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Blog Posts — March 23, 2020

As COVID Cases Soar, So Do Investor Fears — and the Parallels Are Striking

Tracking the Rise in Confirmed Cases and Its Impact on Sentiment

There is no denying the psychological impact that the word “pandemic” can have on investors globally, especially when it is followed by headlines containing the words “global recession” and “global corporate debt crisis”. The effect on behavior is like a fire alarm going off in a crowded movie theater.

In the charts below we plotted the 20-day moving average of the risk-aversion sub-score of our ROOF methodology against the logarithmic[1] values of confirmed COVID-19 cases for the US, UK, Japan, and Developed Europe[2] from January 22 to March 19, 2020. To put the current levels of risk aversion in perspective, the long-term average for all four markets below is 3.65, with a standard deviation of +/- 1.0. This means that the current levels of risk aversion are high. In fact, for all four markets, these risk aversion scores ranked 1, 2, 3, and 4 since January 2019 for the past four days (i.e., investors in these markets have not been that scared for 15 months).


The correlation between the two series is very strong at 0.98, 0.75, 0.87, and 0.95 for the US, UK, Japan, and Developed Europe, respectfully, since the start of the pandemic (January 22). We note that while Japan’s COVID-19 curve is starting to level off, the others are still almost parallel. Why is this relationship important?

As mentioned in previous blogs on the subject, investors tend to react much faster to their fears than they do to their greed (risk tolerance). A rising risk aversion level, even in the face of a flat risk tolerance level, will still lead to an overreaction to negative news—and considerably more so than rising levels of risk tolerance in the face of flat risk aversion will tend to have with positive news.

Taking together the still mostly linear pandemic curves and the fact that we are now entering the phase of the crisis when analysts present their revised forecasts on its impact on the global economy to investors, we can expect more negative overreaction to what is sure to remain a mostly negative news flow in the short-term. Economic data will also only start to reflect the beginning of these curves as most of them, except for Japan, started their sharp rise only in March.

The chart below is a preview of this week’s ROOF Highlights, with data up to last Thursday compared with the end of the previous Thursday. As can be seen, sentiment, which was already negative on the 12th, has taken a turn for the much, much worse in the last week.

At -1.6, the US ROOF ratio mirrors that reached in February of 2008 during the Bear Stearns event, and again in October 2011 during the European-debt crisis. At some point in the movie theatre metaphor, almost all of the patrons are out the door and the handful that are left look like they are exiting in an orderly fashion, but for those looking at this as a signal for a quick rebound, remember that the patrons who ran out that day will probably take a long time and a lot of persuading to get over their fear and frequent that establishment again. 

[1] We used a base of 10 for the log values.

[2] This block consists of the following 15 countries: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.