The performance of stock markets, especially in the United States, during the coronavirus pandemic seems to defy logic. With cratering demand dragging down investment and employment, what could possibly be keeping share prices afloat?
The more economic fundamentals and market outcomes diverge, the deeper the mystery becomes, until one considers possible explanations based on crowd psychology, the virality of ideas, and the dynamics of narrative epidemics. After all, stock-market movements are driven largely by investors’ assessments of other investors’ evolving reaction to the news, rather than the news itself.
That is because most people have no way to evaluate the significance of economic or scientific news. Especially when mistrust of news media is high, they tend to rely on how people they know respond to news. This process of evaluation takes time, which is why stock markets do not respond to news suddenly and completely, as conventional theory would suggest. The news starts a new trend in markets, but it is sufficiently ambiguous that most smart money has difficulty profiting from it.
Of course, it is hard to know what drives the stock market, but we can at least conjecture ex post, based on available information.1
There are three separate phases of the puzzle in the US: the 3% rise in the S&P 500 from the beginning of the coronavirus crisis, on January 30, to February 19; the 34% drop from that date until March 23; and the 42% upswing from March 23 to the present. Each of these phases reveals a puzzling association with the news, as the lagged market reaction is filtered through investor reactions and stories.
The first phase started when the World Health Organization declared the new coronavirus “a public health emergency of international concern” on January 30. Over the next 20 days, the S&P 500 rose by 3%, hitting an all-time record high on February 19. Why would investors give shares their highest valuation ever right after the announcement of a possible global tragedy? Interest rates did not fall over this period. Why didn’t the stock market “predict” the coming recession by declining before the downturn started?1
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One conjecture is that a pandemic wasn’t a familiar event, and most investors in early February just weren’t convinced that other investors and consumers paid any attention to such things, until they saw a bigger reaction to the news and in market prices. Their lack of past experience since the 1918-20 influenza pandemic meant that there was no statistical analysis of such events’ market impact. The beginnings of lockdowns in late January in China received scant attention in the world press. The disease caused by the new coronavirus didn’t even have a name until February 11, when the WHO christened it COVID-19.
In the weeks before February 19, public attention to longstanding problems such as global warming, secular stagnation, or debt overhangs were fading. President Donald Trump’s impeachment trial, which ended February 5, still dominated talk in the US, and many politicians apparently still found it counterproductive to raise alarms about a hypothetical new enormous tragedy looming.
The second phase began when the S&P 500 plummeted 34% from February 19 to March 23, a drop akin to the 1929 stock market crash. Yet, as of February 19, there had been only a handful of reported COVID-19 deaths outside of China. What changed investors’ thinking over that interval was not just one narrative, but a constellation of related narratives.