As a fellow amateur, I greatly appreciate your recent posts trying to understand the events of the last few months, as well as your willingness to publicly and humbly acknowledge your ongoing uncertainty and to update your beliefs based on new evidence. I feel that you may be being too hard on yourself here though—some comments below.
Investors weren’t failing to synthesize the early information or waiting for someone to yell “fire!” They were waiting to see confirmed international community spread, rather than just a few cases popping up here and there.
The coincidence of faster spread of COVID-19 internationally and the beginnings of the stock market crash suggest that hard evidence of community spread of a deadly disease is the world’s evidential benchmark for an economic downturn.
As you point out, the onset of international community spread does seem to be the tipping point for the stock market crash. But the possibility that it might spread beyond China/East Asia must have been apparent throughout Jan and early Feb. Why was this not reflected in market volatility? VIX also stayed very flat until Feb. 20, the same time the markets started to decline. Wei Dai pointed out that this was a contributing factor to the gains on his options trade. I could see stocks themselves remaining high until there was evidence of international community spread, but VIX/option prices at the time suggest markets failed to price in any substantial chance of this happening until it had actually happened.
To argue otherwise is to say that it should be obvious COVID-19 was highly contagious based on some other form of evidence. That’s not impossible.
I think there was a lot of evidence COVID-19 was highly contagious based on the reports from China. What was unclear at the time was 1. if China could control the initial outbreak successfully, and 2. if a few cases did spread, could other governments identify and quarantine incoming cases to prevent escalation to full community spread. Markets may have greatly underestimated the chances of these two scenarios playing out the way they did.
This kind of intellectual work is extremely difficult; only a few people care about it enough to make the attempt, so I’m getting far less feedback than I would for other activities.
Totally agree. Predicting is hard, and predictions often look foolish with the benefit of hindsight. In this case, even understanding the past with the benefit of hindsight is challenging! But still worth doing, to try to understand the world better (or at least less wrongly).
A major league baseball player who hits a home run has far more in common with an MLB player who hits a foul ball than a child who hits a home run.
True—but the only way for a child to reach the majors is through continued practice. Keep swinging!
Thanks for the encouragement! Here’s my take, best enjoyed with salt :)
It’s possible markets underestimated the chances of COVID-19 becoming the crisis it is today. But it’s also possible that they correctly estimated the chances at every step, and this time we got unlucky.
Looking at VIX back only 3 months takes you to mid-January—right at the start of the outbreak. Look back 6 months, and you’ll see that there is a marked increase in VIX starting around Jan. 23rd. Looking at the day-by-day cases, it’s right around Jan. 23-25th that you can see a market increase in the number of countries confirming new COVID-19 cases on a daily basis.
So my interpretation is that this jump in VIX represents the market’s probabilistic forecast that COVID-19 would turn into a major economic downturn. Investors were saying “Yikes, COVID-19 looks scary. But we’ve been through pandemics before and gotten them under control. Hopefully the same will happen here, but there’s a chance we won’t.”
It was around Feb. 21st that the crucial evidence of confirmed international community spread came in, leading to the VIXplosion after that date.
I still think the model I crafted gives some good guideposts for what to look for in terms of transmissibility: spreading via respiratory droplets, a peak of contagiousness coinciding with onset of symptoms, a fast increase in cases at the point of origin, and no widely available point-of-care rapid test. Together, these indicate a virus that spreads efficiently and is hard to screen for. If it’s deadly, too, then watch out!
But I don’t know how to evaluate whether or not the amount of S&P 500 30-day option volatility (which I understand is what VIX measures) during Jan. 23-Feb. 20 was too much or too little given the information we had. It seems clear there was some volatility—the markets didn’t ignore COVID-19 during that period.
Before, I believed my model can help users be smarter than the experts. Now, I believe it can help them approach being as smart as the experts. The key difference is that the former would help you beat the market. The latter only keeps you from losing your shirt!
Would also like to add that there was a significant knowledge gap in those early days in February, with data from China on both the scale of the outbreak, and circumstances, particularly difficult to interpret and extrapolate. Knowing what we know now, those early signs would have been enough, but at the time, it certainly seemed possible that it would be contained within China (very limited spread overseas that could be easily contained), or at least the mortality rate would be lower.
As a fellow amateur, I greatly appreciate your recent posts trying to understand the events of the last few months, as well as your willingness to publicly and humbly acknowledge your ongoing uncertainty and to update your beliefs based on new evidence. I feel that you may be being too hard on yourself here though—some comments below.
As you point out, the onset of international community spread does seem to be the tipping point for the stock market crash. But the possibility that it might spread beyond China/East Asia must have been apparent throughout Jan and early Feb. Why was this not reflected in market volatility? VIX also stayed very flat until Feb. 20, the same time the markets started to decline. Wei Dai pointed out that this was a contributing factor to the gains on his options trade. I could see stocks themselves remaining high until there was evidence of international community spread, but VIX/option prices at the time suggest markets failed to price in any substantial chance of this happening until it had actually happened.
I think there was a lot of evidence COVID-19 was highly contagious based on the reports from China. What was unclear at the time was 1. if China could control the initial outbreak successfully, and 2. if a few cases did spread, could other governments identify and quarantine incoming cases to prevent escalation to full community spread. Markets may have greatly underestimated the chances of these two scenarios playing out the way they did.
Totally agree. Predicting is hard, and predictions often look foolish with the benefit of hindsight. In this case, even understanding the past with the benefit of hindsight is challenging! But still worth doing, to try to understand the world better (or at least less wrongly).
True—but the only way for a child to reach the majors is through continued practice. Keep swinging!
Thanks for the encouragement! Here’s my take, best enjoyed with salt :)
It’s possible markets underestimated the chances of COVID-19 becoming the crisis it is today. But it’s also possible that they correctly estimated the chances at every step, and this time we got unlucky.
Looking at VIX back only 3 months takes you to mid-January—right at the start of the outbreak. Look back 6 months, and you’ll see that there is a marked increase in VIX starting around Jan. 23rd. Looking at the day-by-day cases, it’s right around Jan. 23-25th that you can see a market increase in the number of countries confirming new COVID-19 cases on a daily basis.
So my interpretation is that this jump in VIX represents the market’s probabilistic forecast that COVID-19 would turn into a major economic downturn. Investors were saying “Yikes, COVID-19 looks scary. But we’ve been through pandemics before and gotten them under control. Hopefully the same will happen here, but there’s a chance we won’t.”
It was around Feb. 21st that the crucial evidence of confirmed international community spread came in, leading to the VIXplosion after that date.
I still think the model I crafted gives some good guideposts for what to look for in terms of transmissibility: spreading via respiratory droplets, a peak of contagiousness coinciding with onset of symptoms, a fast increase in cases at the point of origin, and no widely available point-of-care rapid test. Together, these indicate a virus that spreads efficiently and is hard to screen for. If it’s deadly, too, then watch out!
But I don’t know how to evaluate whether or not the amount of S&P 500 30-day option volatility (which I understand is what VIX measures) during Jan. 23-Feb. 20 was too much or too little given the information we had. It seems clear there was some volatility—the markets didn’t ignore COVID-19 during that period.
Before, I believed my model can help users be smarter than the experts. Now, I believe it can help them approach being as smart as the experts. The key difference is that the former would help you beat the market. The latter only keeps you from losing your shirt!
Would also like to add that there was a significant knowledge gap in those early days in February, with data from China on both the scale of the outbreak, and circumstances, particularly difficult to interpret and extrapolate. Knowing what we know now, those early signs would have been enough, but at the time, it certainly seemed possible that it would be contained within China (very limited spread overseas that could be easily contained), or at least the mortality rate would be lower.