“I know why you did it. I know you were afraid. Who wouldn’t be? War, terror, disease. They were a myriad of problems which conspired to corrupt your reason and rob you of your common sense. Fear got the best of you, and in your panic, you turned to the now high chancellor, Adam Sutler. He promised you order, he promised you peace, and all he demanded in return was your silent, obedient consent.” ~ V for Vendetta by Alan Moore
People are dying. Hospitals in the hardest hit areas are reporting an overflow of patients. Everyone knows someone who has been affected by the virus.
No one is questioning that people aren’t dying. That hospitals in certain parts of the country aren’t being overwhelmed by a temporary increase in sick patients. That doctors aren’t putting their lives on the line by working themselves to the bone to deal with the increase in pressure. No one is denying any of this… Well almost no one…
Elon Musk being a horrible human aside, my argument is simple, we’re in a terrible situation, but it’s not as bad as the market believes. And yes, I’m using the word “believe” for a reason. Rational thought and logic are being tossed aside in favor of emotion and anecdotes. We can all see that young person on twitter who has shared their horrifying story of being sick with the virus. Or the unfortunate doctor who died after having been worked to the bone while being infected by a number of different strains of the virus. These are sad stories. If you want to dwell on them, and scream that the system should be burnt to the ground, that’s fine. You have that right, but I doubt you’ll be successful at generating good returns in the market going forward.
The truth is that when we drill down into the data we find that the virus is not as bad as people believe. While many believe the virus has a mortality rate far exceeding 1% the data suggests otherwise.
The one situation where an entire, closed population was tested was the Diamond Princess cruise ship and its quarantine passengers. The case fatality rate there was 1.0%, but this was a largely elderly population, in which the death rate from Covid-19 is much higher.
The countries that do the most rigorous testing find that less than 1% of infected actually die. Iceland has done a great job testing everyone whether symptomatic or not, only to find that young people are far more likely to carry the virus. The mortality rate in Iceland is currently below 0.3%.
Even the data from Italy is somewhat encouraging. The median age of the infected who died was 80.5 and the majority of those people were suffering from at least one other disease.
The crazy thing is I know that it doesn’t matter what data I share with most of you. You’ve already made up your mind. You don’t care what I data I put in front of you. And so I’ll just stop there. From here on out, I’m going to work off the assumption that the virus is not as bad as you or the market believes.
I also be the first to admit that this view actually has been unable to generate any alpha. In fact anyone who realized from the beginning that the virus wasn’t nearly as deadly as the market thought, was promptly run over by the ensuing panic from market participants and policy makers. As Keynes once said, “policy markers can stay irrational longer than you can stay solvent.”
Fortunately, I was not of the view that the virus had a mortality rate of sub 1%. I saw the videos in China and the actions the CCP took to control the spread. It scared the bejeezus out of me. I’ve only come around to the view of the virus having a sub 1% mortality rate recently as more and more data came out. Fortunately, the market has been kind enough to not punish me for my sloth like reaction.
To be clear, the damage done from the shutdowns is catastrophic. The increasing fragility of the economy has once more been exposed. And not just the economy, the markets themselves. The market impacted economy and the economy impacted market both of which have impacted policy response. These dynamics were detailed in a recent paper by Michael Greene and Wayne Himelsein. If you want have any idea of what’s going on, I highly highly recommend you read their work.
Basically, the passive inflows into the market are price insensitive. The monetary flow is the same whether the market is up or down. Doesn’t matter. When active participants panicked, they overwhelmed the passive bid leading to a sharp crash in the market which was exacerbated by systemic short vol strategies a number of which have “blown up”. (This a dramatic oversimplification, please read the Logica paper.)
Unsurprisingly, after the quickest and sharpest bear market in history, sentiment has finally shifted bearish. I’m not going to name any names, but all you have to do is look on twitter to see a number of people pushing their 1929 analog charts. And of course there’s this…
But like the bears and doomsayers, we have to get above the anecdotes and emotion, and focus on the data. And the data is quite clear that everyone is bearish. In fact, people are so bearish that despite a 15% rally in the US stock market last week, the percentage of bulls actually fell.
What this suggests is that people are so down on the fundamental story of the global economy and the virus that they aren’t even responding to price. They are so set in their bearishness that nothing will change their mind. Does this remind you of anything? As a $TSLA bear, I know this psychology well. To be clear Mark Gutman was the first person to notice this dynamic.
While the current fundamental story for the global economy is terrible as it has been for Tesla for many years, it does not mean the Dow is going to zero. (In fact, tesla is one of the few large cap stocks that is up for the year.)
What it does suggest is that making money on the short side, even if the market goes lower will be very very difficult. To be sure, the market can still go lower, but those puts you are rushing to buy are unlikely make money let alone hedge your portfolio.
With the VIX having been at 60 for weeks, I think it’s been difficult to formulate a solid path forward until now. While the virus’s relatively low mortality rate has been relatively clear for a few weeks, it hasn’t been till this past week that the bulls have finally capitulated and the bears have pressed their hands. This suggests that at least a temporary bottom has been put in place.
Going forward the most important data points will come out of NYC. As this city is the the hot bed of the entire US, it will be important to see how fast the virus runs through the city and at what cost. Even if cases in NYC peak in short order, the rest of the country should experience a dramatic rise in infections.
These two conflicting sources of data flow will provide evidence for both the bears and the bulls. The bears will point to the need for the shuttering of various parts of the country, while the bulls note that the night is darkest for the dawn, and the dawn eventually comes. Fears of a multi-month shutdown across various sections of the world’s largest economy could force the market to new lows. Dollar funding cracks could continue to bulge across the globe if the US consumer is not unleashed once more.
This is why it will be critical for the bull case that NYC cases peak in the next few weeks. NYC will serve as the model for the coronavirus in the US. From how many people actually die of the virus, to how long of a shutdown is necessary (if at all) these data points will provide much needed clarity to this highly volatile market. While for now, it looks like the situation is improving it can always change.
And while many will point to the effectiveness of the shutdowns, Iceland’s data clearly shows that there are many infected persons who do not know they are or have been infected. NYC might already have a large herd of people who have been infected by the virus reducing further waves of infected rushing to the hospitals.
If NYC improves, perhaps the market will see this crisis for what it was. An artificial surge in demand that ate up the local supply and caused a panic. Not unlike what has transpired in the physical gold market this past month.
To the bears I say best of luck, though I doubt you’ll make much money from here. As a bottoms up investor in small cap biotech stocks I see plenty of value and will continue to add to my positions if the markets trend lower over the next few months.
DISCLAIMER: This blog is the diary of a thirty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, this blog post is pure fiction based loosely on the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT!