Coronavirus: Baylor Finance Expert Explains How Uncertainty is Driving Market Fears
Researcher says global solutions to curb coronavirus (travel restrictions, closings and quarantines) likely driving market uncertainty
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WACO, Texas (March 2, 2020) – The coronavirus health crisis has led to a rare pummeling of global equity markets over the past 10 days.
Much of the recent market drop is sparked by fear and uncertainty, said Baylor University researcher David Dicks, Ph.D., assistant professor of finance in the Hankamer School of Business. Dicks studies economic uncertainty, which he describes as being driven by situations in which investors are unsure of the current challenges of the world – and they react accordingly, often with pessimism.
“The coronavirus has spooked investors,” Dicks said. “When the original reports of coronavirus came out this January, most investors shrugged it off as just the next in a long line of illnesses. Last week, however, investors learned two things. First, the virus was spreading less predictably than we expected, appearing not only in Asia, but also in Europe. Second, governments are taking more aggressive measures to fight coronavirus, like closing schools and quarantining towns.
“Thus, there is large uncertainty over where the virus will appear and what measures will be necessary to save lives. Investors do not know which firms will be affected, leading to a wave of pessimism sweeping across equity markets."
In the following Q&A, Dicks shares his thoughts on why this uncertainty has damaged the markets (which, he said, is a rare outcome during a health crisis), puts the current situation in historic perspective and offers hope to investors.
Q: Is this kind of change in the market common with global health fears? Have we seen this before with H1N1, SARS, etc?
A: No, which is why this is surprising. No other major stock market correction has been associated with a global health fear, and global health fears tend to have little (if any) impact on the markets. In my opinion, investors are afraid, not of the sickness, but of the cure: limited travel, factory closings and quarantines.
Q: Investors have been riding a strong economic wave for a number of years despite other international scares – global conflicts, weather phenomena, governmental changes like Brexit, etc. – so why would something like coronavirus slow the market down so much?
A: The markets expected that the coronavirus was like most other health scares – important for doctors to address, but not harming the global economy. Now we understand that this is likely to have some impact on the global economy, but we do not know who will be affected. This uncertainty led to a wave of pessimism sweeping equity markets.
This is an uncertainty shock, similar to 2008, but likely smaller. When the markets thought they understood how to price mortgage-backed securities, then discovered that they were wrong, they feared that they had mispriced other assets as well, leading to big selloffs. When you see something you do not understand, you start to worry that you misunderstand other things as well.
Q: What does your research tell us about how investors and markets respond to fear and uncertainty?
A: My recent research with Paolo Fulghieri, Ph.D., Macon G. Patton Distinguished Professor of Finance at Kenan-Flagler Business School at the University of North Carolina, focuses on the impact of uncertainty on systemic risk. When investors are worried that they misunderstand the world around them, they treat different asset classes as complements. When they receive bad news about one asset class, they become pessimistic about others as well. Thus, uncertainty causes waves of pessimism to sweep through the economy.
Q: What is your advice to investors during this time? Can they regain confidence?
A: Individual investors do not really need to worry about the coronavirus. I have my standard advice for individual investors: consume less than you make, save, use tax shelters for retirement savings (IRA and 401k), and invest in a diversified portfolio, perhaps an index fund.
Most likely, the market is overreacting, and this is a whole lot of nothing. There is a very small chance that things will be bad enough that we will have worse things to worry about than our stock portfolio. If you are nervous about the impact of coronavirus, do not call your broker. Get a flu shot and be careful about washing your hands.
Financial panics tend to be a good time to buy, so keep with your investment strategy, knowing that you are getting great deals when the market is down.
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