Omicron, Narratives, and Markets: Under-Correlations and Over-Corrections
NOTE: I was in the midst of a different blog post when the new COVID-19 variant (now known as Omicron) was announced as a “variant of concern” and led to the subsequent market dip. That blog post should be up relatively soon, possibly even tomorrow…but for now I had to get my musings on this subject out there before the iron cools.
The new COVID-19 “variant of concern” now has a name: say hello to Omicron. The announcement of this troublesome new variant has led to a rash of travel restrictions being thrown in place by the UK, the US, and the European Union to southern Africa. Markets took a tumble on news of this new variant: the US market saw its worst day of 2021 in a truncated day of trading, following cliff dives seen across foreign markets on their Friday openings (COVES dodged most of it, thanks for asking!). So, will Omicron fulfill these portents and just simply eat the rest of the variants? All I know is my gut says “Maybe”.
<Ok, I’ll do my damndest to restrict the Futurama references going forward…but I won’t be pleased about it.>
What I do know for sure is that we are observing a very real relationship between the announcement of the new variant, the reaction by the financial markets, and the media narrative. It’s not often that I wake up to a half-dozen BBC news alerts about any topics, much less on the same subject. And a newly-Greeked COVID-19 variant as we head into Holiday Travel Season is potentially a Big Deal! It’s just that…maybe it isn’t as big of a deal as capital T/capital M/capital T/capital N “The Markets” and “The Narrative” make it out to be.
Ok, let’s pause here for a second. What exactly do I mean about “The Narrative”? I’ve run parallel to the idea in a few of our previous blog posts, particularly regarding the GME craze at the beginning of the year and one of its many dead cat bounces (oh, and let’s not forget Robinhood and its shitty practices!). I’ll be the first to admit that my own writing on narratives pales in comparison to the work Epsilon Theory is putting out on the subject (see here for a great ur-example of it). It all hearkens back to Behavioral Finance: the ideas that there is a very real effect of narratives on markets that causes them (either by happenstance or by forced inception) to irrationally bend away from a purely mathematical and quantitative form. Behavioral Finance frustrates the hell out of rigid quants because it prevents the market from bending to their intricate models of How The Markets Should Be. Guess they never took George Box to heart.
Back to Omicron. Yes, a new “variant of concern” is not a piece of news that is filled with warmth and fuzziness. It could potentially set back our global march out of the pandemic by months. But let me ask a quick question here: what place does Omicron occupy in the order of the Greek alphabet? Alpha is clearly first, beta second, and some of your more hard science and/or Classics folk (or hell, Greeks or Greek-speakers) are running straight through Gamma, Delta, Epsilon, etc. right at this moment. Spoiler: Omicron is the fifteenth letter in the Greek alphabet. COVID variants are named similarly to annual hurricanes: one instance per letter starting from the beginning and working its way down the list. This makes Omicron the fifteenth thirteenth* named variant of COVID, or the fourteenth total when accounting for COVID-19 Classic. Outside of Delta, how often do you hear about the other twelve variants?
* EDIT: Greek letters Nu and Xi were not used for naming variants; Nu most likely because of the confusion it’d bring aurally, Xi most likely because of a vast pro-CCP global conspiracy wading into the waters of a named variant sharing a name with the head of state of the virus’ country of origin was not worth it.
Let’s break this down: as of this writing, five COVID variants have earned the label of “variants of concern” (VOC): Alpha, Beta, Gamma, Delta, and Omicron. When was the last time you heard about Alpha, Beta, or Gamma? I remember the concern around Beta because of its higher death rate than the original or Alpha, but it wasn’t able to spread as easily and was susceptible to vaccination. Delta has definitely earned its stripes as a VOC: not only has it led to numerous waves of COVID infections across the world, it has also driven its own dips in market performance (compare the double peak of Delta in Google Trends to the dips in the S&P 500 in June and July). So, out of the established VOCs, one is the Real Deal, one is a bit more Ebola-ish in that the death rate comes at the expense of the R0, and two ended up being covered by vaccinations. That’s not even accounting for variants of interest (VOIs), which explain the gap between Delta and Omicron. In fact, six named variants have already been removed from even this grouping (Epsilon, Zeta, Eta, Theta, Iota, Kappa). Out of the thirteen named variants at this point, Delta is an outlier. Omicron could very well end up to be just as serious or even more than Delta (as the preliminary data suggests), but it could also end up being like one of the other eleven named variants that fizzled out (relatively speaking).
So, why the hubbub around Omicron in the markets? Well, the reaction caused a snowball effect in the narrative. When Beta was announced, many of the travel restrictions to other countries were still in place, so there was no discrete governmental response to the threat of a new COVID variant that the narrative could latch on to. Even Delta’s announcement came at a time when restrictions were mostly still enforced. Furthermore, both of these prior examples came at a time when the US market was operating as-normal. Omicron’s announcement and subsequent travel restrictions came sandwiched between a US Federal holiday and a truncated day of trading. Truncated days of trading tend to see a much lower proportional magnitude of trading volume, essentially making the US market more illiquid than usual on these days. Since they are typically slower news days, this doesn’t really matter in the grand scheme of things; less movement on a relatively uneventful day doesn’t upset the apple cart. However, when a Big News story comes out ahead of a short day in the markets, with traders and other finance types scattered on the winds and without a Bloomberg Terminal within arms reach, panic sets in and price drops happen. In a serendipitous turn of chance, I’ve been reading through The (Mis)behavior of Markets this week, which addresses the unexpected development of and reaction to events such as this. The heightened illiquidity today didn’t help matters, leading to more panic than usual, and a mini, narrative-driven liquidity cascade.
Does this drop make sense? On some level, yes! Absolutely! The COVID recession was the sharpest recession in financial history and skinned a lot of market participants alive in the short-term. Those folks do not want to be caught out in the cold again. It is a Bayesian shock driven by asymmetric emotions: the COVID recession was bad bad not good, and Omicron could cause another one IF everything is as bad as everyone speculates, so why wouldn’t you attempt to get out of your position? You don’t want to be the one left holding the bag this time, so when the market shifts, you attempt to ride the wave. It’s The Narrative, and anyone who goes along with The Narrative won’t stick out. It’s safety in numbers: if you stick out and are right it can make your career, but you’re wrong it can end it. Sticking to The Narrative is the same reason we see little innovation not only in finance but it other fields. Hell, look at sports. NFL coaches for decades always punted away on fourth down despite the stats that state going for it is typically better. Moneyball took decades before other teams co-opted it from Billy Beane and the Athletics (to better success as well). We even had the confluence of Wall Street quants and sports when Cliff Asness and Aaron Brown took a look at when NHL teams pull their goalies (way too late) into the third period. The Narrative keeps you safe, keeps you unremarkable, keeps you at status quo.
But The Narrative isn’t The Truth.
The COVID pandemic is not over. We’re over 5.2 million deaths (confirmed) worldwide from COVID (confirmed deaths from COVID, the true number could be much higher). European countries are going back into lockdown. Vaccination availability varies wildly by country, with some developing countries still awaiting full coverage for their healthcare workers while rich nations sit on unused boosters. We are approaching the anniversary of last winter’s COVID surge in the Northern Hemisphere. Despite COVID still being a very real thing, we collectively got used to it. The VIX has steadily declined over the year from roughly 21 to around 15-16 before today’s spike. The odds favor a less-disastrous resolution for Omicron than the current fear and speculation in The Narrative suggest. There are Z-Pak-esque COVID pills being developed by both Merck and Pfizer (though the former could be less effective than initially believed).
Maybe it’s my perspective as the partner of an EM resident and as someone who saw COVID rip through the in-law side of his family, but I’ve been wary about the somewhat cavalier attitude that’s developed around COVID. Attention spans are hard to hold; it takes something like the announcement of the Omicron variant to wake people up and shock us back to a fairer assessment of the situation. Is it too much of an over-correction in the markets, exacerbated by holiday-induced illiquidity in the US? Probably. Will Omicron fizzle out like all of the non-Delta variants once put under professional scrutiny? Possibly. There’s really no way to know until more-formal analysis concludes and the results are announced. Until then we’re going to be following The Narrative and its everlong search for The Truth…any decisions made on the back of this before that point are based on a weird mix of quant and qual. Perhaps it will end up being nothing and markets will rip back up and beyond. Perhaps it is serious and things grind back down until an updated solution is found. Perhaps there is a third path (or fourth, or fifth). Perhaps something exceptionally unexpected and Black Swan-ish develops in the meantime.