FOMO - The Fear of Missing Out
Updated: Mar 2, 2020
Now that markets have absorbed the initial impacts of the coronavirus outbreak, investors should pause and take stock of the situation.
Let me take a moment to discuss the concept of "correlation". All else being equal, it stands to reason that stocks and bonds should in general be "negatively correlated". That is to say, when bonds return a lot, stocks should return little to negative. Conversely, when stocks return a lot, bonds should return little to negative.
A recurrent theme in the investing community in recent times has been the positive correlation between divergent asset classes. To illustrate this trend, let's consider the performance of several asset classes over the last two months. From December 10th of 2019 to February 10th of 2020, the asset classes performed as follows:
Stocks, represented by the SPY ETF, returned 6.47%.
Implied volatility, represented by the VIX index, dropped from 15.83% to 15.59%.
Long-term bonds, represented by the BLV ETF, returned 4.29%.
Corporate Investment Grade bonds, represented by the LQD ETF, returned 2.92%.
Corporate High-yield bonds, represented by the HYG ETF, returned 1.74%.
Gold, represented by the GLD ETF, returned 7.12%.
In the 21st century, with China acting as an integral node in the global supply chain, it stands to reason that the threat of pandemic should result in meaningful risk-aversion. Unfortunately, and although some risk-aversion has taken place (see January 27th on the VIX chart), markets do not seem to be taking seriously the potential for economic disruption.
A number of market participants have highlighted the low (as-of-yet) fatality rate of the coronavirus as justification for remaining bullish and "buying the dip." Although it is logical to assume that a low fatality rate means it is a low-risk situation, the truth is that a low fatality rate can contribute to the spread of an illness. The dreaded Spanish Flu pandemic of 1918 had a fatality rate in the low single digits, but ultimately killed tens of millions worldwide. Relative to 1918, humanity is far more concentrated in urban areas. Policy makers are right to be worried about the next pandemic, but markets seem to be shrugging it off.
Perhaps we are witnessing a manifestation of the "fear of missing out": where otherwise the threat of global pandemic - a threat legitimized by the unprecedented actions of multiple actors on the global stage - should result in meaningful risk-aversion, markets stubbornly grind higher.
The virus death-toll has now surpassed that of the SARS epidemic, in a far shorter amount of time. We all hope the coronavirus outbreak dies down without causing any more human suffering. The intrepid investor, however, must consider all the possibilities and position themselves accordingly.