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Aswath Damodaran on the COVID Crucible: A Play in Three Acts


Aswath Damodaran decided early on to not deal with the COVID-19 disaster like earlier market shocks.

Because the pandemic unfolded, he might see the way it was creating and realized it was having the identical three-stage impact on traders as earlier monetary upheavals.

“First you lose perspective. Why? As a result of in the midst of chaos, issues are melting down,” he defined in his digital presentation, “Disaster as Crucible,” for CFA Institute on 10 November 2020. “The second factor that occurs is you lose religion in [the valuation tools] that you simply thought mattered. . . . And the third factor is you outsource your considering.”

Damodaran skilled this course of like everybody else, however he determined that he would do issues in a different way this time and maintain a document of his ideas and impressions in actual time.

Why? As a result of hindsight is at all times 20-20: “It’s unattainable to maintain out what you already know,” Damodaran mentioned. “So that you write concerning the 2008 disaster in 2010. You understand how it unfolded. You realize the ending. So you possibly can act such as you knew it proper from the start.”

However with COVID-19, he decided to not let himself fall into that lure.

So on 26 February 2020, he wrote the primary submit in his pandemic-focused collection. It was about two weeks after the true world ramifications of the coronavirus began to return into focus. His submit mirrored the confusion that everybody felt and underscored how a lot we didn’t but know concerning the coronavirus.

And over the subsequent eight months, he recorded his evolving views on the disaster, writing the 14th and closing entry within the collection in early November.

Wanting again over his account of these tumultuous months, he got here to a conclusion:

“This can be a play in three acts,” he mentioned. “The meltdown, the melt-up, the recalibration.”



Act I: The Meltdown

Shares entered 2020 with appreciable momentum.

“What they got here in with was a full head of steam,” Damodaran mentioned. “2019 was an awesome yr for shares. US equities had been up about 30%.”

And for the primary six weeks of 2020, they saved rising additional and approached all-time highs. However then, on 14 February, the Italian authorities introduced that it had discovered 200 COVID-19 circumstances that couldn’t be traced again to a cruise ship or to Asia. It was clear that the pandemic was not contained and had gone world.

“So we woke as much as the disaster,” Damodaran mentioned. “And for the subsequent 5 weeks, bear in mind what occurred? We had a meltdown.”

Lockdowns had been instituted, colleges and borders had been closed, and far of the worldwide economic system floor to a halt. Each the S&P 500 and NASDAQ plummeted by 30% or extra. And it wasn’t simply US markets. Fairness indices around the globe went right into a nosedive.

“On March 20, the very darkest day, they had been all down,” he mentioned. “There wasn’t a single index that was unaffected.”

The plunge in equities initiated a flight to security and US Treasuries.

“Throughout the board, Treasury yields dropped,” Damodaran mentioned. “Thirty-year, 20-year, 10-year T-bills all down within the first 5 weeks.”

The US Federal Reserve stepped in and introduced on 15 March that it could resume quantitative easing (QE). However that wasn’t sufficient.

“The market’s yawned and mentioned, Who cares?” Damodaran mentioned. “It regarded just like the world was ending. In actual fact, on March 23, for those who regarded on the information tales, it was doomsday. Folks mentioned, Promote your shares, head for the hills, the top is coming.”

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Act II: The Soften-Up

However then, simply because the markets regarded poised to plunge into one other world monetary disaster (GFC) or Nice Melancholy, they abruptly stabilized.

What occurred? On 23 March, the Fed initiated much more substantive measures, pledging to function a security internet within the non-public lending markets.

“You realize what they meant, proper?” he requested. “They might lend to firms in hassle, purchase low rated company bonds. And for higher or worse, that appeared to show the disaster round.”

Non-public lenders began lending and the markets halted their downward spiral.

“For no matter cause, we wakened on March 24, and all the things appeared to have cleared,” Damodaran mentioned.

And within the ensuing months, the fairness markets not solely recovered all the things they’d misplaced, they headed to new heights.

“By September 1, shares had been as much as about the place they had been on February 14,” he mentioned. “The disaster was within the rearview mirror.”

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Act III: The Recalibration

Over the subsequent two months, the markets regarded to attain an equilibrium.

“Between September 1 and November 1, there was a recalibration,” Damodaran mentioned. “We had good days and dangerous days, however the market was looking for a gradual state.”

So how had the disaster reshaped the markets in these eight months?

The worst-performing industrial economic system was the UK, which needed to climate Brexit on high of the pandemic. The worst-performing areas had been Russia, Jap Europe, Africa, and Latin America.

Why these 4? Due to their reliance on pure useful resource and heavy infrastructure firms, which had been disproportionately impacted by the financial disruption.

Damodaran additionally recognized the sectors most affected by the pandemic by means of 1 November. Primarily based on his evaluation of S&P world firms, shopper discretionary, expertise, and heath care got here out effectively, whereas vitality, actual property and utilities fared poorly, with financials falling with them.

“In most crises, younger firms endure on the expense of previous firms, risk-on firms get damage greater than risk-off firms,” Damodaran mentioned. “This disaster appears to have flipped the script.”

The one exception to that rule was debt: Excessive-debt companies carried out worse than their low-debt counterparts. However in any other case, high-growth beat low-growth, non-dividend beat high-dividend, and excessive P/E beat low P/E.

Certainly, the main story within the fairness markets throughout these eight months was the reallocation from risk-off to risk-on firms.

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Postscript: The Classes

So what else was totally different about this disaster? For one factor, markets normally soften down first and convey the bigger economic system with them. On this case, it was the opposite means round.

“The sequencing was off,” Damodaran mentioned. “And it got here with a timer. The timer, in fact, was an entire lie: that in six months we’ll all be again to doing the traditional stuff.”

One other distinction was the position of enterprise capital (VC). VC tends to take a seat on the sidelines amid monetary panics, as preliminary public choices (IPOs) are placed on maintain. However the enterprise capitalists by no means left the sphere.

“They stayed within the recreation throughout.” Damodaran mentioned. “In actual fact, the third quarter of 2020 was an all-time excessive for the variety of IPOs.”

And the investor class underwent one thing of a metamorphosis throughout the pandemic. The massive portfolio managers of Boston, New York, and London noticed their roles diminished.

“The composition of traders has modified,” Damodaran mentioned. “This can be a market pushed by the lots of traders the place the portfolio managers have to trace the lots. They hate it. They prefer to name the pictures however they not management this recreation.”

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Nonetheless the bigger story of the eight months between February 14 and November 1 is the have an effect on the pandemic had on risk-on firms, six of them specifically: Fb, Amazon, Apple, Netflix, Google, and Microsoft.

“These six firms had been up about $1.3 trillion,” he mentioned.

Over the identical interval, all different US equities had been down $1.3 trillion.

“You realize why US equities are again?” Damodaran requested. “It’s due to these six firms. You’re taking these six firms out of the combo, all of that upside disappears. The stronger grow to be stronger.”

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All posts are the opinion of the writer. As such, they shouldn’t be construed as funding recommendation, nor do the opinions expressed essentially mirror the views of CFA Institute or the writer’s employer.

Paul McCaffrey

Paul McCaffrey is the editor of Enterprising Investor at CFA Institute. Beforehand, he served as an editor on the H.W. Wilson Firm. His writing has appeared in Monetary Planning and DailyFinance, amongst different publications. He holds a BA in English from Vassar Faculty and an MA in journalism from the Metropolis College of New York (CUNY) Graduate Faculty of Journalism.

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