Swine Flu Potential Pandemic

This is a weekly commentary report that was prepared by my firm LPL Financial.

Over the weekend, the U.S. Centers for Disease Control and Prevention (CDC) announced that the Swine Flu that spread from its apparent origin in Mexico to the United States cannot be contained. The World Health Organization (WHO) indicated this new strain of flu has the potential to become a pandemic. The Obama administration has declared a public health emergency. The situation is developing rapidly. Markets may begin to react to this news and the potential shock it may pose to the fragile global economy.

Our base case for 2009 is for growth to return to the U.S. economy by year end and for modest gains in the stock and bond markets. We believe the conditions related to the financial crisis that resulted in the deep recession and bear market, are getting better— as demonstrated by the improvement in the LPL Financial Crisis Conditions Index over much of the past two months. However, the stock market rebound and economic stabilization remain fragile and vulnerable to any shock—a pandemic could be a shock that puts our worst case scenario back on the table.

Previous Flu Epidemics

There have been three influenza pandemics in the past 100 years. From 1918 to 1919, the unsanitary trench warfare conditions of World War I fostered the virus known as the Spanish Flu, which killed 25–50 million people worldwide. The 1957 to 1958 Asian Flu killed one to four million people. The 1967 to 1968 Hong-Kong Flu killed 750,000 to two million worldwide.

WHO uses a series of six phases for a pandemic alert to help inform the world about the seriousness of a pandemic. The alert system has six phases, with Phase 1 having the lowest risk of human cases and Phase 6 representing a global pandemic. [see table below] A pandemic occurs when a new influenza virus subtype emerges, infects humans, causes a serious illness, and spreads easily among humans. Today’s Swine Flu (H1N1) virus does not yet meet all of these conditions. The current alert is a phase three, but may soon be raised to four. Swine Flu has not demonstrated efficient and sustained human-to-human transmission. The concern is that the virus will soon demonstrate or acquire this ability through adaptive mutation as human infections continue.

The Swine Flu has killed over 100 people and infected about 1,600 others in Mexico. Over the weekend, the president of Mexico assumed emergency powers to deal with the crisis and banned all public gatherings. Dr. Margaret Chan, the director-general of the World Health Organization, said the events in Mexico “constitute a public health emergency of international concern.”

How Has The U.S. Been Affected?

In the United States, 20 swine flu cases have been confirmed in states as varied as California, Kansas, Texas and New York. The CDC and the WHO expect to find many more cases as they begin testing for them. If the number of confirmed cases rises sharply across the United States in the coming weeks, markets may weaken.

An influenza pandemic has the potential to exact a great human and financial toll, but is it time to panic? No. Swine Flu has been responsible for the documented infection of 20 people in the U.S. Only one of the 20 U.S. patients has required hospitalization, none had antiviral treatment, and there have been no fatalities. The WHO has not raised the pandemic threat level to four and may not do so.

Remember SARS?

In early 2003, Severe Acute Respiratory Syndrome (SARS) briefly added to the pressures on global stock markets. In 2006, the Avian Flu garnered much attention and had a small measurable effect on the markets. Polls at the time found that one-third to one-half of respondents were at least somewhat concerned about an Avian Flu outbreak in the United States. On June 23, 2006, the World Health Organization confirmed that Avian Flu was spread directly between members of an Indonesian family, the first known case of human-to-human transmission of the lethal virus. However, the threat level was never raised above three since only limited human-to-human transmission had taken place, and concerns soon faded. Despite the concern at the time, the Avian Flu virus did not evolve successfully into an easily human-communicable strain and become a devastating killer. As the flu spread out from the tightly clustered chicken coops of Asia and into wild birds, it may have adapted to a less lethal strain.

How a Flu Is Spread

A successful flu is transmitted in an open environment through a range of hosts that may become ill, die slowly or are not affected at all. Most viruses, once out of a cramped environment of hosts (like the packed chickens in Asia today or the soldiers in the trenches of the western front of World War I in 1918) evolve into a much milder strain. This weakening is what happened to the 1918 H1N1 strain that killed millions of people. Within a year after soldiers left the trenches of the western front, the virus lost its lethal potency and became just an ordinary flu. The wider the virus spreads, the milder it is likely to become.

WHO PANDEMIC INFLUENZA PHASES: SWINE FLU AT PHASE 4

• Phase 1 No viruses circulating among animals have been reported to cause infections in humans.
• Phase 2 Infection in humans from an animal has occurred and is therefore considered a potential pandemic threat.
• Phase 3 Limited human-to-human transmission may occur, but has not sufficient to sustain community-level outbreaks.
• Phase 4 Human-to-human transmission is able to cause “community-level outbreaks” indicating a significant increase in risk of a pandemic, but does not necessarily mean that a pandemic is a foregone conclusion.
• Phase 5 Human-to-human spread of the virus into at least two countries in one WHO region—a strong signals that a pandemic is imminent.
• Phase 6 The global pandemic phase is characterized by community level outbreaks in at least one other country in a different WHO region.

Source: World Health Organization

It is unlikely the Swine Flu will have the opportunity to evolve into an easily human-communicable strain before it turns into a milder version of the flu. While the market may react negatively to headlines about infections in the United States and limited human-to-human transmission, we, like the WHO, have not altered our assessment of the likelihood of a flu pandemic.  We remain committed to our base case outlook for 2009, but are watching events closely that may alter the late year economic forecasts

IMPORTANT DISCLOSURES

• The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
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