Aswath Damodaran We decided early on to not treat the Covid-19 crisis like previous market shocks.
He was capable of observe the pandemic because it developed and recognized that it had the identical three-pronged effect on investors as previous financial upheavals.
Damodaran experienced this process like everyone else, but he decided to do it otherwise this time and record his thoughts and impressions in real time.
Why? Because hindsight is at all times 20/20: “You can’t ignore what you already know,” says Damodaran. “So you write about the 2008 crisis in 2010. You know how it developed. You know how it ended. So you can act as if you knew it from the beginning.”
But within the face of COVID-19, he was determined to not fall into that trap.
On February 26, 2020, he wrote the primary post in his pandemic series, about two weeks after the true global impact of the coronavirus got here into focus. His post reflected the confusion everyone was feeling and underscored how much we still didn’t know concerning the coronavirus.
And over the subsequent eight months, he recorded his evolving views on the crisis, writing the 14th and final entry within the series in early November.
Looking back on his report on these turbulent months, he got here to the next conclusion:
“It’s a play in three acts,” he said. “The collapse, the collapse, the realignment.”
Act I: The Meltdown
Stocks began 2020 with considerable momentum.
“They’ve come in full steam ahead,” Damodaran said. “2019 was a great year for stocks. U.S. stocks rose about 30%.”
And in the primary six weeks of 2020, they continued to rise, reaching record levels. But then, on February 14, the Italian government announced that it had identified 200 Covid-19 cases that might not be traced back to a cruise ship or Asia. It was clear that the pandemic was not contained and had spread globally.
“So we woke up to the crisis,” Damodaran said. “And do you remember what happened in the next five weeks? We had a collapse.”
Curfews were imposed, schools and borders closed, and huge parts of the worldwide economy got here to a standstill. Both the S&P 500 and the NASDAQ plunged by 30% or more. And it wasn’t just the US markets that were affected. Stock indices around the globe took a nosedive.
“On March 20, the darkest day, they were all in the red,” he said. “There was not a single index that was unaffected.”
The collapse in stock prices triggered a flight to protected investments and US government bonds.
“U.S. Treasury yields have fallen across the board,” Damodaran said. “The 30-year, 20-year and 10-year Treasury yields have all fallen in the first five weeks.”
The US Federal Reserve intervened and announced the resumption of quantitative easing on March 15. But that was not enough.
“The market yawned and said, ‘Who cares?'” Damodaran said. “It looked like the world was ending. In fact, if you look at the news, March 23 was Judgement Day. People said, ‘Sell your stocks, get out, the end is near.'”
Act II: The Collapse
But then – just when it looked as if the markets were about to plunge into one other global financial crisis or Great Depression – they suddenly stabilized.
What happened? On March 23, the Fed took much more substantive motion, promising to function a security net in private credit markets.
“You know what they meant by that, don’t you?” he asked. “They lent money to struggling companies and bought low-rated corporate bonds. And that seemed to turn the crisis around, for better or worse.”
Private lenders began lending again and the markets stopped their downward spiral.
“For some reason, we woke up on March 24 and everything seemed to have cleared up,” Damodaran said.
And within the months that followed, the stock markets not only recovered all their losses but even reached latest highs.
“By September 1, stocks were roughly at the same level as on February 14,” he said. “The crisis was behind us.”
Act III: The Recalibration
Over the subsequent two months, markets attempted to achieve equilibrium.
“Between September 1 and November 1, there was a recalibration,” Damodaran said. “We had good days and bad days, but the market was trying to find a stable state.”
So how has the crisis modified the markets in these eight months?
The worst performing industrial economy was the UK, which needed to address Brexit along with the pandemic. The worst performing regions were Russia, Eastern Europe, Africa and Latin America.
Why these 4? Because they rely upon raw materials and infrastructure corporations that were disproportionately affected by the economic upheaval.
Damodaran also identified the sectors most affected by the pandemic through November 1. Based on his evaluation of world S&P corporations, consumer goods, technology and healthcare performed well, while energy, real estate and utilities performed poorly, together with financials.
“In most crises, young companies suffer at the expense of old companies, with risk-taking companies being hit harder than risk-averse companies,” said Damodaran. “This crisis seems to have flipped the script.”
The only exception to this rule was debt: corporations with high debt underperformed those with low debt. But otherwise, high-growth corporations beat low-growth corporations, non-dividend corporations beat high-dividend corporations, and high-P/E corporations beat low-P/E corporations.
In fact, during these eight months, the stock markets were all concerning the redistribution from risk-averse to risk-taking corporations.
Addendum: The lessons
So what else was different about this crisis? Firstly, the markets normally collapse first, taking the broader economy with them. In this case, it was the opposite way round.
“The order was wrong,” Damodaran said. “And there was a timer. The timer was, of course, a complete lie: that in six months we would all be able to go back to our normal things.”
Another difference was the role of enterprise capital (VC). VC tends to remain out of monetary crises because initial public offerings (IPOs) are placed on hold. Venture capitalists, alternatively, have never left the sphere.
“They’ve stayed in the game the whole time,” Damodaran said. “In fact, the third quarter of 2020 was an all-time high in the number of IPOs.”
And the investor class has undergone a certain transformation in the course of the pandemic. The role of the massive portfolio managers in Boston, New York and London has change into increasingly smaller.
“The composition of investors has changed,” Damodaran said. “This is a market driven by the masses of investors and portfolio managers have to keep an eye on the masses. They hate it. They like calling the shots, but they don’t control this game anymore.”
But the larger theme of the eight months between February 14 and November 1 is the impact of the pandemic on high-risk corporations, and 6 particularly: Facebook, Amazon, Apple, Netflix, Google and Microsoft.
“The profits of these six companies amounted to about $1.3 trillion,” he said.
During the identical period, all other U.S. stocks lost $1.3 trillion.
“Do you know why U.S. stocks are back?” Damodaran asked. “It’s because of these six companies. If you take these six companies out of the mix, all the upside disappears. The stronger ones get stronger.”
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