Are markets overreacting to the coronavirus? Or are they not pricing in the risks of the disease nearly enough?

The virus first emerged in late December in Wuhan, a major commercial metropolis in China of 11 million people. Since then, the Chinese government has moved aggressively to contain the outbreak, while the coronavirus has captured headlines here in the U.S., and spooked the globe.

On Friday, those fears set off a sharp drop in stock markets, with the S&P 500 and the Nasdaq falling 1.77 percent and 1.59 percent respectively — the biggest single-day plunge for the S&P since October. By Monday, those two indexes had regained 1 percent and 1.3 percent, suggesting investors were reassessing their own initial fears. But on the same day, over in China, the widely-followed Shanghai Composite Index spiraled down by 8 percent. That index had already fallen 4.5 percent since the initial outbreak, but trading had been suspended since late January for the Lunar New Year, a major Chinese holiday.

To understand the diverging reactions, and whether either is justified, we need to investigate the nature of the coronavirus, and the potential damage it could do both in China and elsewhere — not to mention just what, exactly, the markets are measuring.

Since the coronavirus first showed up in Wuhan, confirmed infections have jumped to over 17,000 cases across more than 20 countries, including 11 in the United States — though the vast bulk of the infections remain in China. More than 360 people have died, though only one outside of China as of Sunday. Both the World Health Organization and the U.S. government have declared the virus a public health emergency, multiple airlines have shut down travel in and out of China, and the U.S. has barred foreigners who have been to China in the last two weeks from entering the country. (It's quarantining returning Americans.)

Within China, provinces accounting for roughly 69 percent of the country's economic output have extended the Lunar New Year holiday until February 9 in an effort to keep people away from factories and other workplaces. Universities are still closed, and Chinese officials have cut off travel in and out of Wuhan and a number of other cities — effectively quarantining 50 million people.

These last points are really the foundation of the economic worries around the coronavirus outbreak. The freedom to move and associate is crucial to modern commerce. If people can't get out to shop or go to work for fear of spreading infection, then production and consumption slow down, and supply chains seize up. Even if everyone stays home and shops online, it won't do much good if the networks of producers, sellers, and shippers who get the goods to them have major holes in their staffing.

The same point also extends internationally: China is a major source of demand for exports from the rest of the world — its oil purchases have dropped by a fifth since the start of the outbreak, for instance — as well as a massive producer of all sorts of parts and inputs for global supply chains. Not to mention that roughly 150 million Chinese travelers flew internationally in 2018, for either tourism or business reasons. Even if the virus doesn't spread beyond China, a significant and sustained outbreak within the country could be a major drag on economic activity around the world.

Ultimately, the movement of stock markets is about the returns investors expect to get from the companies they hold stock in, and how they manage those perceived risks. There are, of course, plenty of ways returns for investors can be improved that have nothing to do with — or are even damaging to — the underlying economic activity. But in the case of market reactions to diseases, the causal mechanism really is worry over whether the underlying production and trade will continue. China, with its heavily state-run financial system, has pledged a major monetary stimulus to shore up the markets. While that could certainly protect investors wallets for a while, it won't change the coronavirus' impact on what human beings are actually doing — and not doing, to be more precise.

Whether the markets are overreacting or not really depends on how bad the coronavirus is likely to get.

In terms of its deadliness, the coronavirus actually sits in an uncomfortable middle position compared to other diseases. The death rate for infection is about two percent right now, which is far lower than other famous viral outbreaks like SARS (10 percent) and MERS (30 percent or more). On the flip side, the coronavirus spreads much more rapidly and easily than either of those diseases — its transmission is so far more similar to the swine flu, which has a death rate of 0.02 percent.

Indeed, the case against panic rests largely on comparisons to the common flu. It comes around every year, and kills far more people — 60,000 in a bad year. But we've also learned to live with it, and don't really think of the flu as a threat to the economy's ability to function. The SARS outbreak in China back in 2003 also led to a major economic stoppage in the country, and for a bit the stock markets there also saw a dive of nine percent — somewhat in the same vicinity as the coronavirus' hit to the market there now. And while SARS is well-remembered, it's not as if it did significant long-term damage to economic activity or to stock returns.

As for the U.S. specifically, it's worth remembering that our economy is extremely big, multi-layered, and resilient. One Congressional Budget Office projection of a hypothetical flu-like outbreak that kills 100,000 Americans still found the hit to the economy, while bad, likely wouldn't be enough to cause a recession. (A cold-blooded way to characterize 100,000 human beings dying, but this is an economics column.)

Meanwhile, the case for panic rests in the unknowns. We have no idea what will prove more consequential: the coronavirus' relatively low death rate, or the speed and ease with which it jumps from person to person. If the coronavirus really takes off, the difference between a 2 percent death rate and the common flu's 0.01 percent death rate would matter a lot.

We may live more or less comfortably with the flu, but we also have a vaccine for it; not so for the coronavirus. The SARS outbreak in 2003 may not have left any lasting scars, but China is also far larger and more integrated into global economic exchange than it was two decades ago. Western nations have robust and vigorous public health infrastructures to guard against the physical spread of the disease. But there are a lot of ways that an outbreak of similar magnitude to SARS, even if contained to China, could do a lot more damage this time around.

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