By now, most people have heard the exciting news regarding three of the leading COVID-19 vaccines in Operation Warp Speed. Pfizer and BioNTech — 95% effective. Oxford and AstraZeneca — 70% effective. Moderna — 94.5% effective. So… time to start inoculating, right? Not quite. Even though these vaccines are extremely successful in producing the required antibodies to fight the novel coronavirus, each company must show that their vaccine is safe (i.e. no adverse effects after vaccination) before mass distribution. Therefore, it will still be several months before we achieve the necessary herd immunity to safely reintegrate into society without masks, social distancing, etc. Regardless, this new vaccine data shows that we are moving in the right direction. In the meantime, how exactly will this new information affect the stock market? Keep reading to find out.
By: Matthew Rojas, Biotech Financial Analyst
The Efficient Market Hypothesis
One of the most highly contested theories in behavioral finance is the efficient market hypothesis (EMH). The EMH states that “share prices reflect all information and consistent alpha generation is impossible.” Alpha is defined as “the excess return of an investment relative to the return of a benchmark index.” In other words, the EMH says that stocks almost always trade at their appropriate value on various exchanges; therefore, investors cannot consistently buy undervalued stocks and sell them for inflated prices to create an arbitrage opportunity.
There are three forms of the EMH: the weak form, the semi-strong form, and the strong form. The weak form suggests that the current stock prices reflect all the data of past prices; additionally, no type of technical analysis can help investors. The semi-strong form assumes that investors know all information available to the general public; therefore, stock prices only display significant movement with positive or negative media signals. However, with the semi-strong form, private information can provide investors with a potential arbitrage opportunity. An important note is that if the semi-strong form holds, so does the weak form. Lastly, the strong form implies that investors know all information, both public and private, so no type of information can give an investor an advantage over the market. Just as with the semi-strong form, if the strong form holds, so do all of the other forms.
There are several criticisms of the EMH; a popular criticism is that investors may overreact or underreact to certain media signals. If investors behave in either of these ways, then a particular stock would not trade at its fair value, and there is a potential for abnormal returns. It is important to remember that investors do not always behave rationally, and oftentimes they are driven purely (or at least partially) by emotion. There is another argument that certain financial ratios such as the price-to-earnings ratio can be used to value stocks using a multiples approach. People also attack the EMH from different angles, but these are two of the simplest and most common arguments. In summary, the EMH is not perfect; however, it is a general guideline when evaluating the prices of various stocks and deciding whether or not to invest.
The EMH and New Vaccine Data
Out of the three forms of the EMH, Pfizer, AstraZeneca, and Moderna’s stocks all display the semi-strong form. Still don’t see it? Let me explain. On Friday, November 6, Pfizer’s stock (NASDAQ: PFE) closed at $34.48. On Monday, November 9, Pfizer released the excellent results for its phase III trial; as a result, the stock price instantly shot up nearly eight percent to $37.14. On the other hand, AstraZeneca’s stock (NASDAQ: AZN) closed at $55.30 on Friday, November 20. When the company released its phase III trial results, the stock price decreased by approximately one percent to $54.70. As more information became available over the following days that the average efficacy of both vaccine doses was 70%, the stock price decreased by about another four percent to $52.60. Although an average of 70% is still respectable, AstraZeneca’s findings were dwarfed by Pfizer and Moderna’s superior results. Lastly, On Friday, November 13, Moderna’s stock (NASDAQ: MRNA) closed at $89.39. On Monday, November 16, Moderna released the results for its Phase III trial, and the stock price increased by about 10% to $97.95. As you can now see, each of these stocks increased or decreased immediately upon the emergence of new public information — the textbook definition of the semi-strong form.
Applying the Semi-Strong Form to Investing
Now that we have established that each of these COVID-19 vaccine stocks displays the semi-strong form of the EMH, what are the key takeaways? For starters, the average person typically invests in a particular stock based on positive or negative media signals. For example, there were probably several people that invested in Pfizer on Monday, November 9, hoping to reap the benefits of the successful phase III clinical trial. However, in the days following November 9, Pfizer’s stock decreased, and it closed on Friday, November 27 at $37.23 (only a few cents higher than the closing price on November 9). By the time an investor reads a positive headline, it is already too late to reap the immediate benefits of the good news. Nevertheless, just because an investor is too late does not mean that he/she should not invest in the company, it just means that there is not a guarantee that the stock will continue to increase or decrease based on the positive or negative media signal. The main point here is that investors should only invest in particular stocks if they truly believe in the company. Positive media signals are important, but investors should look for a trend of several positive media signals over an extended period. If a company is constantly in the headlines for the right reasons, then it is time to invest.
Conversely, investors should not immediately sell a stock based on a negative media signal. Investors should evaluate the negative media signal and then determine if the company can overcome a particular obstacle. However, if a company is consistently in the headlines for the wrong reasons, then it may be time to sell.
COVID-19 is still at the forefront of people’s minds because it is affecting almost everything we do on a daily basis. Therefore, new vaccine information, positive or negative, is likely to affect the overall stock market. Just as Pfizer, AstraZeneca, and Moderna’s stocks exhibit the semi-strong form of the EMH, so do benchmark indexes such as the S&P 500. When the next positive or negative media signal emerges about the coronavirus, do not be one of the investors that reacts immediately to the headlines. Remember, by the time you read a headline, the stock has likely already adjusted to the appropriate price. Evaluate the positive or negative media signal with this information in mind, and make a decision to buy or sell based on long-term trends.