Question

- As you know, recently stock returns all around the world have fallen dramatically. This seems to be mainly due to coronavirus. In contrast, I have noticed that the return of a stock (let me call it XYZ Stock) has increased substantially recently. (I am sorry that I cannot tell you the name of the company now for various reasons.) Does this mean that XYZ Stock is definitely overpriced, so XYZ Stock price will definitely fall after the crisis? Please justify your answer. (I know that I have not given you detailed information, hence, there can be many possible explanations, so a few (2 or 3) possible reasoned explanations from you will be more than enough.)

- (Please note that the only finance course I took back in my university days was Introduction to Finance and I remember basic finance terms, but it has been a long time. So, please answer my questions clearly in simple terms. I will be ok with some formulas, but please try to minimize the use of them. Also, could you please not copy and paste sentences from other sources? I would like to know your thoughts and see your writings on the above issues.)

Answer 1

Reason 1: Well, lets look at what fundamentally drives stock prices. Its news! But whether the stock price is overpriced in a bear market and whether the price will subsequently fall or not is dependent on how "structurally" the business is expected to change. Sometimes, its events like these which throw up opportunities and markets will jump into the first opportunity they get to buy into something. For example, in this time of crisis, humans still need entertainment. So companies who develop and sell digital content would benefit hugely as the surge in app downloads and online activity will spike because everybody at home will log into say a Netflix or Amazon Prime and "binge watch". Similarly, online communications companies who facilitate video conferencing and video calls will benefit hugely as there will be a surge worldwide as businesses would not want to shut shop and will want employees to continue to work. So, it depends on how "structural" the change in the environment is. Subsequently, if people resume to the way they worked before, its quite likely that these companies which ran up, will also fall equally fast, if not faster! On the other hand, if businesses realise that they can continue functioning with employees working from home, (in a post crisis scenario), then its quite likely that these companies may actually move much higher.

Reason 2: At times like these, its quite likely that world over, both Federal Governments as well as Central Banks would do a lot to minimise the damage of the fallout. Governments will typically focus on boosting infrastructure spending as they contribute to bulk of the job creation worldwide. Hence, there could be significant spikes in prices of some infrastructure or infrastructure related companies (steel, construction equipments, cement, etc.). So policy changes in such times could also drive prices as some guys always benefit....even in a crisis.

Reason 3: More often, in times of such extremes, liquidity in the hands of a few savvy and risk taking investors also impact the markets. For example, some investors would bet that Medical R&D companies may be significant beneficiaries as they would be most likely to develop an equipment which could find signs of the disease early on or develop a medicine/vaccine which could prevent the disease from affecting anybody.