By Dr. Mike Walden
The world has been shocked by the coronavirus outbreak. One part of the economy clearly impacted has been the stock market. The stock market is now in – what experts term – a “bear market,” meaning losses from the last high now exceed 20 percent. However, some predict that once the virus is controlled, the market could rebound just as quickly.
The stock market’s reaction to the coronavirus presents an opportunity to address how and why the stock market changes. I don’t mean offering tips on buying and selling stocks to make money. Instead, my goal in this column is to explain what influences the stock market, thereby allowing you to understand – but not necessarily predict – its ups and downs.
At the core of any stock’s value is the “earnings per share” of the company issuing the stock. Earnings per share is simply the company’s total profits divided by the number of shares of stock issued by the company. The higher the earnings per share, the more profitable is owning the stock. Hence, as earnings per share rise, the stock’s value should rise. In contrast, if earnings per share fall, the stock’s value should fall.
So – you might say – if I just buy stocks whose earnings per share has been rising, then I’ll make money. Unfortunately, that’s not necessarily the case. Past performance of a company is already incorporated – some say “baked in” – to current stock values. Buyers of stocks look to the future for information about how a stock and the stock’s company will perform. In other words, the stock market is future-oriented.
Understanding this looking-ahead view of stock investors lets us see why the market responded so negatively to the coronavirus. First, the virus appeared out of nowhere. I don’t know of anyone who predicted it. If there was someone, their prediction wasn’t publicized. The coronavirus wasn’t on investors’ radar screens.
Second, viruses are scary things. Each is different and requires its own vaccine. Vaccines take months to develop. In the meantime, the virus can spread, induce illnesses and deaths and cause economies in widely infected countries to almost shut down.
Yet contagious viruses periodically pop up, and those in the past haven’t seemed to affect investors and the stock market so dramatically. So, what is different today?
In a word, the answer is “globalization”. Today, we are a more interconnected world in terms of both trade and travel. China – where the coronavirus was first detected – is considered the world’s manufacturing superpower. Over 28 percent of global manufactured output comes from China, almost twice as in the second-place country, the U.S. This means there’s tremendous worldwide contact with China. Also, Chinese tourists now exceed tourists from any other country in worldwide travel.
Therefore, the essential reason why the stock market took a plunge after the outbreak of the coronavirus is that the virus put a big question mark over the future earnings per share of many companies. Clearly, US companies that trade with China or other countries with major virus outbreaks can be impacted. Shortages of products from China have already occurred, so US companies using or selling Chinese- made products have been affected.
US and North Carolina farmers were expecting increased sales to China as a result of the Phase 1 US-China trade deal signed in December. There’s a good chance those sales will be postponed. Travel and tourist companies will also take financial hits.
But even companies with no direct ties to international trade can be hurt by the stock market pullback. Investors who have lost money in the stock market now have less wealth. Studies show declines in wealth can translate into declines in spending on many products and services, even those not tied to China or other countries with numerous coronavirus infections.
My point is the stock market is forward-looking, always trying to find clues about what the economic future holds. The coronavirus has put a big cloud over that future. Yet it’s that same forward-looking that could generate a big stock market rebound.
How so, you ask? Prior to the coronavirus outbreak, most forecasters were optimistic about the economy. Production was rising, jobs were being added and wages and incomes were improving. There were no apparent imbalances in the economy that could trigger a recession.
This means that if the news on the coronavirus goes from bad to good, then the pessimism on Wall Street could quickly turn to optimism. “Good” news about the virus could be many things – such as a reduction in new cases and deaths, the impending development of a vaccine or an evaluation that the symptoms of the virus are not as bad as originally thought.
Such good news would begin to remove the gloom hovering over the economic future and make it clearer for investors to see a positive path. It certainly wouldn’t erase the losses already incurred from the virus, and it may not eliminate all the losses to come. But just for investors to see the future as “less bad” than it could have been would lead to optimism and overall gains, rather than continued losses, in the stock market.
Investing in the stock market can be both rewarding and challenging. A big reason is because stock values today depend on guesses about the future economy, and everything that affects the economy. This is why some people stay out of the market, while others stay in regardless of its ups and downs. You decide which approach is best for you!
Walden is a William Neal Reynolds Distinguished Professor in the Department of Agricultural and Resource Economics at North Carolina State University who teaches and writes on personal finance, economic outlook, and public policy.
Last week’s article updated:
You Decide: Could a Virus Take Down the Economy?
By Dr. Mike Walden
I’ve recently been asked a new question about the economy when I speak to groups and organizations. It’s a question I haven’t heard in many years. The question is whether the coronavirus that has hit the world – including the U.S. – could send us into a recession, or worse.
The worry is understandable. Viruses are scary things. I’ve read my share of medical thrillers based on some new virus spreading throughout the globe, killing millions, destroying businesses and almost ending civilization until heroes contain it at the last minute.
We only have to look back one hundred years to find a real example of what an unchecked virus can do. The 1918-1920 influenza pandemic, also known as the Spanish flu, killed at least 50 million people worldwide, with some estimates putting the number as high as 100 million. In the U.S., almost one of every three people became infected, and 500,000 died. Even for those who survived there were numerous cases of long-term physical disability.
To date (mid-March) the infection and death rates of the coronavirus are far below those of the Spanish flu. Still, cases and deaths are rising and medical experts are unsure of how far the virus will spread.
There has been some modest good news recently. Reports indicate the virus has been contained in Asian countries. Also, more widespread distribution of testing kits is planned in our country, thereby giving us greater ability to measure the pervasiveness of the virus and to assist those who are infected.
Yet even if the infection and death rates turn out to be relatively low, there still can be economic impacts. These economic impacts come in four forms: impacts from the reduced availability of products from other countries – importantly China, impacts from reduced sales to foreign countries, impacts from changes in consumer spending based on fears about the virus and impacts on stocks. Let me evaluate each.
The U.S. imports over $500 billion of products each year from China. The products range from cell phones and other technology, to clothing and furniture, to machinery parts. Sick people in China can’t work, and closing off parts of the country from other areas also curtails production. The reduced availability of Chinese products could slow some segments of the U.S. economy, with the computer and electronics industries being the most vulnerable.
On the flip side, U.S. firms sell over $100 billion of products to China annually, with the most important being technology products and farm commodities. These sectors have already taken a hit from the tariffs imposed by China during the U.S.-China “trade war” of the last two years. Ironically, the recent thaw in this trade war has created optimism for U.S. factories and farms that increased sales to China are around the corner. Now that corner may take longer to reach if Chinese purchases of foreign products take a dip as a result of the coronavirus.
Consumer spending drives the economy. Significant declines in consumer spending are usually the most direct cause of a recession. Consumers reduce spending if their incomes fall, for example, as a result of higher unemployment. Consumers can also reduce spending simply as a result of fear. If there are widespread worries that something very bad has a high chance of happening, that’s enough for consumers to cut back on spending, which then can trigger a recession.
We saw this happen with the SARS (severe acute respiratory syndrome) virus in 2003. Consumer confidence about the future dipped, and so did consumer spending, especially on durable products like appliances, vehicles and furniture. However, the spending dip was short-lived, and no recession resulted.
Although coronavirus related deaths already exceed SARS deaths, consumer confidence has not yet been affected. However, we don’t yet have confidence measures for March. Many experts fear it will take a plunge. More pessimism, combined with the effects of business slowdowns already happening, could cause consumer spending to fall in coming weeks.
Last is the potential impact of the virus on the stock market. One thing the stock market absolutely does not like is uncertainty. Until we have a good idea of how much the virus will spread and whether containment efforts will be successful, the market will be wobbly. We’ve already seen the market fall into “bear” territory, meaning average stock value declines of over 20%.
My assessment is the economic damage from reduced international trade, subdued consumer spending, and stock market losses related to the coronavirus should be enough to cause economic growth to slow – and possibly contract – in the first half of 2020. Whether the contraction is severe enough to be labelled a recession is yet to be seen.
Yet the good news is that the economy was in good shape before the virus hit. This suggests that once the virus passes, there should be a significant rebound in both the general economy and the stock market.
Unfortunately, we don’t yet have a playbook telling us the path and timing of this virus. This makes it exceedingly difficult for experts – as well as you and me – to decide what the future holds, including the future of the economy.
Walden is a William Neal Reynolds Distinguished Professor in the Department of Agricultural and Resource Economics at North Carolina State University who teaches and writes on personal finance, economic outlook and public policy.
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