The widening gap in performance and the valuation surge among a few elite companies demonstrate the pandemic-induced acceleration of trends.
The gaps in performance between different sectors, and the companies within those sectors, increased last year. A major reason is a small group of outperformers that already had massive stock valuations before the COVID-19 crisis and have pulled further ahead since. Coauthors of a recent article, Sean Brown, Tim Koller and Peter Stumpner discuss what the performance of capital markets during the pandemic indicates about future economic and investment trends.
Sean Brown: Peter, in your article you describe the capital markets going through four acts during the first year of the pandemic. Can you walk us through that?
Peter Stumpner: If you go back to 2019, the markets went up significantly and that momentum continued into 2020. The markets peaked on February 19, 2020, when investors started to realize that the pandemic would have a significant impact and the markets started to drop—first gradually, and then rapidly. All sectors sharply declined in the early days of the pandemic (Exhibit 1). A couple of days in early March of last year saw declines of over 10 percent.
In mid to late March, we hit a turning point. After March 23, the markets started to rebound and by June some sectors had recovered and turned positive. Others, however, such as the aerospace and defense industry and the air and travel sectors, continued to be significantly affected by the travel bans and lockdowns. By October, that differentiation became more pronounced. Some sectors declined further between June and October while others had not only recovered but turned significantly positive. A steep decline across the board at the beginning of a crisis is fairly normal, but the recovery was faster than in some previous crises. Also, while most sectors had recovered a year in, the difference between the top- and bottom-performing sectors did not shrink but rather has continued to grow. The difference in performance between consumer durables and aerospace, for example, was bigger this past February than it was at any point before.
Sean Brown: Tim, you have analyzed capital market movements over many decades. Do you see anything else distinctive about the stock market patterns during this crisis?
Tim Koller: We saw a similar pattern in 2008 and 2009, and also in the early 2000s. Bad news about the economy leads retail investors to panic and sell a lot of stocks, but then institutional investors realize that some sectors are undervalued, they start to buy, and the markets come back. The comebacks tend to vary by sector based on how the market expects the crisis to affect each sector. This is why you saw such big differences in sector performance last year.
Sean Brown: What about the effect of surplus cash? There was a lot of cash in the market last year, especially with consumer savings rates rising in many countries.
Tim Koller: That cash is spread among a lot of people, not all of whom are investors. It will be interesting to see what consumers spend that money on and whether they keep it as savings. This does not, however, appear to have affected the stock markets directly. What really matters is companies’ ability to generate cash. If investors believe that consumers will spend more of that cash on certain types of companies, their shares will go up. For example, the travel and leisure sector still has not recovered because consumers may hesitate to spend money on travel for a while.
Sean Brown: Peter, you mentioned there are growing differences in the performance of various industries. Have the gaps widened between companies as well?
Peter Stumpner: Across all industries, we see significant differences between companies on the lower end of the spectrum in terms of shareholder returns and those at the higher end, with the differences being more pronounced in some industries. The reason is that some companies were much more negatively affected by the pandemic than others in their sectors. Entertainment, for example, includes online gaming as well as theme parks or casinos. While online gaming did well last year, casinos and parks did not because of travel bans and lockdowns. The variance is largely due to companies at the top of the distribution pulling ahead. There is a group of companies with very high shareholder returns, which widens the distribution more than particularly low shareholder returns for companies at the bottom.
Sean Brown: You mentioned earlier the disconnect between the capital markets and the broader economy. Are there reasons other than the Mega 25  that explain why the markets have performed so well even though the economy has been in a deep downturn?
Tim Koller: Another reason is that the economy and the stock market have different characteristics. The real economy has a lot of activity in sectors with few publicly listed companies. In the US, the real estate and construction sectors for the most part are not made up of public companies. Professional and technical services are the same; so are healthcare services and doctors’ offices. When you look at employment, restaurants and hospitality play a major role, but there are few publicly listed companies in those sectors.
Public companies tend to be concentrated in technology, pharmaceuticals, medical devices, finance, and insurance, and the technology and pharmaceutical companies have done particularly well recently. Additionally, many US technology and pharma companies are effectively exporters: they earn a lot of their profits abroad, which does not directly contribute to US employment, but it does affect their stock market value. The disconnect is not as extreme in other markets.
Who is who?
Sean Brown, global director of communications for McKinsey’s Strategy & Corporate Finance Practice, is based in Boston.
Tim Koller is a leader in McKinsey’s Strategy & Corporate Finance Practice and the author of the best-selling book, Valuation.
Peter Stumpner leads the corporate performance analytics group within the Strategy and Corporate Finance Practice. He is the coauthor of another article on which this podcast is based on, “ The impact of COVID-19 on capital markets, one year in.”
Source This interview is based on, “The impact of COVID-19 on capital markets, one year in” Inside the Strategy Room podcast. This is an edited and shotened transcript of the discussion. You can listen to the full podcast episode on Apple Podcasts.