As if the fear about getting the corona virus isn’t bad enough, we have a secondary virus going around: bad analysis. While this virus won’t get you sick, it will hurt your bank account and might even cost you your job as the decreased economic activity due to fear has real economic impacts.

Recessions can be self-fulfilling if people talk themselves into believing things are worse than they would otherwise be. The spread of bad analysis increases the risk of this adverse outcome. My goal here today is to correct some of the misunderstandings out there to help you to be better informed and make a more accurate assessment of the risks.

“This is a demand shock”

No, it’s a supply shock. There is a restriction of goods being produced, whether it be the obvious example of a Chinese factory unable to fill an order or the domestic fear factor leading workers to stay home, conferences to be cancelled, Amtrak service to be reduced, etc.

While demand is going down, it is due to a move along the demand curve in response to the supply shock in order to find a new equilibrium.

See the graphic above. When there is a supply shock, buyers consume less of a product and prices go up. This might sound counterintuitive. After all, you can’t give away a cruise right now! How can I say prices are going up?

But that’s not the right way to think about it. If there were a cruise ship or a plane that could 100% guarantee every passenger was healthy and the vessel had been thoroughly decontaminated, it would quickly sell out and at a high price. The reason nobody wants to take a cruise is because the supply of cruise ships that don’t pose a health risk has been severely contracted.

Demand is responding to the change in supply, not the other way around. There is nothing to suggest people don’t want to go to restaurants or concerts or on vacation if they knew it was safe. If there were, that would be a demand shock.

This might seem like semantics, but it’s important because the appropriate policy response depends on the correct diagnosis. If this were a demand shock, then the appropriate response is monetary policy.

However, a supply shock is most effectively dealt with through fiscal policy. Tax cuts or direct payments to those affected directly by the virus would be the most obvious tool. If someone is told to stay home from work, they don’t need lower interest rates. They need cash to pay the bills.

“Lower oil prices are bad”

Crude prices are down 20% in a day and the reaction is…this is bad for markets. Excuse me? Yes, it’s bad for oil producers but energy is <5% of the S&P now. True, we have a lot more domestic oil production than we used to, so there will be some job losses from cutting production, but the net benefit for consumers is significant.

What OPEC did is a supply shock…a positive supply shock! That means it counters the negative supply shock from the virus. It’s certainly not a 100% offset, but it’s a material one. It’s one of the more effective remedies available to counter a negative supply shock. We should be thanking the Saudis!

“You should stock up on toilet paper”

I actually heard a doctor say this! This is not the stomach flu! It’s a respiratory flu. If the theory is you’ll be quarantined at home for two weeks, well, you need a lot more than toilet paper and Purel. You need food and cleaning supplies and soap and paper towels and laundry detergent. Why in the world is everyone panicked about toilet paper???

“The lost economic activity will never return”

This might be the biggest mistake of all. I can’t tell you how many times I have heard this one. Those skipped vacations, trips to the movies, going out to dinner, etc. are supposedly permanently lost economic activity.

Nothing could be further from the truth. In a typical recession, economic activity contracts because people lose their jobs and cut back spending because they lost purchasing power.

If people are voluntarily choosing to shelter in place, their disposable income has not changed. If they don’t spend it this month, they have it available to spend some time in the future. In fact, it’s probably good in the long term for some people to cut back on dining out and use that money to pay down their credit card balance.

The pent up demand coming out of this shock will be tremendous. Think about all the tailwinds: increased savings, lower gas prices, lower interest rates, lower mortgage costs.

There will be an explosion of spending, especially with all the cash out refis people will be shopping for while they’re stuck at home. Housing sales will take off, not just from lower rates, but as prospective buyers take all that money they’re saving from staying home and apply it towards a down payment.

The silver lining in this whole episode is it’s a great opportunity for Americans to improve their balance sheets. That is going to lead to a much stronger recovery than expected once confidence returns.

“The virus spreads much faster than influenza”

This is true in a vacuum. Corona appears to spread faster than influenza. This fact is a big part of the panic. That and the false belief that the 3% mortality in China is reflective of reality rather than what the Chinese government has been able to measure.

The problem is we don’t live in a vacuum. Our actions can influence events. This is the Soros’ concept of reflexivity. Normally, we think about this as applying to markets but it really applies to any circumstance where there are countercylical second order effects.

In the case of the virus, the panic itself lowers the transmission rate. Fear keeps us inside, keeps us from shaking hands, makes us neurotically wash our hands, etc. It also leads governments to isolate people once they are infected. We don’t do any of these things for the flu.

Thus, while the gross (aka uninfluenced) R0 may be double that of seasonal flu, my bet is the net R0 (aka after behavioral change) will be less than the flu and likely significantly less.

If you want a reason to believe the consensus about corona is too bearish, this is your best argument! People are influencing R0 and thus lowering the infection rate.

Whether this is worth the economic toll is a debate for another day, but failing to understand the behavioral influence is the biggest thing the market has gotten wrong in understanding the ultimate health risk to Americans.

“We are suffering from extreme confirmation bias”

Actually, nobody has said that, but that is what the experts should be saying. Confirmation bias is when one seeks out only facts that agree with what they already believe.

If you have spent the past couple weeks reading every story about every new case found, have become obsessed with finding masks, are determined not to leave the house more than necessary, are certain you will get sick if you go on a plane and touch the tray table, think the US is more likely to look like Wuhan than South Korea, and convinced yourself you will die if you get this, then you are likely suffering from confirmation bias.

The coverage of this event is similar to how the local news covers crime. If you just watched the local news lead with a murder story every night, you would think the crime rate was a lot higher than it actually is. Similarly, when all you hear about everywhere you go is how corona is the worst thing since the Spanish flu, you will only focus on stories that tell you that things are getting worse.

Go to your favorite news site and look at the corona headlines. I would bet they are all about how things are getting worse. You don’t see stories about how R0 will likely be less than expected or that the mortality rate for people under 50 is the same as the flu or that new cases are declining already in South Korea.

Those type of stories don’t confirm what we already think, so people don’t seek those out. But if you were to look at the data on what the actual infection rate is in other countries, you might feel a lot better about things. I will have more to say on this in an upcoming post.