Traditional economic studies are built upon the assumption of rational human behaviour, where the final decision made is unmoved by emotions and external factors. This is known as the rational choice model. However, in the real world, we often observe irrational behaviour, decisions which lead to economic loss and market failures such as the aggressive practices of financial institutions which led to the global financial crisis in 2008. This can be explained by behavioural economics, a rather recent field of mainstream economics. It is the study of how psychological factors affect the economic decision-making process of individuals.

Irrational behaviour tends to be more prevalent in the presence of factors such as extraordinary circumstances and emotional disturbances, both of which are present during the COVID-19 pandemic. In this article, we will take a look into behavioural anomalies we have observed throughout these uncertain times.

Hoard or not

As nations across the globe pushed for extended lockdowns, demand for essential goods spiked to cope with a change in lifestyle, with healthcare-related items leading the change. The shortage worsened as some individuals began hoarding toilet rolls, sanitizers, and face masks. None of this should come as a surprise as similar trends have been observed in previous turmoils, where toilet rolls were stockpiled extensively during the oil embargo of 1973. Back then, the domestic shortage of oil ignited a chain reaction of hoarding mentality. The situation was quite extreme, as black markets for toilet rolls emerged as it became a tradable commodity. Eventually, the public came to a realization that there wasn’t a shortage of toilet rolls, and the self-fulfilling prophecy died off.

As herd mentality for sanitizers and face masks becomes normalized, the hoarding of toilet rolls warrants a separate discussion as these items are used for different purposes. Face masks protect against airborne transmission, sanitizers help eliminate infectious pathogens while toilet rolls provide no protective uses in the midst of a pandemic. What seems like fear-mongering actually boils down to the survival instinct of mankind. In the face of danger and uncertainty, our brains are hardwired to prepare for worst-case scenarios, which is an evolutionary trait. If lockdown measures intensify and get extended, the demand for toilet rolls would spike, potentially turning into a tradable commodity or currency, replicating the demand curve of the toilet rolls during the 1973 oil price embargo. Toilet rolls also symbolise hygiene, acting as a contrast to a disease, providing a false sense of security.

In general, there is a major factor that prompts hoarding. It falls under game theory, where one’s optimal move depends on the behaviour of others. The classic example of a prisoner’s dilemma corresponds to this scenario.

The table above demonstrates the interaction in the prisoner’s dilemma. If both prisoners remain silent, they receive shorter jail sentences. If both prisoners confess, they receive longer jail sentences. Since the prisoner’s dilemma assumes that individuals act optimally according to self-interest, we dissect the scenario from an individual standpoint. Prisoner A receives either 2 years or 7 years of the sentence when remaining silent and 1 year or 5 years of the sentence when confessing. The same applies to Prisoner B and we can conclude that it is always optimal to confess to minimize jail sentence. These characteristics translate to hoarding.   If the public bought only what they needed, there would be no shortages. However, if a large number of people are panic buying, the optimal play is to follow suit, merely a rational move to increase the odds of securing the said item. Prisoner’s dilemma also assumes that participants are unable to communicate, or at least do not possess perfect information, similar to how individuals are unable to gauge accurately on whether the general public is hoarding or not. Furthermore, the lack of consequences is what fuels hoarding behaviour, given the durability and affordability of healthcare-related goods, especially toilet rolls. Hence, a hoarding will almost always occur under circumstances free of external interventions. Hence, authorities started limiting purchases per person and imposing price controls to prioritize societal benefits. Supermarkets are advised to maintain a strict refund policy on sold items as well.

Divergence in equity markets

Diagram 1: Seasonally adjusted quarterly real GDP growth
(Source: U.S. Bureau of Economic Analysis)

Diagram 2: S&P 500 index from the start of Q3 2019 to end of Q2 2020
Source: Tradingview

COVID-19 had dealt irreversible economic damage, with the quarterly seasonally adjusted real GDP growth reaching a new low. However, a visual comparison of the trajectory of GDP growth rates and the stock market indicates the clear divergence between these 2 factors that are intuitively intertwined. While the economy heads towards greater uncertainty, the fact that global equities are close to previous highs is simply bewildering. It is important to be aware of the driving forces of the stock market, which is ultimately a voting machine, and the ability to predict other’s moves will pay for itself. Hence, we deduce several factors that might have caused the divergence in certain equity markets.

The outperformance of major components

Diagram 3: Indexed returns from 1st December 19 to 26th July 2020
Source: Goldman Sachs Global Investment Research

Diagram 4: Market cap of FAAMG as a percentage of market cap in the S&P 500 as of 26th July 2020
Source: Goldman Sachs Global Investment Research

As we examine the rally of S&P 500, we note that the returns are mostly driven by the top 5 components of S&P 500, the so-called FAAMG, which is Facebook, Amazon, Apple, Microsoft, and Google are up 35% on average. On the other hand, with these 5 components removed, S&P 495 is actually down 5% within the same time frame. Put that together with the fact that the market cap of the top 5 components is at an all-time high, the contribution by FAAMG has become even more significant.

Diagram 5: Consensus estimated EPS vs Actual EPS vs Earnings Surprise of FAAMG in Q2 2020
Source: Earnings Whisper

Furthermore, FAAMG has collectively exceeded the consensus estimate in terms of earnings per share during Q2 of 2020, with a collective average of 114% as an earning surprise. With FAAMG being in the information technology sector which is the least affected by the pandemic, perhaps the 35% increase of FAANG leading to the impressive recovery of broader markets in the specified time period is justified after all.

Market weighted indexing vs equal-weighted indexing

Diagram 6: Cumulative return of $1 invested in the S&P 500
(Source: Seeking Alpha)

The index recovery is partially due to the way it is calculated using the market-weighted methodology, where the index components would contribute proportionally based on their market capitalization. For example, assuming the market cap of the S&P 500 is $100 whereas the market cap of Facebook Inc being $20, Facebook would contribute 20% of its percentage change to the S&P 500. Components with larger market cap carries a higher influence to the index, in this case, potentially providing a distorted view of current markets. Critics of market-weighted methodology have opted for the usage of equal-weighted methodology, where components are given equal weightage within the index. Equal weighting has several advantages over market weighting. Historically, equal-weighted indexes would outperform market-weighted indexes over long time frames. But one could argue that this is due to the higher weight is given to small-cap companies, where it consistently outperforms large-cap companies on a historical basis at the cost of higher volatility. Equal weighted indexes prevent overexposure to certain companies and sectors. Information technology, financials, and healthcare constitute up to 20.69%, 16.48%, 15.17% of the S&P 500, which might translate to a lack of diversification. With passive investing via index investing gaining popularity in recent years, experts have considered the possibility of an index bubble, where large components would be continuously propped up by index fund inflows to replicate the returns of a market-weighted index if larger components continue to outperform. Lastly, equal-weighted indexes also lean towards value investing, where exposure of underperforming components are increased and exposure of outperforming components are decreased. This might be well suited for investors depending on one’s preference, compared to market-weighted indexes which lean towards momentum-themed investing.

Expansionary policy

Government intervention is crucial in cushioning the blow to equity markets. The Federal Reserve has pumped 1.5 billion worth of loan injections into the repo markets during March 2020. By purchasing these collateralized securities, the Fed is said to provide liquidity to financial institutions to smoothen their operations, indirectly allowing financial institutions to increase their equity exposure. Interest rates or yield has also been decreasing since the pandemic began due to the Fed steadily cutting funds rate, which is the rate where commercial banking institutions lend between one another on an overnight basis. The fund rate is directly correlated to base lending rates, fixed deposit rates, saving accounts rate, etc. As the yield of these assets turn unattractive, it is only natural that money flow is sought towards equities.

The retail madness

Diagram 7: Retail investor participation as of May 2020
(Source: Bursa Malaysia)

Diagram 8: Volume of penny stocks accounted up to a quarter of volume on 8th July 2020
(Source: Bloomberg)

As we shift our attention to the local scene, retail participation in the stock market is also on the rise since the pandemic. It is said that the shutdown of gambling avenues has attracted gamblers to search for alternatives. The availability of idle time during lockdowns also allowed retail investors to allocate time to study about investments, which have resulted in an increase in retail participation. One shouldn’t simply attribute the surge of retail trading volumes as uninformed and speculative. But the higher traded volume of penny stocks does indeed indicate so. The number of limit ups, with stocks hitting their upper limit for no apparent reason also increased drastically where Bursa Malaysia had to issue unusual market activity (UMA) queries, prompting the queried company to disclose relevant corporate developments or clarifying rumors that might’ve been driving the increase in prices. Self-declared investing guru’s became a trend on social media, making buy calls that resemble a typical pump and dump process with retail investors following their advice without making their own assessment. Rakuten Trade, a brokerage firm became a victim after certain individuals were found to misrepresent the company in an investment scam. Despite the aforementioned circumstances, there is no short of fixation on the meteoric rise inequities, which induced fear of missing out among the retail investors. After all, it doesn’t feel good when everyone is prospering without you. But abnormal profits like this don’t last forever, and markets always revert to its true mean. Investors are ultimately responsible for their portfolio so that they are not swimming naked when the tide goes out.

Curbing the craze

There are several countermeasures that could be taken to reduce rampant speculation. As mentioned before, stocks have been frequently seen hitting limit ups. The upper limit, which is currently 30 cents for stocks below RM1 and 30% for stocks above RM1 can be reduced to prevent prices from spiraling beyond control. Most speculative traders rely on margin financing, where one buys stocks by borrowing from their brokerage and contra trading, which clients are able to buy stocks without having cash upfront, all which allows one to reap short-term gains in an efficient manner. Perhaps brokerage firms can impose limits on the amount of margin financing and contra trading to trim down speculative trading. More unfavorable policies like imposing a tax on stocks that are bought and sold less than a specific number of days, effectively acting as a tax on short term capital gains could also be considered. However, it is important to proceed with caution as these measures directly oppose the principles of a free market, reducing overall liquidity which might deter prospective investments.

Ban on short-selling

On 23rd March 2020, Securities Commission Malaysia (SC) decided to impose a short-selling ban until the end of 2020 to mitigate heightened volatility, potentially increasing the upward bias. Market participants are mixed on the decision to extend the suspension on short selling. Some are favouring the move to prevent a continuous downward spiral, which is a bearish phenomenon with continuous selling pressure causing investors to sell their positions, leading to more selling pressure, effectively creating a deadly loop. There are others who disagree due to the unavailability of short selling leading to inefficient prices, in a sense to avoid unrealistic valuations, given that there have been signs of market euphoria.


Behind the facade of irrationality, there is always a glimpse of intuition that drives seemingly unreasonable actions. The study of behavioural economics is fairly new compared to other schools of economics, rendering some to view it as pseudoscience. As we delve deeper into behavioural studies and explore more into human behaviour, time will tell whether behavioural economics can stand on its own feet.

Researcher: Cheong Jian Yan

Reviewers: Vikky Beh, Yang Ler

Editors: Adam Jantan, Hui Zhen Tay

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