Swine Flu's Economic Impact

For our subscribers to The Index Investor, we have regularly reviewed the asset class valuation and return impact of a “wild card” influenza pandemic scenario, and in particular, a step-function increase in the transmissibility of H5N1 – so called “bird flu.” Given the headlines over the past few days about a new strain of H1N1 influenza that is apparently spreading from Mexico, we have prepared this short background memo for our subscribers. It covers three issues: (1) Background on influenza, and its potential economic impact; (2) Warning Indicators to monitor; and (3) Our estimate of the possible implications of H1N1 Mexican influenza for asset class valuations and returns over the next twelve months.

Background on Influenza

Influenza viruses are classified first by type (A, B, or C); then by subtype, and then by strain. Most influenza viruses, including the most recent Mexican “swine flu” and so called “bird flu” (or, more technically, “Highly Pathogenetic Avian Influenza” or HPAI) are type A influenzas. Viruses are subtyped based two of the eight strands of RNA found on their genome: HA (which affects the production of the glycoprotein hemagluttin) and NA (which affects the production of the glycosylate enzyme neuraminidase). Hence, HPAI is of the subtype H5N1, and the latest Mexican swine flu is of the H1N1 subtype. Currently, 15 HA subtypes and 9 NA subtypes have been identified.

These subtypes are further classified according to their so-called “strain”, which is based on the genetic heritage of the different strands of RNA they contain. In between periodic outbreaks in humans, the world’s population of influenza viruses resides in the intestinal tract of waterfowl, which are usually not affected by them. In contrast, human influenza viruses have a marked preference for the upper respiratory tract. Hence, in order for an avian influenza virus to attain the capability to infect humans, its genome must change, so that it develops a preference for attaching itself to the human upper respiratory tract rather than the intestinal tract of aquatic birds.

There are different theories about how these changes happen. Some treat them as random accidents, produced by the tendency of the influenza virus to replicate itself in great numbers, but with poor fidelity between generations (i.e., to randomly mutate different aspects of its eight RNA strands). Another theory is that the creation of new virus types is facilitated when a host becomes infected with more than one type of influenza virus. Pigs are the prime suspect for this mechanism, because their intestinal tracts are similar to waterfowl (in that influenza viruses that bind to the latter can bind to the former), while the upper respiratory tracts are similar to humans’. Hence the reassortment of influenza RNA in pigs can produce new “swine” viruses with both avian and human characteristics. Yet another theory posits that the evolution of the influenza virus is driven more purposefully, in that variants with higher fitness (i.e., ability to attach to a host, replicate, and be transmitted) are (through some mechanism) selected as different subtypes recombine (e.g., this seems to account for the rapid spread of antiviral resistance through multiple types of flu viruses around the world in the past two years).

Three different terms are critical when it comes to assessing the danger posed by an influenza virus. The first is its transmissibility, or the ease with which it is passed from human to human (abbreviated as H2H), without any common exposure to aquatic or other birds (e.g., chickens have become a reservoir for HPAI) or pigs. The second is referred to as either the virus’s “virulence” or its “pathogenicity.&... Both of these terms refer to the degree of sickness (and, ultimately, the death rate) produced by a given strain of influenza.

Finally, you may hear the term “tissue tropism” in the same context as virulence or pathogenicity. This refers to the specific body organs that are affected by an influenza virus. The typical influenza virus affects the upper respiratory tract. It kills via a number of mechanisms, including aggravation of preexisting respiratory and cardiopulmonary conditions, and weakening a host so as to allow the development of a secondary bacterial pneumonia infection.

Less often, an influenza virus can directly cause a type of viral pneumonia (which, unlike bacterial pneumonia, cannot be treated with antibiotics). This was the main way that the 1918 pandemic influenza (which was also of the H1N1 subtype) killed its victims, via rapid lung inflammation and associated hemorrhaging. What has made many medical professionals particularly fearful of H5N1 has been the evidence of its broad tropism, with apparently severe effects on a range of organs, including the brain, liver, and intestinal tract.

Last (but certainly not least), history has shown that in most cases (1918 being an exception) there is an apparent evolutionary tradeoff between transmissibility and virulence – for example, while easily transmissible, seasonal flu is not particularly deadly; in contrast, while quite virulent, H5N1 has thus far shown (in humans) very weak transmissibility.

Let us now turn to the economic impact of influenza. One thing to keep in mind is that our knowledge of these issues is limited by the weakness of the underlying data we have to work with. For example, records from the 1918 pandemic are quite poor. More surprising is that even more recent data has significant weaknesses. For example, there is an ongoing controversy about the measurement in the United States of “flu related deaths.” The narrower definition is based on influenza and pneumonia related deaths, leading to estimates of on the order of 36,000 annual deaths from seasonal flu in the United States. Yet on its website, the Center for Disease Control also offers a higher annual estimate (51,000) that also includes deaths from other causes (e.g., cardio-pulmonary and other respiratory diseases) that are aggravated by influenza.

One commonly used assumption is that each year in the United States, 15% to 20% of the population is infected with seasonal influenza. Based on a population of 306 million, this amounts to about 61 million infections per year. However, since the strains of seasonal flu in circulation are usually relatively mild, only 1% of infected people (about 610,000) end up being hospitalized. The highest hospitalization rates are typically found among the very young and the very old. Of those who are hospitalized because of influenza, roughly 8% die (which yields 49,000 deaths, or about 0.08% -- i.e., eight one hundredths of one percent -- of those infected, or 0.016% of the overall population).

As noted above, data on the 1918 pandemic are limited. However, available estimates suggest that 675,000 people died in the United States, out of a population of about 103 million, for an overall death rate of about 0.66% of the population. Of those infected, an estimated 2.5% died. To put that into current terms, out of a 2009 population of 306 million, an exact repetition of the Spanish flu would lead to just over 2 million deaths.

However, many things have changed since 1918, and it is therefore highly unlikely that we would see such an exact repetition. Specifically, three factors seem likely to reduce the death rate from any pandemic. First, influenza vaccines exist today. To be sure, the 2008 vaccine does not appear to give any immunity to the latest Mexican swine flu. But vaccine development and production technology is sufficiently advanced that significant dosage volumes could be available about six months after the outbreak of a highly virulent new strain of influenza (there is a caveat here, which is that H5N1 is lethal to chicken eggs, which is a primary production technique for traditional influenza vaccines; however, the latest Mexican H1N1 strain has not been reported to be lethal to eggs).

Second, much more sophisticated modeling methodologies are available to help devise policies (e.g., school closings and travel bans) that can help to limit the spread of a virus until large volumes of vaccine become available (of course, the caveat here is that globalization enables viruses to move around the world much more quickly, as we are seeing with the Mexican case). Third, modern medicine has more treatments at its disposal than were available in 1918, including antivirals (though rising levels of virus resistance to amantadine and Tamiflu have limited the effectiveness of this line of attack), mechanical ventilators, and antibiotics to control secondary infections. So it is unlikely (though not impossible) that we would again see the high death rates associated with the 1918 influenza pandemic.

Warning Indicators to Monitor

Thus far, based on available media reports, the Mexican swine flu does not appear to be highly virulent. The cases outside of Mexico appear to have been mild, with few hospitalizations required and no deaths. However, the data from within Mexico paint a different picture, with more than 143 deaths now reported. Since we don’t have an estimate of underlying infection rates (which are at best very rough, even under ideal conditions), we can’t reach any conclusions about the meaning of this figure. Moreover, we have very little information on the cause of death – though the good news here is that there are no reports of unusual tropisms – apparently, deaths are caused by traditional (for flu) respiratory tract complications (and Mexico City’s high level of pollution and pre-existing respiratory conditions would logically elevate its death rate from these).

That said, we are looking for the following warning signs that this outbreak represents a more serious threat than it now appears to be:

1. Reports that the Mexican swine flu affects other organs – e.g., that it is neurotopic, or that it affects the digestive tract, liver or kidneys.

2. Also with respect to virulence, we are looking for any reports of coinfection (e.g., in swine) with Mexican H5N2 poultry influenza, which was associated with heart, pancreas and kidney tropism. Similarly, we are looking for any reports of Mexican swine H1N1 reaching Indonesia or Egypt, where H5N1 infections in poultry (and possibly other animals) have reached high levels (it is no coincidence that two of the United States premier infectious disease research organizations – Naval Medical Research Units 2 and 3, are, respectively, deployed to Indonesia and Egypt). The analogy we have in mind is 1918, when the initial mild wave of flu infections was soon followed by a subsequent wave of much more serious infections (which could have been caused by reassortment or recombination with more dangerous strains of the influenza virus).

3. Reports that it is associated with viral pneumonia, and cases of severe inflammation (which produce so-called “cytokine storms”, in which inflammation sets off a positive feedback loop, sending the body’ immune system into overdrive, and filling the lungs with white blood cells and other fluids). This may be associated with an unusually high death rate for 19 – 64 year olds, relative to the death rates for younger and older infected patients

4. Reports that the virus is characterized by unusually high replication rates in a host.

5. Rising rates of hospitalizations – above 1 – 2% of infected patients.

6. Reports of more than 10% of those hospitalized with Mexican swine flu dying from the disease.

Economic and Asset Allocation Implications

In recent years, there have been a large number of estimates of the amount of economic damage that could result from a serious global influenza pandemic (see, for example, “Pandemic Economics: The 1918 Influenza and its Modern Day Implications” by Thomas Garrett, or “A Potential Influenza Pandemic: Possible Macroeconomic Effects and Policy Issues” by the U.S. Congressional Budget Office).

All of them agree that the impact on a normally functioning global economy could be quite serious – e.g., a reduction in global GDP of more than 2.5%. However, that is already happening, even in the absence of an influenza pandemic. The real question is whether a pandemic would make things much worse. Our guess is that while it would worsen the situation somewhat in the short term, it might actually help it in medium term. This view rests on the key assumption that a flu pandemic might move the world back towards our cooperative scenario, and off the track towards increased conflict that we seem to be on today.

In terms of asset class valuations, our previous analysis was that the primary impact of an influenza pandemic would be a sharp rise in uncertainty, and an associated increase in demand for appropriate hedges, such as short term government securities and gold. Differential demand for different currencies could be driven by perceptions that one or more areas were coping significantly better or worse with the flu outbreak.

The reduced economic output associated with a flu pandemic would obviously be bad for equities, as well as commodities, assuming that the fall in demand for them would be much greater than any offsetting fall in supply. The impact on commercial property would depend on the severity of the influenza outbreak, with the more severe scenarios associated with lower valuations for commercial property, due to reduced demand.

However, as noted with respect to the economic impact of pandemic flu, these negative asset allocation effects have already occurred due to the financial panic of 2008. So rather than a substantial effect, at this point we estimate that the most likely result of the Mexican swine flu (assuming it doesn’t become much worse) is a damping of the (quite possibly premature) rally in global equity markets, and some further upward pressure on gold and short-term government security prices.

Comments

[kelm:]

An excellent article! As of the reports I read this morning they have apparently identified patient zero who does live near an intensive pork farming complex but tests at the complex so far are all negative.

I will say I am somewhat disappointed with the level of information that is being provided on both the WHO and CDC web sites. One very meager daily update. If you know of any more comprehensive information source please pass it on. So far, BBC.com seems to be the best source.

Apr 29 09:48 AM

[journalrhythm:]

These days there's more articles about it in the news
than people who have actually contracted swine flu
more people gonna die driving in their cars
but that don't make news like new flus or SARS

35,000 deaths occur every flu season
we weren't concerned last year, what's the reason?
i'm not saying that you shouldn't be worried
but worry on the news gets bigger in a hurry

to hear me rap my full opinion, watch:

www.youtube.com/watch?...

Apr 29 11:03 PM