the following months, the economic activity numbers in China show a significant decline, and the yuan depreciates again as well. To offset this effect, financial regulators in China have prepared an emergency package (US$ 173 Bn.) to inject liquidity and provide support to companies and markets.



Even tough 2019 represented a year of a significant advance in terms of vaccines, it seems that it has not been enough. Early last year, the European Medicines Agency and the US Food and Drug Administration approved Ervebo, the first Ebola vaccine. Also, last year, doctors in the US used gene therapy to cure children afflicted with severe immunodeficiency. In contrast, this year started with a mysterious outbreak in Wuhan, China, involving individuals who have contracted a novel coronavirus. The coming weeks or perhaps months will be key to answer relevant questions like how the virus is acquired or if this black swan will have far-reaching economic and financial repercussions.

Gino Beteta