The ghost of 2008 is back

Coronavirus: Market reaction is heavily exaggerated

By Andró Griessel

14 Mar 2020

Just in case you were in a coma recently or in the Kalahari without signal, I would like to share the following with you: Since 19 February, the Coronavirus, which causes the disease COVID-19, consumed the imagination of the media and financial markets.

See the table below illustrating the declines of the world’s main bursaries (all in US dollar) from 19 February to the writing of this article (11 March 2020).

All these markets (except for China and Hong Kong) have flipped from showing relatively decent 12-month returns to technically being in a “bear market” (in other words a decrease of more than 20%) in less than one month.

It leaves you breathless and many questions are currently being asked around where it can/will end and what an investor should do in light of this?

I’m not a virologist, so I do not want to comment on the death- or infection rate, nor the possibility of a vaccine being developed and the timeframe thereof.

I do however want to give some perspective on the drastic price movements and why I believe this will, like previous events where the markets were sold off internationally, bounce back afterwards.

Data as at 11 March 2020:

• Confirmed cases = 124 663 (0,002% of the total world population)
• Total deaths = 4 595 (3,69% of the number of infections; 0,00006% of the total world population)
• Average number of COVID-19 deaths = 55 per day
• Average number of tuberculosis deaths = 3 014 per day
• Average number of deaths due to tuberculosis, hepatitis B, pneumonia, HIV and malaria = 9 772 per day

Allow me to share a few thoughts:

• There is no doubt about the fact that the Coronavirus has already had a significant impact on some industries. More specifically, the hospitality and tourism industries have been severely affected.

Nonetheless, it is important to understand that it is as a result of a reaction to (a) news flow and (b) steps taken in order to avoid the spread of the disease (steps such as the cancellation of congresses, sport gatherings, travel plans, etc.) and not as a result of current infection- or death rates.

• There are a few ways to determine the realistic value of a company. One of the most common methods is the so-called discounted cashflow model.

It involves the projection of future cashflows/profits under normal circumstances, given what you currently know about the company, and then discounting these cashflows by a given discount rate.

The sum of all the discounted cashflows will give you an estimated present value. When doing this exercise, the exclusion of one year’s profits from your calculations will not significantly change the “value” of the company.

If we then continue to follow this logic and assume that the Coronavirus will eradicate an otherwise profitable company’s profits for one whole year (or even longer), it still does not justify a permanent reduction of 20% of the value of the company.

• There will be companies that fold due to the Coronavirus and more specifically the measures taken to contain infections.

This will typically be companies that have a lot of debt on their balance sheets and/or little to zero cash reserves. There will also be companies that take advantage of the situation and will make more profits than ever before.

It is however apparent from the above-mentioned declines (with the exception of the Chinese stock exchange) that companies are currently being sold at major discounts, irrespective of their business model or geography and that the assumption is being made that their future profits will be permanently limited.

This is just not logical.

I believe the current declines are over-exaggerated, but that it is very possible (especially given the current state of panic) that stocks can decline even further from current levels.

I don’t think anyone has an idea of where the infection-rate will ultimately max out, but I believe that before a permanent worldwide decline in the value of companies will realise, a major obliteration of the world population is needed.

Even if the number of infections increases to 10 million people (from the current 125 000), the total deaths will be limited to roughly 0.005% of the world population (if the current death rate stays constant).

Furthermore, I still struggle to justify the declines if I consider the fact that the majority of the 0.005% are economically inactive people.

In my opinion, if you have a ten-year investment horizon, you ought to do nothing. The fact that the market is giving you 20% less than a month ago does not mean that you are obligated to accept the offer.

On the contrary, some resilient investors use the current environment to increase their exposure to good quality companies that are on “sale”.

Andró Griessel is a certified financial planner and managing director of ProVérte Wealth & Risk Management. Contact him at info@temp.sg-build.co.za

Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth & Risk Management is an authorised financial service provider with FSP no. 5966.