Just recently, Bank of America had a great piece of analysis on the “5 Lessons From the Nifty Fifty.” Of course, if you are unfamiliar with the importance of the “Nifty Fifty,” it is worth explaining.
The “Nifty Fifty” refers to the 50 most popular large-cap stocks in the 1960s and 1970s. These “household” names traded at extreme valuations and included household names such as Xerox, IBM, Polaroid, and Coca-Cola. Many of these Nifty Fifty stocks had price-to-earnings (P/E) ratios as high as 100 times earnings. However, investors piled into these companies at the time due to their proven growth records and continual increases in dividends as inflation weighed on everything else.
Wall Street touted the “Nifty Fifty” stocks to investors as “one-decision” picks, just “buy and never sell.”
“The greater fool in growth stocks isn’t the one who buys them but the one who sells them,” said Carl Hathaway, senior Vice President at Morgan Guaranty, in March 1973.
Those stocks propelled the bull market of the early 1970s. But, unsurprisingly, as investors repeatedly learn, overpaying for value eventually reverts to the mean. The 1973–74 bear market became known as the “Black Bear Market,” as the massive decline convinced investors “equities were dead.”
- 1965–68: Government spending on the Vietnam War and Great Society policy platform combined with unionization and an accommodative Federal Reserve to stoke inflation. Asset winners were small caps and tech stocks.
- 1969–73: Volatility and inflation surged with the end of Bretton Woods and the failure of wage/price controls. Stocks and bonds underperformed in real terms.
- 1974–79: Oil price shocks, power shortages, food price shocks, wage-price spirals, and budgetary pressures led to stagflation.
The Fed Repeating Itself
During the 1970s, the Federal Reserve was entrenched in an inflation fight. The end of the Bretton Woods and the failure of wage/price controls combined with an oil embargo sent inflation surging as market markets crumpled under the weight of rising interest rates. Ongoing oil price shocks, spiking food costs and wages, and budgetary pressures led to a stagflationary environment through the end of that decade.What was most notable was the Fed’s inflation fight. Much like today, the Fed is hiking rates to quell inflationary pressures resulting from exogenous factors. In the late 1970s, the oil crisis led to inflationary pressures as oil prices fed through a manufacturing-intensive economy. Today, inflation resulted from monetary interventions that created demand against a supply-constrained economy.
As shown, the Fed repeatedly took action to slow inflationary pressures throughout the 1960s and 1970s, which resulted in the repeated market and economic downturns. Most notable was the period from 1973–74, the final bear market of that period, when the Fed hiked rates from 5.5 percent to 13 percent before inflation peaked as growth turned negative. During that period, stock investors lost 48 percent of their portfolio values.
Currently, the Fed is once again fighting spiking inflation at a time when wages are also rising. Of course, the problem currently is that while wages are rising and affecting corporate profit margins, they are not keeping up with the pace of inflation.
Valuations Remain Key
From 1960 to 1982, investors repeatedly suffered significant market declines as valuations reverted to substantially lower levels. As noted, the Federal Reserve steadily fought repeated bouts of inflation. The resulting market volatility pounded investors with bear markets and economic recessions. While many focus on the final bear market of 1974, most don’t realize there were three preceding bear markets. On an inflation-adjusted basis, real returns for investors over the entire period were substantially negative. Unfortunately, by the time 1982 arrived, and valuations had fallen from 23 times earnings to 7 times, the Nifty Fifty were no longer the portfolio of choice.
Unfortunately, despite the correction so far in 2022, valuations remain well elevated above historical bull market peaks. While the Federal Reserve is fully engaged in its inflation fight, earnings and margins have yet to adjust for slower economic growth rates in 2023. This suggests that as that occurs, we may be another period whereby markets continue to underperform Wall Street expectations.
Given the high valuation levels, inflation, and an aggressive Fed emulating former Fed Chair Paul Volcker, it is possible that ta period of stagflation persists and markets trade in a fairly broad but frustrating range over an extended period. As Michael Hartnett suggests:
Five Lessons From the Nifty Fifty
If we are indeed repeating some form of that “1970s show,” there are several things that investors should consider.Risk management will become crucial to navigating what could be more volatile markets over the next decade than what we witnessed over the last. This would be historically consistent with a valuations reversion period and potentially a period with fewer monetary policy interventions by the Federal Reserve.
However, risk management also means there are no safe strategies, particularly when stocks and bonds may be more correlated than in the past. “Buy and hold” and “passive indexing” will most likely give way to more active strategies, and performance and capital preservation demands become key.
Most important, investors should begin to prioritize companies that have, and continue to have, strong balance sheets, resilient cash flows, and high levels of visibility into future growth. Companies with solid business models and a focus on shareholder stewardship (read dividends) will play a more critical role than companies with outsized future growth promises.
Let me conclude with Michael Hartnett’s five lessons from the “Nifty Fifty.”
Two are bearish:
1) Don’t buy the leadership dip when the Fed is fighting inflation; and,
2) “Deep value” can be a value trap.
Three are bullish:
3) Active asset allocation is essential;
4) Growth stocks can age gracefully, maturing into dividend-paying value stocks; and,
5) Even bear markets have some big winners.
Just something to think about as we head into a new year.
