By MICHAEL R. SESIT (The Wall Street Journal)
Updated: 2005-11-25 12:46

PARIS -- If avian flu sparks a global flu pandemic, the world will have a lot more to care about than financial markets. But that hasn't stopped economists and strategists ruminating over the possible impact on everything from economic growth to interest rates to stock prices and foreign exchange.

Concerns about a possible pandemic have risen with the emergence of the H5N1 bird-flu virus, which has jumped from birds to humans, killing 67 people in Asia in the past two years. Some scientists fear that if the virus mutates to the point where it can be transmitted between humans, the world could face a pandemic.

"While it is difficult to quantify the precise likelihood of a human H5N1 pandemic, analysis suggests that avian flu is a rising risk to the global economic outlook," says Robert Bonte-Friedheim, an equity analyst at Citigroup specializing in medical affairs and lead author of a recent report on avian flu.

The prospect of that is still viewed as extremely low. But the World Health Organization estimates that a relatively mild global flu outbreak could cost two million to seven million lives. But others contend that a truly virulent virus could rival the 1918-1919 "Spanish flu" in which anywhere from 20 million to 100 million people died.

"The bottom line is that flu pandemics have already developed in the past and may well show up again in the future, with potentially devastating consequences for the global economy and markets," says Lorenzo Codogno, co-head of European economics at Bank of America.

A relatively mild -- and containable -- outbreak of bird flu would likely slow economic activity, cause stocks to fall, bonds to rally and trigger sharp jumps in so-called haven currencies, such as the Swiss franc and possibly the U.S. dollar and sterling. But these effects should prove temporary, contend Citigroup analysts. In fact, they regard the equity selloff as an opportunity to buy stocks that would be expected to rebound with economic growth.

A full-blown pandemic is another story. Even people who regard predictions of a repeat of 1918-1919 as alarmist acknowledge the ruinous impact of such an event. "A virulent, global outbreak of avian flu, which is still considered to be a low-probability event, would cause global economic activity to decline, raw-material prices to collapse, risk aversion to rise, monetary policy to ease and interest rates to fall," says Ben Walker, a fund manager at Gartmore Investment Management.

Economies would be buffeted by curtailed individual travel, increased absenteeism from the workplace, reduced shopping, a steep drop in consumer and business confidence and government-imposed quarantines.

Meanwhile, the combination of increased investor aversion to risk and slowing global growth would damp cross-border investment. That, in turn, should be bad news for the currencies of countries with large current-account deficits that rely on financing from abroad, such as the U.S., Australian and New Zealand dollars, the U.K. pound, South African rand and Mexican peso, says Marvin Barth, a Citigroup currency economist.

Slowing growth, especially in Asia, would also put a big dent in the demand for raw materials, particularly jet fuel. "Severe constraints on global mobility will have a huge impact on oil demand," say Citigroup analysts. "However, some commodities, such as gold and silver, could benefit from a 'flight-to-quality' trade," says Gartmore's Mr. Walker.

To get a notion of what might happen in various markets, investment strategists often use the outbreak of severe acute respiratory syndrome, or SARS, in 2003 as a template. East Asian growth shrank. Deflation set in as consumer prices fell in Hong Kong, China and Singapore.

In Hong Kong, tourist arrivals plunged, hotel-occupancy collapsed and the stock market tumbled 10% in six weeks. Consumer discretionary, industrial, bank, materials and real-estate stocks in Asian markets excluding Japan fell 7% to 17%; utilities and health-care stocks rose slightly. Post-SARS, the sectors that fell the most came roaring back. Even so, SARS may be too-optimistic a benchmark. It was short-lived and mostly restricted to four Asian countries.

"In SARS, the market didn't start coming back until the caseload of new patients was on a sustained downward trend," says Citigroup's Mr. Bonte-Friedheim. "With a potential H5N1 influenza, it would probably be a long time before that point is reached."

Under a pandemic scenario, the stock sectors that should perform well include companies that make antiviral drugs and vaccines, hospital chains, cleaning-product manufacturers, home-entertainment providers, telecommunications and Internet-related companies and utilities, according to Citigroup and Gartmore's Mr. Walker.

Meanwhile, Standard & Poor's notes that "businesses that depend on large numbers of people congregating -- such as airlines, lodging, leisure and restaurants -- would suffer serious setbacks." Other "losers" include shopping-mall operators, luxury-goods companies, oil companies and mining and metals concerns.

For all the prognosticating though, some contend that such an event would be so serious that there is little that investors can do. "I don't think you can do anything about it," warns Crispin Odey, head of Odey Asset Management in London. "It's uninsurable."