Investors rarely misjudge a threat at the moment it first appears. They misjudge it weeks later, when the threat has become familiar and the mind files it under background noise. That pattern is visible in Canadian and U.S. markets this week, and it has a long research record.
On Tuesday, the first session after the Thanksgiving closure, the S&P/TSX composite gained 319.36 points, or 0.9%, to close at 35,983.98, led by energy stocks. The Cboe Volatility Index finished at 15.27. The same stretch produced a United Kingdom Maritime Trade Operations report of an oil tanker struck by an unidentified projectile as it left the Strait of Hormuz on Monday, and a Reuters tally of at least 12 attacks on oil, liquefied natural gas and liquefied petroleum gas tankers between September 28 and October 5.
Disaster Myopia and the Fading of a Vivid Threat
Economists Jack Guttentag and Richard Herring described disaster myopia in 1986: the tendency to treat a low-probability, high-impact event as if its probability had fallen to zero once enough time passes without it striking. A Hormuz disruption that has persisted since at least the summer is now a standing condition. Familiarity does the work that reassurance would otherwise have to do.
Amos Tversky and Daniel Kahneman showed in 1973 that people judge how likely something is by how easily examples come to mind, the availability heuristic. The first tanker strike of the conflict was easy to recall. The twelfth registers as a repeat of something already known, not as new information about the strait.
The volatility data fit the pattern. Across the 22 sessions from September 14 to October 13, the VIX closed between 14.21 and 17.71, never above 18, and each rise was reversed within a handful of sessions. That includes September 28, when the index jumped 8.07% and had given the gain back by October 2.
The VIX held a narrow range across 22 sessions while tanker attacks around the strait escalated, and it fell on the day Canada reported its second straight monthly job loss.
The shaded band marks September 28 to October 5, the window in which Reuters counted at least 12 tanker attacks around the strait; the VIX rose 8.07% on September 28. Source: Cboe via Investing.com.
The Rational Roots of the Calm
The calm is not purely psychological. On October 6 the S&P 500 reached a record high as the probability of a Federal Reserve rate hike in October fell to about 20% from nearly 70% a week earlier, according to XTB, after weaker U.S. labour market data. The same note put consensus third-quarter earnings growth for the index above 30% from a year earlier. Investors are responding to real information.
That also explains the reaction to Canadian data. Statistics Canada reported on October 9 that the economy shed 68,300 jobs in September after losing 41,700 in August, and the unemployment rate rose to 6.5% from 6.4%. The VIX fell 3.70% that day to 14.84. Weak data now reads as lower rate risk, a trade that works until the data turns from soft to broken.
The behavioural question is what happens when information points the other way. Kahneman and Tversky, publishing in Econometrica in 1979, showed that losses weigh more heavily than equal gains, and their later estimates put the ratio near two to one. Shlomo Benartzi and Richard Thaler, in a 1995 paper in the Quarterly Journal of Economics, tied the size of the equity premium to investors who combine that loss aversion with frequent portfolio evaluation, which they estimated at roughly once a year.
Why the Turn Is the Dangerous Part
Calm leaves investors with the least preparation for a loss at the moment it arrives. Terrance Odean, studying about 10,000 brokerage accounts for a 1998 paper in the Journal of Finance, found that investors realized 14.8% of their paper gains but only 9.8% of their paper losses, the disposition effect. Brad Barber and Odean, in a 2000 paper in the same journal, found that the most active households earned 11.4% a year from 1991 to 1996 while the market returned 17.9%.
For Canadian portfolios the exposure sits in two places. The TSX is weighted toward energy, which benefits from the supply risk that markets have stopped pricing, and toward financials, which carry the labour market and rate path that the Bank of Canada addresses on October 28 at 9:45 a.m. ET. A shock in either direction would land on investors who have spent weeks learning that nothing happens.
A VIX of 15.27 measures what option markets charge for protection today. It says nothing about what the Strait of Hormuz can still do, and the research suggests the costly decisions cluster at the transition, when a long quiet stretch ends and the first large loss reaches people who had stopped expecting one.