Strategy & Corporate Finance Practice

In conversation: The
impact of COVID-19 on
capital markets
The widening gap in performance and the valuation surge among a
few elite companies demonstrate the pandemic-induced acceleration
of trends.

© Andriy Onufriyenko/Getty Images

June 2021
 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. In this episode of the
Inside the Strategy Room podcast, coauthors of a
recent article discuss what the performance of
capital markets during the pandemic indicates about
future economic and investment trends. 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 per­
formance analytics group within the Strategy &
Corporate Finance Practice. He is the coauthor of
another article on which this podcast is based, “The
impact of COVID-19 on capital markets, one year
in.” This is an edited transcript of the discussion. You
can listen to the podcast episode on Apple Podcasts,
Spotify, or Google Podcasts.
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
‘A steep stock market decline across the
board at the beginning of a crisis
is fairly normal, but the recovery was
faster than in some previous crises.’
–Peter Stumpner
2 In conversation: The impact of COVID-19 on capital markets
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?
Exhibit 1
The stock
The went through
stock market went through four acts.
acts.

Weighted average shareholder returns by industry since February 19, 2020, %

Act 1: Decline across sectors (Mar 23, 2020) Act 3: Amplification of difference (Oct 23, 2020)

Act 2: Differentiation of sectors (Jun 9, 2020) Act 4: Anticipated recovery (Feb 19, 2021)
–50 0 50 100

Aerospace and defense

Telco
Oil and gas
Real estate
Utilities
Insurance
Air and travel
Banks
Transportation and infrastructure
Food and beverage
Business services
Diversified financials
Personal and office goods
Pharma and biotech
Conglomerates
Healthcare supplies
Apparel, fashion, and luxury
Retail
High tech
Consumer services
Basic materials
Chemicals
Medical technology
Automotive and assembly
Logistics and trading
Advanced electronics
Media
Healthcare services
Consumer durables
Mega 251

–50 0 50 100

A group of 25 companies with market-capitalization gains that place them in their own category.
1

Source: Corporate Performance Analytics; S&P Global

In conversation: The impact of COVID-19 on capital markets 3

 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 come­
backs 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: Did interest rates have much of an
impact on how capital markets reacted? The rates
have been exceptionally low and central banks
were signaling that they would not raise them in
the near term.
Tim Koller: We have been studying the impact of
interest rates on valuations and the cost of equity
for well over 20 years now. While interest rates
obviously affect the cost of corporate borrowing, we
have found that they do not affect the cost of equity.
Investors demand the same returns regardless
of what is happening to interest rates. We saw that
during the Great Recession and we see it now.
As interest rates go up or down, corporate valuations
do not change much. That makes sense because
if you are an investor, you don’t want to assume that
interest rates will stay low—they could rebound
and that would affect valuations. We have a model
that reverse engineers share prices and we
consistently come up with about 7 percent for the
“real” cost of equity. The nominal cost of equity,
assuming approximately 2 percent inflation, is about
9 percent.
Sean Brown: Typically, one would talk about the
cost of capital as the risk-free rate plus a risk
premium. Is that different now because the risk-free
rate is going down?
Tim Koller: We used to say that the return on long-
term government bonds was the risk-free rate. Now,
there is a question about whether the market’s
perception of the risk-free rate is the same as the
current yield on government bonds because
central banks have begun to manipulate those rates.
4 In conversation: The impact of COVID-19 on capital markets
They have been buying a lot of both government
and corporate bonds and pursuing quantitative
easing. You also have risk-averse investors moving
into government bonds, pushing up prices and
lowering rates. We have found that the most logical
way to address this is to construct a synthetic risk-
free rate based on long-term trends in the risk-free
rate, an approach a number of banks and academics
use as well. From this, we come to the conclusion
that the typical cost of capital for a large company is
about 7 percent in real terms. That is why there
is a disconnect between the government bond rate
and what we used to think of as the risk-free rate.
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 com­
pa­nies’ 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 indus­
tries. 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: In your article, you call the group of
companies with extremely high shareholder returns
the Mega 25. How did you define them?
Peter Stumpner: When we were doing the research,
we realized that a small number of companies
accounted for a significant share of the total market
capitalization. Our sample included 5,000
companies, which covers most of the market, but
25 of them accounted for 40 percent of the total
market cap added between February 19, 2020, and
February 19, 2021 (Exhibit 2). So it was important to
take them out of the overall sample and treat
them with a separate lens.

Exhibit 2
The ‘Mega
The ‘Mega 25’
25’ are a sector of their
sector of their own, with exceptional market
market performance.
performance.

Market cap change since Feb 19, 2020, peak for Mega 25 companies,1 $ billion2

Category, % of total 5,774

China Tourism Group Duty Free 83
Chinese consumer 8 Wuliangye Yibin 124
Kweichow Moutai 251
Semiconductor 10 ASML 95
NVIDIA 177
Taiwan Semiconductor Manufacturing Company 289
Electric vehicles 13 Contemporary Amperex Technology Co. 83
BYD 84
Tesla 581
JD.com 102
Asia tech 23 Alibaba 117
Sea 120
Samsung 132
Pinduoduo 197
Meituan 246
Tencent 406
Square 88
Zoom 93
Shopify 113
North America tech 47
Facebook 125
PayPal 191
Alphabet 364
Microsoft 393
Amazon 556
Apple 764

Figures may not sum to total, because of rounding.

1

At constant, average exchange rates.

2

Source: Corporate Performance Analytics; S&P Global

In conversation: The impact of COVID-19 on capital markets 5

 Sean Brown: Is the performance of these
companies a major reason why the stock market
did so well last year?
Tim Koller: Yes. There is a disconnect there
and part of the reason is the valuation of these
Mega 25 companies.
Peter Stumpner: There are some clear patterns in
the type of companies included in that group. Almost
half of the total market cap was added by North
American technology companies. The group with
the second-biggest market-cap growth are
Chinese and other Asian technology companies,
which benefited from similar trends around
working from home, digital payments, and online
shopping and entertainment. The third-biggest
are electric-vehicle companies, followed by the
semiconductor industry. Finally, there are a couple
of Chinese consumer-goods companies that
did very well last year. The Chinese market is slightly
different because its recovery from the pandemic
happened much faster and sooner. One important
point is that we saw trends which were already
there accelerate during this crisis and companies
that did well before the pandemic did particularly
well during the pandemic.
Sean Brown: Given the market capitalization of the
Mega 25, should investors worry that those
companies may be in a bubble?
Tim Koller: A bubble is when share prices of
a company or a sector—and sometimes an entire
market—rise to a level out of line with economic
fundamentals. Ultimately, all bubbles burst, so you
can recognize a bubble after the fact when the
share prices come back down. We saw that the 1999
tech boom was a bubble. We have seen bubbles
in utility stocks in the US and in biotech. Bubbles
usually don’t last more than a couple of years.
The question about the Mega 25 is whether the
economics can sustain their valuations. If a
company is worth $1 trillion or $750 billion, what
would you have to believe about its future
performance to justify that valuation? Businesses
eventually mature and their valuations always
come into line with their economics—at least that
has always been the case.
6 In conversation: The impact of COVID-19 on capital markets
Another thing to assess when you are looking for
bubbles is who is driving up the share price. Is it
retail investors or institutional investors? If it is retail
investors, that is more likely to indicate a bubble
because it suggests that more sophisticated
investors think those stocks are overvalued. That
creates bubbles because the markets are not
perfectly liquid. If you think a stock is overvalued, it
is difficult to bet against that stock. You can short
it, but that is very risky because the share price could
continue going up for a while, even if you are
right. This happened in 1999 and 2000 in tech and
it happened in 2008 in the real-estate market.
Many people went bankrupt because they could not
provide enough capital to maintain their positions
long enough to be proven right.
To see what is driving the market, one thing to look
at is the weighted average price-earnings [PE] ratio.
In the US market, average PE weighted by the
market capitalizations of the companies is extremely
high now, at a multiple of 23. Interestingly, the
median is much lower, at 16. Over time, ignoring
some unusual years like 2008, the median
has been fairly constant, with the typical large US
company trading at a multiple of 13 to 16. Over
the past two years, the weighted average deviated
substantially from the median, which means that
a handful of very large companies are distorting that
number. If the cost of equity had gone down, you
would expect the median company to be trading at a
25 multiple or higher. This is further evidence that
the cost of equity has not changed.
Sean Brown: Considering what you just explained,
Tim, does that suggest to you that the Mega 25 have
entered bubble territory?
Tim Koller: We have done some back-of-the-
envelope calculations on Mega 25 companies and
for some, it is hard to imagine them achieving
a level of performance far beyond what it is today on
a sustainable basis. For example, some of those
companies rely primarily on advertising for their
revenues and there is a limit to how much an
economy can spend on advertising. You either have
to believe that advertising as a percentage of
the economy will increase, which is highly unlikely, or
that these companies will find new sources of
‘It is hard to imagine the Mega 25
companies achieving a level of
performance far beyond what it is today
on a sustainable basis.’
–Tim Koller
revenue. Their valuations are unlikely to be justified
by their current core businesses in the future,
so you have to believe that they will enter new
businesses that will create massive amounts of value.
You typically do not see that. In the past, most
companies that were very successful in a particular
market rarely created as much value in the second
or third market they entered. To put it in a nutshell, I
am skeptical about the sustainability of these
companies’ share prices.
Sean Brown: Unlike past bubbles, these companies
are not just speculative investments—they have real
earnings and cash flows. Do the winner-take-all
scenarios that are emerging in the digital economy
play a role in these companies’ valuations?
Tim Koller: Yes, the winner-take-all phenomenon
does exist but only in specific markets, such as
advertising. Online advertising is becoming a bigger
part of total advertising, for example, and it shifts
to certain players. But there is a limit to how big the
advertising business can be. Secondly, it is not
clear that the other businesses these companies
will get into will have the same winner-take-all
characteristics. Many companies are entering into
electric vehicles, but if you look at the history
of the automotive industry, it does not have the
characteristics of a winner-take-all business.
Consumers are willing to switch brands and compa­
nies catch up on innovations quickly. Over time,
almost all of the value that has been created from
innovation in the car industry has flowed to
consumers and you would expect that to be the
In conversation: The impact of COVID-19 on capital markets
case going forward. If ten or 15 global automobile
companies continue to compete vigorously in
electric vehicles to the benefit of the consumer, the
profit margins can only go so high.
Sean Brown: As central bank easing continues and
government bonds potentially become overvalued,
is it possible that institutional investors are viewing
the Mega 25 as less risky and more attractive
from an asset allocation perspective?
Tim Koller: That is conceivable. But if you are an
institutional investor, you will be very cautious about
a company that is valued so highly, because what
matters is what the value is in five years, not what it
is now. Chasing trends can be dangerous because
you are often behind and you have to be smart
enough to know when to get out. I don’t think that is
a big driver. I think the Mega 25 are being driven
up by retail investors and the institutions are sitting
on the sidelines.
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
7
 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 tech­
nology, 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.
Sean Brown: Given that stock market composition
is different around the world, how have capital
markets’ performance varied across regions?
Tim Koller: China is up 40 percent, North America
is up 22 percent, Asian markets excluding China
have risen 20 percent. Much of this has to do with
different compositions of the regional economies
and different presence of the Mega 25 companies.
For the North American market, the Mega 25
accounted for 8 percent of the total returns to
shareholders. Europe does not have many
of those high-flying companies and that took
7 percent off their returns last year.
Peter Stumpner is an associate partner in McKinsey’s New York office. Tim Koller is a partner in the Denver office. Sean
Brown, global director of communications for the Strategy & Corporate Finance Practice, is based in Boston.
Designed by McKinsey Global Publishing
Copyright © 2021 McKinsey & Company. All rights reserved.
8 In conversation: The impact of COVID-19 on capital markets
Sean Brown: Institutional investors increasingly
focus on environmental, social, and corporate
governance [ESG] issues. To what extent do you see
ESG affecting the market performance of different
sectors and companies in the future?
Tim Koller: Yes, there is an enormous increase in
focus on ESG among both institutional and retail
investors, but it is not clear yet that they are willing
to sacrifice returns and pay a higher price for the
shares of companies with high ESG ratings. Right
now, there is no empirical evidence linking ESG
performance and stock market performance. A lot of
studies are very short term oriented and do not
adjust for industry.
Part of the problem is that companies with the
highest ESG scores tend to be in industries that
have been performing strongly, such as tech
and pharma. Those sectors also do not have much
emissions and tend to be more forward thinking
on social issues, so there is more of a correlation
than a causation. Oil and gas has gone down in price
with the economic decline, but it is hard to tease
out the ESG element there. The other problem is that
a lot of ESG ratings are contradictory. A company
may have a high rating in one company’s index and a
low one in another. That said, there are plenty of
opportunities to do better from an ESG perspective
while also creating value for shareholders.