Coronavirus: crisis of confidence

As I write this post, the so-called “coronavirus” provides a rather depressing illustration of the fragility of many things, not least the hopes for rational long-term investing. While every day provides additional speculation on the financial impact, here are a few snippets from the past couple of weeks.

  • (Thomson Reuters) (Finance Minister Bill) Morneau told a business audience in Calgary that prices for crude – one of Canada’s major exports – had dipped by 15 per cent since the outbreak started in the Chinese city of Wuhan…
  • “The virus is undoubtedly going to have an economic impact … we know the impact is real and it’s going to be felt across the country,” Morneau said in comments that were web cast.
    He cited “impacts on tourism, impacts on the oil sector and of course impacts on the supply chain” of any business that was integrated with Chinese producers or consumers.
  • (Canadian Press) Air Canada has seen its stock fall about 12 per cent in the past week. The Montreal based carrier offers direct flights to Beijing and Shanghai from Canada’s three biggest cities, as well as to the airport at Wuhan — the epicentre of the virus — through a partner…
  • All sorts of sectors, such as retail, insurance, mining and manufacturing, are bracing for impact. Companies including Canada Goose Holdings Inc., Sun Life Financial, Teck Resources Ltd., and Magna International Inc. — which has nearly 19,000 employees at factories and offices in China — put employees’ travel plans on hold or instructed staff to work from home. All except Sun Life saw their stock fall between five and 15 per cent since Jan. 20, when authorities confirmed human-to-human transmission of the virus.

My intention here isn’t at all to discount the individual cases of loss and anxiety caused by the virus, but rather to wonder what this says about the stock market’s supposed all-seeing rationality. At least as I write, there’s little or no indication at present that any major company’s customer base is likely to permanently shrink by 5% or 15% or whatever as a result of this. The main challenge, it seems, is to certainty and confidence. As one recent commentator put it:

  • The way the coronavirus epidemic is playing out might have lessons not just for China’s government but perhaps for the United States as well. Once trust in the government and a free press are eroded by the government’s desire to manipulate information, the costs can be great — especially in difficult times, when that trust becomes crucial for maintaining confidence and stability.

Trust, confidence, perceived stability – vital attributes, certainly, but not the same thing as rational assessment and pricing of risk. If a double-digit percentage of a major company’s market value can be so easily lost based on fluctuations in those factors, then presumably that portion always represented a degree of irrational aggressiveness in the valuation multiple. Contrast this with climate change, which appears to be steadily gaining visibility as a reference point in long-term investing, but doesn’t generally seem to affect current valuations in the same way (not so far anyway). It’s not news, of course, that our failure to grapple with the big issues is intertwined with our excessive, somewhat self-gratifying preoccupation with more easily-articulated, paranoia-narrative-friendly smaller ones.

Anyway, such events can make it tough to keep faith in the concept of informed long-term investing based in part on careful analysis of financial reporting. What’s the point of trying, you might ask, if the carefully assessed asset allocation decision you make today can be dramatically undermined by next week’s colourful crisis of confidence? Perhaps financial statement users are among the world’s great optimists…

For now at least, partly through an accident of the calendar, a recent PWC bulletin emphasizes that financial statements will be mostly immune to infection in the immediate future. It reminds us: “the situation at December 31, 2019 was that a limited number of cases of an unknown virus had been reported to the World Health Organization. There was no explicit evidence of human-to-human transmission at that date.” In most cases then, the impact of the virus belongs to 2020 and wouldn’t be reflected in measuring assets and liabilities as at the end of 2019. The bulletin observes though: “events after the reporting date sometimes provide additional information about the uncertainties that existed at the reporting date. Judgement might be required in some situations – for example, the bankruptcy of a customer subsequent to the reporting date might reflect existing issues beyond the spread of the coronavirus.” PWC also observes that events after the reporting date might have an impact on the application of the going concern assumption, and that “entities should consider disclosing the impact of developments after the reporting date on the carrying amount of assets and liabilities (for example, the need to impair assets or remeasure fair values), or the impact on revenue or on borrowing covenants.”

To us accountants, this all makes perfect sense. But unfortunately, for those already inclined to regard formal financial reporting as being largely irrelevant, it may only add to the body of evidence. If you’re flailing around in the trust and confidence crisis of February 2020, you’re not likely to be comforted by a reminder of how relatively better things looked two months ago. This isn’t the fault of IFRS of course. Actually, our problems seldom are…

The opinions expressed are solely those of the author

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