The ‘Black Swan’ is a popular concept in investment circles – an unpredictable event with the potential for severe consequences (in this case, losing money).

The 2020 coronavirus outbreak in China meets at least some of the Black Swan criteria (particularly for energy markets). Certainly no one saw it coming, and no one can predict where it will go.

But while global health experts and Chinese authorities scramble desperately to prevent further loss of life, investors are yet to adopt the same sense of urgency.

In fact, since the outbreak first started making headlines in mid-January, the response from global markets has been notably benign.

The biggest shock so far took place on January 31 (a Friday), when investors assessed the relative uncertainty and erred on the side of “risk-off”. US stocks fell by almost 2 per cent, a selloff which briefly reverberated across global markets.

However, that concern was short-lived as the S&P500 returned to positive territory the following week and posted four straight days of gains.

China’s benchmark Shanghai Composite index plunged by 7.7 per cent when markets reopened on February 3, before posting a seven-day winning streak (which came to an end yesterday).

It’s been a different story in oil markets, where prices have now fallen for five straight weeks amid a rapid slump in Chinese demand.

But despite the uncertainty, analysts in the investment community have often leaned towards a more optimistic view.

The global economics teams at Goldman Sachs maintains a base-case forecast that the number of new reported cases will fall sharply by the end of the March quarter.

And data points which indicated a slowing rate of growth in new cases were cited as one of the catalysts for another round of gains in US stocks last week

However, when it comes to forecasts, one defining aspect of the outbreak so far is that collating reliable data is an almost impossible task.

 

Australia impact

That fact was made starkly evident yesterday, when China’s Hubei Health Commission — which oversees the region at the epicentre of the crisis — announced it had revised its method for diagnosing new cases.

As a result, the number of new cases surged by almost 15,000 overnight, while reported deaths rose to a new daily high. Clearly, containment isn’t on the cards in China just yet.

However, investors still weren’t fazed — the ASX200 posted its third straight day of gains to close 0.21 per cent higher.

For their part, the domestic economics team at UBS doesn’t expect the broader Australian economy to skate through the corona-fallout unscathed.

The analysts noted that Australia’s domestic exports to China totalled $175bn in 2019, compared to just $11bn at the time of the 2003 SARS outbreak.

They also cited research from UBS’ China team, which forecasts a 30 per cent decline in Chinese tourists visiting Australia.

The resulting slump in services exports will further weigh on Australia’s anaemic GDP growth, which UBS expects will now turn negative in the March quarter.

“Overall, we downgrade our Q1 GDP forecast (again) to -0.1 per cent quarter-on-quarter and 1.5 per cent year-on-year — the weakest since the GFC,” UBS said.

“Given the impact of coronavirus is worse than SARS, we still have downside risk and Q1 could be up to -0.5 per cent quarter-on-quarter.”

The net result will see Australian economic growth rise at just 1.9 per cent in 2020 — far below the RBA’s current forecast of 2.7 per cent.

In response to a slowing economy, the analysts expect at least one more rate cut from the RBA this year (most likely April), which would bring the official cash rate to a new all-time low of 0.5 per cent.

 

Managing risk

That’s important for stock investors, because expectations of lower rates typically extends the bullish outlook for stock prices.

But given that clear communication around rate settings is a primary focus of central banks, predicting their future path is a lot simpler than a viral influenza outbreak with increasingly unreliable data.

So, how should investors make decisions around a health-based catalyst with potentially negative consequences that are impossible to predict?

To get an idea of how a professional frames the problem, Stockhead spoke to Craig Scheef, managing director at Technical Investing.

He noted that while coronavirus has proven to be more contagious than its predecessor SARS, the market probably still has a tendency to look at historical examples (eg SARS) which were ultimately contained.

“I think as long as the prevailing view is that there’s an end-point to the scenario, it lessens the negative impact,” he said.

“But it’s true we don’t know how big it’s going to get, that’s obviously the big question and it is interesting that markets aren’t pricing in a negative side at this point,” he said.

Scheef added that as part of its broader view of the market, the team at Technical Investing had adopted a more cautious view in general to start the year.

“We think the market’s at a level at the moment where it probably has been a bit overbought, and sentiment has been a bit extreme on the upside,” he said.

“So in view of that, we’ve actually added some downside coverage — short positions as well as some put options — because we think markets were probably due for a pullback of around 5 per cent or so anyway.”

He noted efforts last week from China’s central bank to boost the economy, with a $US60bn ($89.2bn) special funding facility for eligible lenders.

And given that central banks globally are still providing plenty of liquidity to the financial system, Scheef said there’s a possibility the virus outbreak could have the effect of extending the framework underpinning the current economic cycle.

But until evidence changes to the contrary, he doesn’t expect the virus to be the long-awaited catalyst that leads to an “ongoing economic problem”.

“We’re not changing our long-term positions — we’ve still got those in place. But we’ve taken steps to just overlay that with a bit of risk management,” Scheef said.

For now, the outbreak continues to take a grim health toll on those Chinese citizens at the centre of the crisis. By the middle of this week more than 1,100 deaths had been reported, with another 1,400 patients declared critically ill.