Swine Flu pandemic and impact on world stock markets

Swine Flu pandemic and impact on world stock markets

                                                                             SUNIL KEWALRAMANI

                                                                                     September 12, 2009

The correlation of gamma and ? was used by Wall Street financial engineers to calculate predicted loan "mortality" rates which some believe created the huge trouble in the securitization business (CDO, CLO, CPDO, SIV). It is interesting to note that the entire mathematical theory was lifted from epidemiology, i.e. the study of how communicative viral diseases spread.  Ironically, both securitization and swine flu pandemic are a matter of grave concern to the world today.

The provisional conclusion is that this latest pandemic is “moderate”: less severe than the 1918 Spanish flu, more in line with that of 1957, and perhaps up to four times as dangerous as a typical seasonal flu virus, which each year kills an estimated 500,000 people around the world.

In Mexico, which has had 14,800 cases and 138 deaths, swine flu may knock 0.3-0.5 per cent from GDP this year, according to the United Nations Economic Commission for Latin America and Caribbean.  The Ernst & Young Item Club, a forecaster, warns that swine flu could cost the UK up to 3 per cent of GDP this year and 1.7 per cent next. If everything goes reasonably well, the epidemic will probably knock around half a percentage point from World GDP. If things deteriorate, it could cause a 1.3 to 1.5 per cent drop.

 W.J. McKibbin and A.A. Sidorenko’s 2006 research paper on The Global Macro-Economic Consequences of Pandemic Influenza finds that “even a mild pandemic has significant consequences for global economic output”, costing close to 0.8 % of World GDP. World Bank estimates that the negative impact on GDP in South Asia as a result of the pandemic will be 0.6 %, if the epidemic is mild.

Pandemics compared – from the Spanish Flu to SARS.

The Spanish Flu unfolded in two waves over 1918-1919, killing  around 50 million people worldwide. An estimated 10-17 million died in India alone, contributing to a steep drop in economic activity. According to economic historian Angus Maddison, India’s GDP declined by 12.8 % in 1918.

  The Asian Flu of 1957-1958 also unfolded in 2 waves, killing 1-2 million people world wide. The SARS outbreak was mercifully less severe, lasting only several months and claiming an estimated 774 lives.  As traumatic as SARS was in terms of its human impact, the markets scarcely reacted to it.

The 1918 Spanish influenza pandemic, which killed tens of millions, descended with devastating virulence on a world ravaged by four years of war. The swine flu pandemic of 2009, by comparison, is arriving when the world is largely at peace but when the global economy is most vulnerable and what appears as green shoots could wither at any time.

Impact of SARS on the Asian economies :  Tourism (visitor arrivals) and retail spending growth dipped sharply into negative for 1-2 quarters during the SARS outbreak. The IMF estimated that East and Southeast Asia lost almost USD 18bn in demand and business revenue due to SARS.  At the height of the SARS panic in February 2003, Singapore and Hong Kong reported month/month declines in retail sales of -35% and -27.5% respectively.  In Hong Kong, retail sales in year/year terms did not return to positive growth until August 2003.   In response, Asian governments put together relief packages to prevent and contain the problem as well as to help businesses with cash flow problems. Malaysia, for instance, spent an additional 2% of GDP in May 2003.   Hong Kong and Taiwan spent roughly 1% and 0.5% respectively on similar aid packages.
 
Impact on equity markets

Despite the widespread social and human impact of SARS, there was scarcely detectable impact on the stock market recovery in 2003. Asian ex-Japan equities (using the MSCI Asia Pacific ex-Japan as a proxy) continued on their recovery off the lows of 2003 (please see chart below).  

Exhibit: MSCI Asia Pacific ex-Japan during SARS outbreak

… please find chart on next page …

To be sure, there are significant differences this time around – the global economy is clearly in a weaker state today than in 2003. The markets for risk assets are clearly more vulnerable today than in 2003. There is that crucial unknown – is this outbreak going to develop into a pandemic more severe than SARS in 2003 or resemble the 1918 Spanish Flu ?

I have done a worst-case scenario analysis to determine the impact the swine flu can have on world equity markets, by looking at past precedence.

1918 Spanish Flu and the Market

The 1918 Spanish Flu was a global flu pandemic that affected nearly half of the world's population at the time (or up to one billion people).  The 1918 outbreak was the worst of the 20th century, and it fell under the H1N1 virus subtype, which is the same subtype as the current swine flu outbreak.  It's estimated that the 1918 flu killed anywhere from 20 million to 100 million people, which would have equaled a mortality rate of 2.5%-5% of those infected.

Below is a chart on the 1918 Influenza that highlights deaths per 1,000 people infected with influenza and/or pneumonia, and overlayed is a chart of the Dow Jones Industrial Average.  There were three pandemic waves from 1918-1919, with the worst coming from October to December of 1918.  Following the first pandemic wave, the market sold off a little bit, but then rallied during the summer months before topping out prior to the second wave.  The market trended downward during the worst wave of the flu outbreak, but it only went down 10.9% from peak to trough, and then it rallied significantly during and following the third wave.  World War I was also coming to an end in late 1918, so the end of the pandemic and the war probably contributed to the subsequent rally in stocks.

The correlation between economic recession and a pandemic appears to be quite high. The last economic crisis hit in 2001 with the dot com and telecom bubble burst and that was instantly followed by 9/11 and then the SARS crisis in South East Asia and the Anthrax cases in USA.

As you can see in the chart of the MSCI World Stock Index below, there are similarities between the 2003 SARS epidemic and today’s flu outbreak.

 Source : www.socioeconomics.net

Below is a chart of Asian bird flu outbreaks plotted against the prices of Hong Kong's Hang Seng stock index, a measure of Asia's social mood.  As one can see, bird flu outbreaks have occurred during downturns in the stock market:

Source : Elliott Wave

So, is it a coincidence that the first cases of swine flu in Mexico were reported in early March, when global stock markets were hitting lows they hadn't seen in years or decades?

If swine flu plays out like the SARS outbreak of 2003, the market’s focus is likely to remain on how the world will return into growth trajectory. And if this outbreak appears to be one that can be contained in a few months, the market is going to remain more focused on how Chinese and India growth story can save the world from a deep recession.  Or whether there is an Asian bubble in the making.

Sunil Kewalramani is a Wharton Business School MBA and Chief Investment Officer, Global Money Investor