Weekly outlook

Investors on edge as swine flu spreads

By Tom Stevenson, 29 April 2009

Memories of SARS bring market rally to a halt

Just when it seemed the stock market’s animal sprits were stirring again, a black swan arrives in the form of a sick pig. The outbreak of swine flu in Mexico and its rapid spread to a handful of other countries is a reminder to investors of the importance of sentiment in financial markets and of the need always to expect the unexpected. Comparisons are inevitably being made both with the SARS outbreak in Hong Kong in 2003 and pandemics such as the Spanish Flu of 1918-1919 which may have killed 50 million and was, therefore, more deadly than the First World War it followed.

"A lot of what is being said about swine flu is speculation" Tom Stevenson

The usual knee-jerk market responses have seen tourism, travel and retail stocks sold off while pharmaceuticals shares have risen in anticipation of massive demand for anti-viral treatments. Oil and industrial metals have retreated on fears that a pandemic could hit already weakened economies. The dollar benefited from the usual flight to safety.

The first point to make is that a lot of what is being said about the latest outbreak is speculation and there is no certainty that it will turn into a more widespread infection with the kind of profound human and economic costs that are currently making the headlines. The World Health Organisation ranks the outbreak as “phase 4”, serious but two notches away from "phase 6 pandemic"

What we do know is that the number of cases in Mexico is around 2,000, resulting, it is thought, in around 150 deaths. We almost certainly know that the H1N1 strain in question can be transmitted between humans, which makes it different from (and more dangerous) than the H5N1 avian flu strain, which has killed many people in Asia but has not yet mutated into a human to human strain.

Early signs, according to Sir David King, UBS’s chief scientific adviser, are relatively positive on the mortality of this strain – other flus are more deadly and SARS was much more potent, killing around 10% of those infected. We are also much better prepared today than before – the UK, for example, has anti-viral treatments such as Relenza and Tamiflu for around half the population. The timing of the outbreak, at the start of spring in the northern hemisphere, is also helpful as flu does not transmit so well over the summer months.

Markets have been jittery this week, however, because the economic consequences of a flu pandemic could be serious. According to a 2008 World Bank study, even a “mild” pandemic such as the 1968-9 Hong Kong flu could reduce global GDP by 2%. A “serious” pandemic such as the Spanish flu could hit growth by twice as much. With GDP already forecast to fall this year in many countries, the timing could hardly be worse.

According to Credit Suisse, the Hong Kong market underperformed the rest of the world by 15% during the SARS crisis and it predicts that if concerns rose to SARS type levels then markets could fall by 10% to 15%. It believes, however, that this is “very unlikely”.

A key difference between SARS and today’s outbreak is that the earlier crisis was contained in one region whereas swine flu has already shown an ability to travel around the world. The impact on behaviour could therefore be greater. It is too early to tell.

Coming after seven weeks of rising share prices, the latest scare has provided some investors with the excuse to crystallise the profits they have made since the Geithner plan galvanised equities in early March. Whether this proves to be no more than a bump in the road or something more serious remains, like everything else about the swine flu outbreak, a matter for conjecture.

One final observation – the drop in Hong Kong’s GDP in 2003 was dramatic as its hotels emptied and flights were cancelled. But so too, as the chart below shows, was the rebound. It is human nature to focus on the scary numbers but being overly pessimistic can be as dangerous as being too optimistic.