How will the market contend with a major unknown?
BY GREG OLIVER
What is the Ebola virus doing to stocks? That depends on who you ask. While the threat of another European recession, rapidly falling oil prices and the oncoming end of QE3 all had a hand in the selloff that intensified this week, the Ebola virus – a great unknown – sent a definite shudder through Wall Street.
As respected economist and market analyst Ed Yardeni commented last week in a note, “The stock market is now driven by emotion rather than fundamentals. The former rapidly switches from greed to fear on Ebola news.” According to CNBC’s Jim Cramer, stopping Ebola is top-of-mind on Wall Street, with recent headlines suggesting that “we do not know what we are doing as a nation. The fear is so palpable that we have to expect a SARS-like cutback in travel.”1,2
There is no precise way to measure the impact of Ebola fears on the S&P 500, but industry groups have certainly felt it. Shares of some of the major airlines and cruise lines have fallen as much as 20% within the past month. Major hotel stocks have taken a pronounced turn south as well. Shares of biotech companies linked to potential Ebola cures and firms that make Hazmat suits have recently doubled and tripled in value. The CBOE VIX, the so-called “fear index”, is up about 90% in the past month.1
A global health problem implies a global economic problem. The S&P is down about 8% at this writing from its last record close, and the market’s potential to rally suffers when you have an X factor that seems unquantifiable breeding bearish sentiment.1
Last month, global investors largely perceived Ebola as a West African health crisis, but that perception has changed. Stopping the pandemic before it gains ground in America is vital not only to our health, but also to our economy. If dozens or hundreds of Ebola cases were suddenly diagnosed in the U.S., you would see significant changes in consumer behaviors – and that could really dent corporate earnings.
As Cumberland Advisors CIO David Kotok put it in an October 10 note to investors: “Economic consequences [result] when fear and concern change behavior. If consumers and businesses retrench by reducing flights on airplanes, changing vacation plans, or altering business connections in a globally interdependent world, GDP growth rates will fall farther. We do not know how much, at what speed, or for how long.”3
The World Bank recently ventured a couple of guesses. In its worst-case scenario, the world sees 200,000 cases of Ebola by the end of 2015 and $32.6 billion drains out of the global economy. In the best-case scenario, the pandemic is almost wholly contained within Guinea, Liberia, and Sierra Leone with a short-term cost of $359 million to the global economy.4
Can stocks bounce back soon? Pessimists see a correction in progress, caused by Ebola fears, worries about Europe and the Middle East and a collective admission that the market is way ahead of the economy. Optimists see a buying opportunity – a turbulent moment that will pass with the federal government ultimately containing the virus, the eurozone and Japanese economies buoyed by stimulus efforts and earnings surprising to the upside.5
The health of the bull market may not depend entirely on keeping the Ebola pandemic in check, but it is undeniably important to its sustenance.