Updated: Sep 5
By Ari and Bernard at IntuitEcon
IntuitEcon will be posting weekly updates on our subscribers only page every week. Brain Trust members are welcome to contribute.
We provide a risk assessment of the Delta Variant. Our approach is one we often use for macroeconomic risks. To begin we list the material facts of the risk. We then evaluate the characteristics of the shock. Psychological factors at play are then listed and considered to determine their impact on exacerbating the shock. This provides a basis for finally determining the contagion and into a systemic risks posed by the shock.
Readers are encouraged to consider the context of the Delta risk we provide as well. Especially our recent market updates and thesis on the #2ndTechBubble.
Delta is a more contagious SARS-CoV-2 virus strain first identified in India in December. It has spread throughout the world and is now the dominant strain in the United States. According to the CDC, Delta went from causing around 20% of cases in the U.S. in Mid-June to over 80% this week of July 22nd. The reason is a mutation in Delta that allows it to spread 50% faster than the original Alpha strain. The rate of spread hinges significantly on circumstances. According to epiforecasts.io the national rate is fast enough to double infections every week.
This is causing concern around the globe. Government responses have been mixed with some countries slow to enforce any additional rules and others like France enforcing restrictions on access to restaurants, cafes, movie theaters, long-distance trains and more for those who have chosen not to get vaccinated. Global new cases have already been rising for more than a month...leading to rise now in global deaths.
Delta is not, however, more lethal. There is a risk that faster spread and more cases will lead to new mutations of COVID19. But viruses do not think...mutations are random, and mutations that lead to fewer deaths are more likely to dominate because those strains are more likely to survive. This is true for all viruses. So while more lethal strains are a risk the true market risk comes from the shock of more cases, subsequent deaths and the economic as well as psychological impact on markets.
Economic and Market Shock
The impacts on the economy have thus far been predictable given our familiarity with pandemics. Cruise and airline stocks have been falling since the beginning of June. Oil prices tumbled earlier in the week although they have since bounced back and remain over $70 a barrel. School closures have put tremendous stress on some families and businesses. The CDC has thus far pushed against closing schools, announcing on July 9th that, “Students benefit from in-person learning, and safely returning to in-person instruction in the fall 2021 is a priority”.
Despite the now obvious trend toward another wave the market reaction has been mild. The VIX did spike to above 22 earlier in the week, its highest close since May, but the jump was short lived with VIX back to around 17 by the close Friday. We view the falling VIX channel as a confirmation of the Call Option Bubble thesis published late last year and our prediction that as we moved past the pandemic, irrationally high premiums on these options would fall after the Tech crash in February.
Sectors sensitive to the pandemic have been reacting. For example, the JETS ETF has been falling in a manner that suggests data measuring waves of the pandemic are now built into models that dominate a lot of trading...part of our Algo Efficient Market Hypothesis. This most certainly was not the case before the pandemic which is why the market reaction did not recognize the virus until the impact hit earning and macroeconomic data that was built into pricing models.
Oil prices have yet to fall meaningfully from fear of Delta. One reason is that commodity prices are driven more by fundamental supply demand as opposed to just market psychology. The lack of reaction thus far is therefore in part driven by the lack of change in household and corporate behavior. Delta just hasn't had much of an impact on actual mobility statistics...at least not yet.
So while there has been some reaction in markets to certain sectors there has yet to be a truly systemic shock. That could change if people start to really fear Delta.
What psychological biases and heuristics are at play that could impact the economy and markets because of a Delta shock? We see three...
Recency Bias - People tend to believe that whatever shock they just experienced is more likely ... such as a pandemic.
Fear Decay - People tend to be more afraid of new risks, and the fear decreases over time the longer a risk has been around...like a pandemic.
Moral indifference - People tend to have less emotional reaction to people getting sick and dying from something they can control, such as not getting vaccinated.
All three of these psychological biases play against the possibility of people generally becoming overly fearful of Delta. That is key because the risk to markets from Delta is largely psychological.
The record drop in economic activity in 2020 was driven by fear of the unknown. Asian countries statistically did a better job of handling the outbreak in part because SARS was a fairly recent memory...at least enough so that the value of mask wearing needed little education and stockpiles were readily available. In contrast, the pandemic of 1917-1918 had been essentially forgotten in the western world.
Damage caused by the 1917-1918 pandemic would have been devastating even without fear of driving down economic activity. About 650,000 of 105 million Americans died. Roughly half the deaths were among young adults ages 20 to 40, causing tremendous damage to working age people integral to the functioning of the economy. So far the current pandemic has killed about the same number of people in a country 350% larger with fatalities highly concentrated in older adults not in the labor force.
The risk of human damage from Delta is real and given the facts it seems we could be headed for another wave of infections and fatalities. The human suffering that would come from another wave should not be ignored. But from an economic standpoint we can take some comfort in the tools and experience we have from haved lived more than a year in a pandemic...and that may be enough from preventing psychological impacts from causing systemic risks to the economy.
Stocks on the whole have largely ignored the rise of Delta. As we discuss in our Weekly Update, the S&P 500 has continued to rise since bottoming last March despite fears from the COVID19 variants, three waves of the pandemic, a challenged election, wide swings in earnings expectations, extreme moves in treasury yields, changes in Fed policy, changes in state and local unemployment benefits, wild swings in commodity prices, historically very large changes in fiscal policy (rivaling that of WWII) in terms of size relative to GDP...
...and through all of this, stock market momentum, corporate bond spreads, and the VIX kept ticking higher levels of risk appetite like clockwork. No one can know for sure why...but given that all the narratives mentioned have been changing it stands to reason that this unprecedented level of consistency in asset prices appreciation has little to do with fundamentals risks such as another wave.
All the money created during the pandemic is slowly driving down the equilibrium expected return on financial assets. All the liquidity is preventing fundamental shocks from turning negative sentiments in the market into consistently falling prices.
Delta will have some impacts on specific sectors and trends. We see these impacts helping just about every stock in our portfolio which is concentrated in Genomics, 3D Printing, and Education Revolution leaders. It may end up having a beneficial impact on gold and silver as well given the likely fiscal and monetary response to any increase in perceived threat from the pandemic. But as far as negative effects...we don't see any material systemic risk at this time.
By Ari Nikola and Bernard at IntuitEcon
We will discuss this along with our Crypto podcast published on our home page and the why stocks are experiencing their strongest bull market on record during our Sunday podcast. Everyone is free to listen in on Twitter although the reliability of this is not guaranteed. Subscribers are welcome to join by Zoom link will be sent out at 6pm EST. Recording starts promptly at 7pm. [UPDATED: Podcast now on Monday 6PM EST]
Thank you for your support!