Last month has been world-changing, and it’s not over yet.
With the caveat that I do shares and stocks, not viruses, one thing that I have found fascinating is the similarities between epidemiology and investing.
First, both are based on statistics and forecasts unlike say chemistry. In investing there are always a range of potential paths to which you have to assign probabilities, and those paths change dynamically as a company or its market changes.
Secondly, they both involve exponential curves. Humans are renowned for not understanding exponential curves and Donald Trump has had an abrupt lesson in the laws of power distribution in the last month. Or, as I’ve read: “If you’ve seen one pandemic, you’ve seen … one pandemic”. Because starting conditions (city density, season, health system) interact with community choices (social distancing now or one week later) so a country can have 6,000 cases or 600,000 cases.
But with markets having rebounded more than 20 per cent off their March lows, investors are of the belief that the curve flattening that is being seen across the world suggests the world is starting to move to the exit phase. Now, before you point out that there is a long way to go, remember that markets are forward looking and always price the change, not the level. So once things become less bad, they rally, even if there is disagreement on the size of the rally.
The biggest question in my mind currently is what, if anything, will permanently change after COVID-19? Recessions are bad for cyclical stocks, but when the rebound comes they will do well. I’m much more interested in whether this has forever changed peoples’ behaviour.
And for that, we need to turn to the psychologists. So I’ve been getting a crash course in psychology 101 in the last two weeks from some in the industry with a psych background.
My initial starting position was that human habits are terribly hard to change.
I worked through September 11, 2001. It was argued that the event, plus the new security regime, would see people less willing to travel by plane. Nope. Americans were all back on planes within months. At an individual level, how many are sticking to their New Year’s diet four months in?
So why may COVID-19 be different? I now know that in psychology repetition is the key to changing habits. A University College of London study in 2009 showed that it takes an average of 66 days for a new behaviour to become automatic. Many parts of the world are now entering the second month of lockdown and social distancing.
We are starting to enter the realm where our newly formed habits are done without thinking.
If we look at China, this is in fact taking place: despite no lockdown, restaurant dining remains down and companies report many workers bring their own lunches in each day.
The Health Belief Model in psychology argues that perceived susceptibility and perceived severity weigh on the probability of changed behaviour. Unlike climate change, dying from COVID-19 is both severe and the benefits of survival are tangible.
Finally, group psychology says a heterogeneous group can unite over a shared threat, the downside being the group amplifies the underlying emotion. This can be seen in the shared outrage against Bondi Beach, or, bizarrely, the attack on 5G towers. This is important as this can help inform thoughts on what governments do, as the populace will dictate their group desires to some degree.
If we turn to the implications for stocks and markets, it seems, as per China, likely that restaurant dining may be impacted for much longer than many people expect. The length and repetition of this event is why it’s different to 9/11.
Look for well-connected monopolies.
COVID-19 has also changed the interaction between monetary policy and fiscal policy – they have become one. It may not have been planned, but MMT has arrived for many countries.
The left has always argued the system is rigged against workers, but in government directed markets, money flows to those with the best connections, rather than the Silicon Valleys of the world. No wonder the whole private equity industry has turned up in Washington looking to be added to the largesse. Spoiler alert: they will succeed.
But the long term track record of populist-led nepotistic spending, funded by compliant central banks is poor overall. It is good, though, for inflation and gold.
Lastly, I’d speculate that it may also change our relationships with government and our personal freedoms. A lot of power has been handed over recently and governments prefer more power to less. COVID-19 may become the “reds under the bed” fear factor of our generation. Your overseas travel may be further away than you think.
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I know things are easy in hind sight, but one of the biggest threats to the world as a whole was a pandemic, according to science articles starting mainly in the 1990's until now. These were not epidemiologist crying wolf, these were well researched pieces based on sound statistical probabilities and knowledge about viral outbreaks. No one saw it coming, I hear. Well, the truth is that no one in the financial world saw it coming. No one in the financial world had anything like this factored in in any way. And now, as always, financial experts continue to be experts and are still getting paid handsomely. There is no accountability in this area and experts' reputations are never blemished in their own minds. I have always maintained that financial experts should ONLY ever be paid as a percentage of the overall profits they make. If they are so wonderful at investing as they claim, they would have no problems with that and would be billionaires in no time.
Harry - agree your principle about switching Finance Industry' fee structure and incentives from fixed to performance based. That is hard to argue against, and would be a huge win to investors, at cost to Managers and intermediaries. Disagree that no-one was tracking/preparing for the Pandemic risk (see 4-5 Livewire posts in February flagging it). Also disagree that it was blindly obvious that COVID would explode from a known risk, to become a decade-defining market-event. Chad' piece highlights the multitude of scenarios/possibilities that are constantly changing, which is the reality of dealing in today's newsflow, with today's eyes, rather than 20-20 hindsight vision. Ironically, the only group that definitely did zero de-risking in advance of the Pandemic threat was Passive-ETF style exposures. Passive ETF's most often the place that those disgruntled with Active Managers or the Industry Fee structure concentrate their capital, with strong rationale over a whole cycle, but maximum draw-down participation also.
Excellent read Chad. Really enjoyed this piece
Harry - I think we need to differentiate here between cumulative and discrete probabilities. Your cumulative probability of dying on a 125 year view is 100%. Your discrete probability of dying in any one year for an average Australian is 1/1000. So whilst over many years the cumulative chances of a pandemic is high, in any given year its low. In my investing career I've seen SARS, which didn't become an pandemic; Ebola; MERS; and swine flu. All which stayed local. Markets can only know after the fact which becomes a pandemic - and they did price this very swiftly in 2 weeks from late Feb to early March, well before the case numbers were high. On pay, there are a range of business models and views of profit share vs. fixed pay. Germany for example bans fund managers being paid a percentage of profits as they believe it introduces risks of to clients by the fund taking too much risk. Clients in Australia are of course free to choose to allocate to whatever model they think suits them best.