The S&P 500 index is having its worst week since 2008 and has entered “correction” territory, defined by a 10% decline from the highs.
Some will argue this is an overreaction. It is not.
The coronavirus threat is still being underestimated — not just to human beings, but to businesses and corporate earnings, and the global economy on the whole.
The Johns Hopkins University Global Cases dashboard is still showing an alarmingly high death rate. If you divide the total number of reported deaths by the total number of confirmed cases, the death rate remains well above 3%.
The good news is, the actual coronavirus death rate is probably nowhere near that high.
The bad news is, the dashboard’s numbers are likely off because huge numbers of cases are going unreported. Within the United States, for example, there could be hundreds of coronavirus cases we don’t know about, or even thousands by now.
Then, too, even if the real death rate is only 1% to 2%, that would still be 10 or 20 times higher than seasonal flu — and roughly 20% of coronavirus sufferers are hospitalized.
The problem goes back to that 80-20 mix, where 80% of cases are so mild that the infected don’t know they are sick. There is also a lack of testing; in much of the U.S., there is no means of being tested at all.
The Economist, a British weekly founded in 1843, is known for its sober data-driven analysis. Here is an excerpt from the latest issue:
Many governments have been signaling that they will stop the disease. Instead, they need to start preparing people for the onslaught. A broad guess is that 25-70% of the population of any epidemic country may be infected…
For the global economy, though, the problem is not the human toll (as deadly serious as that is). It’s the vulnerability of supply chains.
The “Just-In-Time Supply Chain,” known as JIT, is a marvel of modern commerce. The idea is to reduce costs and increase efficiency by operating in an elegant, coordinated dance, with no redundancies and no room for error.
Companies that rely on JIT keep very few components in stock — or none at all — and order new ones almost in real time. For highly complex technology products, like the Apple iPhone for instance, JIT supply chains can stretch across multiple countries and continents.
JIT supply chains are vulnerable to the coronavirus because they are “chains” in a literal sense. The setup is complex and delicate by nature. If a single step in the chain is taken out, it is like removing a link from an actual metal chain — the whole thing comes apart.
For example: If a technology product has to go through nine separate steps, with various components added or modified along the way, and one of the factories in the middle of the process is shut down, the whole process stops. Everything grinds to a halt.
Then, too, under normal circumstances, hiccups in a supply chain can be addressed by shifting production to another factory nearby, or paying overtime to do an emergency shipment.
But if the factory is literally closed, and the workers are quarantined due to asymptomatic infection risk, there is nobody to pay and no plan B. Production just stops. Nor can the mechanics of a complex and delicate supply chain be easily uprooted and set up with new suppliers. A full-on migration can take years.
This is why Microsoft has joined Apple in delivering a guidance warning. Microsoft’s supply chains are going to be hit. This could slow production substantially, if not stop it outright in some places.
We already know, as of late February 2020, that JIT supply chains are under severe strain. The warnings from Microsoft and Apple are canaries in the coal mine in that regard.
If the coronavirus threat worsens — and it almost certainly will — some of these chains could break completely. That would wreak havoc on corporate earnings in ways that could wipe out not just a week’s or month’s or quarter’s worth of profits, but a year’s worth or more.
It would obviously be preferable to say markets are overreacting, that the brutal price action of the past few days is overdone, and that things will get back to normal soon.
But that isn’t what the data is telling us. If the government response turns severe, and various Western countries go into lockdown, the fallout will not just be psychological or fear-based.
Severed supply chains will have a serious impact on earnings outlooks, and chain-dependent businesses with high debt levels and thin margins could face a solvency threat.
