MD, Salt Funds Management
A fascinating aspect of equity markets is that a bubble seems to form every 10 or so years due to a loss of generational investor memory regarding the extremes that were previously reached and the sell-off that ensued thereafter. Think 1973, 1987, 2000 and 2008.
This article relates those episodes to the current experience. While we see elements of each of those historical events, the “Nifty Fifty” boom of the late 1960’s that finally burst in 1973 carries some eerie similarities to today.
A Sydney Morning Herald headline last week encapsulated the current boom perfectly with, “I Don’t Do Boomer Stocks.” Call us old-fashioned but a share is nothing more than a claim on the discounted future free cashflows of a company after it pays its debt finance and capex. Whether it’s a boomer stock or a hot new darling stock is irrelevant – everything has its price in an efficient market.
A sudden boom in mass-market retail involvement seems to be focusing on a “diamonds and rust” trade. Recognisable brand-names and glamour growth stocks are being bought at any price, while there is also a perverse bid for businesses that are being hammered in the face of severe structural challenges.
The sheer breadth of retail involvement, their role in driving prices and the social/casino elements have strong similarities to 1987. Helpful differences to then are that interest rates are massively lower and that most companies have real businesses unlike the vapour-ware models in 1999 and blatant fraud in the 1987 boom. Wirecard is the exception rather than the norm.
The role of retail also has elements of 1999 in how trendy “new economy” businesses are being aggressively bought at any price. Just like railroads in the mid-late 1800’s, car companies in their heyday, radio companies post World War 1, internet stocks in the late 1990’s and buy-now-pay-later stocks today. History suggests that future competition and further technological change ultimately makes many of the “new economy” companies extremely poor investments.
The current market boom is similarly notable for the extreme valuation of the winners and the large cap nature of those stocks. Think the FANG’s in the US, the WAAX stocks in Australia and a2 Milk and Fisher & Paykel Healthcare in NZ. The key question of whether today’s winning business will be the winner in five or ten years’ time is not being asked – it is being assumed.
As just one small example, Tesla’s R&D budget is swamped by those of the major legacy manufacturers. Will they really have the leading car technology in ten years, will entirely new solid-state battery technologies be developed by someone else or could an entirely different technology path such as hydrogen ultimately win?
A similar phenomenon occurred from the mid-1960’s onwards with the “Nifty Fifty” boom, which finally went bust in 1973. A combination of general economic optimism and low bond yields due to low inflation saw a group of 50 “growth at any price” stocks being phenomenal outperformers. In 1972, the PE ratio for the S&P500 Index stood at a far from cheap 19x but the 50 names identified by Morgan Grenfell as the “Nifty Fifty” had a PE of a staggering 42x.
Right now, using Jarden numbers for NZ equities, the forward PE for the S&P/NZX50 Index (ex airlines and property) sits at circa 37x while the median is 19x. History may not repeat but it sure is rhyming.
The idea back in the day was that in a world of solid growth and low interest rates, it didn’t matter if you over-paid for stocks in the short term as they would grow into their earnings as they reinvested and earned strong returns. It was a “one shot” decision to buy the structural winners that would keep compounding returns for many years into the future.
These winners included such titans as IBM, McDonalds and Wal-Mart that turned out to be wonderful investments over time. However, it also included Eastman Kodak, Polaroid, Xerox, Kresge (now Kmart), and Simplicity Pattern (they made patterns for home sewing). Oops.
Take arguably NZ’s best company in Fisher & Paykel Healthcare. Will they successfully pioneer lucrative new products that are not even on investors’ radar screen? Conversely, will a pill be invented for sleep apnea in the next few years? Will someone else invent a better way of delivering pressurized, humidified oxygen to a patient? Maybe, maybe not. What we do know though is that on a forward PE of 59x, analysts and investors are assuming that they will win for decades into the future.
The lesson here is that foresight is imperfect and that all forecasts are wrong. Today’s winner may be tomorrow’s winner or it may suffer in the face of unforeseeable structural and competitive changes.
Buying a portfolio of such names certainly makes more sense than a rifle-shot approach but renowned investor Howard Marks of Oaktree fame recently highlighted that it would have taken 26 years for the average Nifty Fifty stock to return to break-even from the 1973 peak. There are two classic problems here – this puts you at the 1999 peak and would the average investor actually hold on for 26 years?
What caused the “Nifty Fifty” bubble to pop? The US market fell 45% over two years, with many of the “Nifty Fifty” falling far further. Are there lessons to be learned for today?
The first oil crisis was one obvious driver. It was a supply-side shock that drove up inflation and bond yields. Higher yields have a disproportionate impact on today’s value of future earnings from the secular growth stocks. Today, the oil price has instead fallen but it will pay to keep an eye on powerful deglobalization forces in a post-Covid world – these will prove inflationary. It is worth remembering that NZ has had non-tradeable inflation of 3%+ in recent years and overall inflation has only been held down by flat to negative tradeable sector inflation.
Secondly, the Bretton Woods system broke down in 1971, with this seeing the US dollar devalued against gold. This surge in fiat money supply also contributed to an inflation surge. This sure does sound familiar. With the money-printing machine of central banks currently over-heating around the world, it is surely only a matter of time before inflation moves from asset markets to those for goods and services. Relating this back to stocks, this would likely see a vicious 1970’s style rotation from the secular growth winners back to cheap cyclicals and value names.
To conclude, the strength of equity markets since March has been a surprise to many and has been led by a “Nifty Fifty” cohort of large cap “structural winners”. There has been a mass-market retail boom with echoes of 1987 and 1999. Even more than those events, the inevitable end to the current boom will have its own story to write but there are some compelling similarities to the early 1970’s.
Disclosure: Salt Funds owns shares in Fisher & Paykel Healthcare and a2 Milk.