Manning School’s Hieu Phan Says Businesses Unprepared for ‘Challenge of This Scale’
Image by Ed Brennen
03/05/2020
By Ed Brennen
The stock ticker hanging in the Pulichino Tong Business Center atrium has been a blur of uncertainty in recent weeks, as fears of the coronavirus outbreak have sent global financial markets into a tailspin.
In the last week of February, as coronavirus cases began appearing in the United States, the Dow Jones industrial average plunged 12 percent, its worst week since the 2008 financial crisis. The Standard & Poor’s 500 stock index and the Nasdaq composite index also suffered double-digit losses in a week that saw trillions of dollars in value erased from global markets.
Volatility has ensued since then, with the Federal Reserve delivering its first emergency interest rate cut since 2008 and investors responding favorably to Joe Biden’s surge in the Democratic primary race.
As government and health officials struggle to keep the coronavirus from becoming a global pandemic, businesses are dealing with unprecedented disruptions to their supply chains and international travel plans. Nervous investors, meanwhile, are trying to figure out what will happen next.
Hieu Phan, an associate professor of finance in the Manning School of Business whose research interests include financial risk management, recently shared his insights on what to make of the market volatility – and what it could mean for the future of the globalized economy.
Q: Why are the financial markets reacting so sharply to the coronavirus?
A: Investors are concerned about the disruptions in the supply chains due to the outbreak of coronavirus that negatively affects businesses’ operation, directly hitting their cash flows while increasing future cash flow volatility. In addition, investors may feel uneasy with the mixed messages of the government and health care officials about the threat of coronavirus, the seemingly initial underestimation of the seriousness of the problem, and its readiness to deal with the coronavirus spread.
Q: How does this market volatility compare to reactions to other recent pandemic scares like the Ebola virus, H5N1, MERS and SARS?
A: Market reaction appears to be stronger this time, which could be due to several factors including the quick spread of the coronavirus and its fatality rate, increasing global integration of trade and U.S. businesses’ dependence on Chinese supplies.
Q: Was the stock market due for a correction anyway?
A: The stock market had been on the rise since the global recession, and it was at its peak just before the outbreak of the virus in the U.S. American businesses’ fundamentals are strong; thus, a correction is unlikely at this point. However, if the coronavirus spread cannot be contained within a short period of time, it will have a devastating effect on the economy and accelerate stock market correction.
Q: If the coronavirus continues to spread as expected here in the U.S., how will markets react?
A: Investors will incorporate new information about the virus spread and its possible effects on business operations into the stock prices. A large spread of the virus with more fatalities that disrupts business operations, reduces consumer demand and increases uncertainty that heightens business and consumer risk aversion would lead to more negative market reaction.
Q: What kind of steps can be taken by central banks to soothe tumultuous markets? Should they?
A: Faced with uncertainty, businesses typically adopt the wait-and-see approach by delaying investments and hiring while increasing cash reserves. Central banks can alleviate such risk aversion by lowering interest rates, which decreases the cost of capital and stimulates demand and investment. However, the current interest rates in the U.S. are already low and lowering them further will have limited effects. For some other countries that have extremely low or even negative real interest rates, like some countries in Europe, lowering the interest rates may have no effect. From the business and investor perspective, containing the coronavirus spread is particularly important.
Q: Companies have so much to consider with this pandemic – supply chains, employee travel, workplace health, consumer fear. Are businesses prepared for this kind of challenge?
A: Businesses are not prepared for a challenge of this scale. Lean manufacturing and the integration of global supply chains have lowered the need for companies to keep large inventory to cut costs. The disruption of supply from China and low inventory maintenance are forcing companies that rely solely or mostly on Chinese supplies to halt production. Obviously, both their sales and profits will be hit hard. As an example, Apple Inc. recently warned that it could not meet its revenue projection for this quarter due to the coronavirus outbreak. Following this warning, Apple has lost $100 billion in its market value. Car manufacturers like Volkswagen and Fiat Chrysler Automobiles NV have suspended operations at some facilities. Given the more frequent outbreaks of viruses in recent years, companies should include pandemic risk in their overall risk management strategies.