The FT has an article today comparing the flu outbreak with the economic crisis. The market response to the flu has been similar to that during an economic crisis—irrational and erratic. The powerful effect the swine flu (now apparently renamed H1N1) has had is based on the unpredictability of the system. It could be a pandemic that kills millions of people. But this is highly unlikely. You are more likely to get into a deadly car accident than for this to occur. And the BBC reported today the swine flu is a mild strain that would have to mutate to be deadly.
In Fooled by Randomness, Taleb describes how people focus on risks that are vivid and ignore the abstract, because risk detection and aversion is an emotional process rather than a logical, thinking one. Taleb’s argument is based on Daniel Kahneman and Amos Tversky’s work on how people manage risk and uncertainty, which they called “prospect theory” (it also shows up in Peter Bernstein’s Wall Street classic Against the Gods). An experiment from Kahneman and Tversky showed people will pay more for insurance against a terrorist attack while traveling than for insurance if they died on the trip. Similarly, people in California view floods from earthquakes in California as a bigger threat than any floods in North America. People focus on risks they have vividly imagined.
Last summer, Hurricane Dolly displayed a similar effect. After the strong effect past hurricanes have had on refineries and the price of oil, upon hearing about the hurricane the market responded drastically as if destruction was assured. I was lucky enough to notice this and managed to get in a few nice shorts. I think a similar thing is happening now. The specter of a flu pandemic has lead to much speculation on which firms will profit. For that reason, many small cap biotech firms have ballooned in value. They have already fallen somewhat today, but I think they still have some downside.
I've had some luck with Novavax (NVAX):
And BioCryst (BCRX), though I would wait a day at least:
