Key Questions: Should Investors be Concerned About the Coronavirus?
A first-hand account of keeping the long-term in perspective.
In 2002, I was working as an equity analyst tasked with identifying high-quality companies that generated high returns on capital, possessed enduring competitive positions and strong balance sheets, and were led by effective allocators of shareholder capital. My then boss had a predilection for such companies, but he also actively encouraged me to seek out unique opportunities that were not on most investors’ radars. And he was further enamored with identifying long-term secular themes that could create favorable tailwinds.
Under this framework, my quest for compelling ideas led me to evaluate companies levered to the growth of China. At the time, China’s economy was the world’s sixth largest (only slightly larger than Italy’s). It had just been permitted to join the World Trade Organization, validating its role as an emerging economic power, and was seemingly poised for a positive inflection point.
Following extensive due diligence, in late fall 2002, I presented my argument to the firm’s investment committee to invest a portion of our clients’ capital into a rapidly growing e-commerce company located in mainland China. After considerable debate and further analysis concerning the liquidity profile of the stock, we made the investment.
Within a week, news of an unknown virus spilled across every media outlet. Financial markets sold off, but the shares of my recent recommendation were halted — trading was suspended, not for a few mere minutes (as is occasionally the case) but for several agonizing days. When the stock later resumed trading, it immediately collapsed by over 30%. To say that I had a sunken feeling in the pit in my stomach would be a major understatement. I was devastated.
By early 2003, the unknown virus had been given a name: SARS (Severe Acute Respiratory Syndrome). Images of people wearing masks and being quarantined were ubiquitous, and reports were emerging that people had died by contracting the virus. Later that year, the World Health Organization issued travel alerts, economic activity in China sunk, and anxieties throughout the world were running high.
Curiously, however, prior to the anxiety peaking and well before the virus was contained, the stock that I recommended advanced, quickly reaching and then exceeding the price at which we made our purchase. Several years later, the stock had appreciated by many multiples of our original initial purchase price, and the company was well on its way to becoming a major player on the global financial stage.
Last week, it was reported that a new coronavirus that originated in China has spread to the US. Wuhan, the area in which the virus is said to have begun, is a major logistics and transportation hub. Lying about 500 miles west of Shanghai and home to more than 11 million people, Wuhan has been completely quarantined — travel into and out of the city is prohibited.
Elsewhere, travel in other Chinese cities is restricted, Chinese New Year festivities are being canceled, and health screenings are occurring across the globe. As of this writing (Jan. 24), according to the Department of Health of Hong Kong, there are over 900 confirmed cases and at least 26 deaths attributed to this new virus. Sadly, these numbers will almost certainly go up.
While not wanting to appear callous by pondering economic implications while human lives are at stake, how this episode evolves is unknowable. How serious will it be? How long will the outbreak continue? These are questions for epidemiologists, and our guess is that they too don’t know the answers at this point. Accordingly, focusing on what we do know and assessing economic risks is a worthy exercise.
During the SARS epidemic, the mortality rate for those contracting the virus reached 10%. During a 2012 incident known as MERS (Middle East Respiratory Syndrome), the mortality rate reached 34%. The death rate of the current coronavirus (~4%) is far lower. Should this pace be maintained, it would be akin to a seasonal influenza rather than a major epidemic. Economic risks under this scenario are low.
Conversely, if mortality rates appreciably rise and the length of time until the virus is contained grows, economic activity in China and other countries could experience a sharp slowdown. From late 2002 to mid-2003, for instance, Chinese airlines experienced an 80% decline in revenues.
Moreover, this latest outbreak couldn’t have come at a worse time. The Chinese Lunar New Year (typically a boost to economic growth) has just gotten underway. And China’s economy was showing nascent signs of stabilization following two difficult years created by escalating trade tensions between China and the US.
That said, while it felt more severe at the time, the impact during the SARS episode was relatively short-lived.
If past is prologue, any severe drawdowns in equity prices will hopefully be short-lived and mistakes I made in the past won’t recur. What I neglected to say when recounting my first direct investment overseas was one important fact: Immediately after the stock had returned to my initial purchase price, I sold every share that I had previously bought.
No permanent loss was realized, but my clients missed out on an enormous amount of upside had I been more focused on long-term fundamentals and logic rather than short-term momentum and my emotions. Simply put, I had become arbitrarily anchored to the purchase price of the stock initially thinking that the level was the floor, only later to surmise – incorrectly – that it was the ceiling.
With this experience still rooted in my memory, I encourage investors to recognize that, while fear and uncertainty can be powerful forces, maintaining a long-term time horizon has proven to be a far superior strategy for building wealth over time.
For more information, please contact your Key Private Bank Advisor.