23 Oct 2015

Nifty Fifty Stock Bubble of the Seventies – Is There a Similarity with Today’s Market

What can we learn from this post:

. What was the Nifty Fifty Stock Bubble all about
. Reasons for the bubble buildup
. Investor behavior during the bubble
. How did the bubble collapse
. Comments of Warren Buffett during the bubble

. Lessons from the bubble


The Nifty Fifty stocks captivated investors for the significant part of a decade prior to its demise in 1973. It revived the high-risk investing style that had been out of vogue since the Crash of '29. The era of stock investing during that period was also popularly known as the Go-Go era.

Constituents of the Bubble:
The 50 stocks identified by Morgan Guaranty Trust represented some of the fastest-growing high quality large sized companies in existence in the latter half of the 1960s. Their popularity among institutional and individual investors sparked a radical shift from "value" investing to a "growth at any price" style of investing.
Some of Nifty Fifty constituents indeed went on to become dominant companies of today like the innovation driven 3M, cosmetics major Revlon, Consumer giants like Procter & Gamble and Philip Morris (now called Altria),Food and Beverage behemoth Pepsi, Pharmaceutical heavy-weights like Pfizer, Merck & Co and Eli Lilly and Company.
Some companies received a significant investment from legendary investor Warren Buffett including the likes of Coca Cola, IBM, Gillette, Wal-Mart, Disney and Lubrizol (Chemical manufacturer which was acquired lock, stock and barrel by Buffett),
The group also contained market leaders whose fortunes vastly faded a few decades later. They included Eastman-Kodak and Polaroid, massacred by digital photography; Simplicity Pattern, whose business slumped along with home sewing-machine sales, and S.S. Kresge, a retail chain founded in 1897 that in the 1970s morphed into now-struggling Kmart.


Reasons for the bubble buildup:
As Seth Klarman has pointed out, bubbles are always born with a perfectly rational reason. It is only that the reason is carried too far that it creates a bubble. During the 1960s post the election of a young, charismatic president and the civil-rights movement, there was a popular belief that the U.S. industry would dominate the global economy. The Nifty Fifty embodied that new sense of economic power. One of the most important reasons for the popularity of these companies was that they had strong business franchises which would earn them high returns on capital for the foreseeable future. Also, they were displaying an above average growth track record. Even well known investors like T Rowe Price and Phillip Fisher had advocated investments in ‘growth’ companies to generate above average long term returns.

Investor behavior:
While most of the reasons were sound and logical, the Nifty Fifty school of investors departed from the tenets of sound investing in one aspect – Valuation. Nifty Fifty stocks were deemed as "one-decision" stocks and were meant to be bought and not sold. In the process, new investors were willing to pay unlimited prices to own a piece of the Nifty Fifty pie.
To quote the Forbes magazine:
“The delusion was that these companies were so good, it didn't matter what you paid for them; their inexorable growth would bail you out.
Obviously the problem was not with the companies but with the temporary insanity of money managers – proving again that stupidity well-packaged can sound like wisdom. It was so easy to forget that no sizable company could possibly be worth over 50 times normal earnings.”

Bubble buildup:
The Nifty Fifty bubble was visible in a key valuation parameter of the stocks' value: the price-to-earnings ratio or P/E. By 1972 when the S&P 500 Index's P/E stood at a then lofty 19, the Nifty Fifty's average P/E was more than twice that at 42. Among the most inflated were Polaroid with a P/E of 91; McDonald's, 86; Walt Disney, 82; and Avon Products, 65.

Bubble collapse:
The correction in Nifty Fifty was led by a collapse in the Dow Jones Industrial Average, which started falling in January 1973. Some of the key reasons for the fall were:
. High Valuations of Stocks
. High crude oil prices
. Watergate scandal which had engulfed the then President Richard Nixon,
. End of the Bretton Woods monetary system
. Increase in Inflation and Interest Rates
. Civilian unemployment which increased below 4% to over 6% by the end of 1970

One of the Forbes columnist described the situation aptly – “the Nifty Fifty were taken out and shot one by one." From their respective highs, for instance, Xerox fell 71%, Avon 86% and Polaroid 91%.


Pied Piper of the bubble:
Gerald Tsai's of Manhattan Fund was the de-facto pied piper of the Go-Go era.
During his early days in what would be a remarkable career, he became the original celebrity fund manager. The Fidelity Investments performance fund which he created in 1957 was the first of its kind investment vehicle for general public. It grew 27-fold in terms of assets under management (AUM) in eight years, according to Bloomberg. When Fidelity's founder decided to appoint his own son instead of Tsai as his successor, Tsai quit and started his own Manhattan Fund. When it launched in 1965, it drew US$247 million in capital (10x of the initial targeted corpus), "the biggest offering in investment company history", according to The New York Times. In a profile in Business Week, Ron Stodghill II wrote, "Tsai wowed Wall Street with an unprecedented method of picking speculative stocks for short-term appreciation and selling them the moment their growth slowed. The method shook up the conservative money-management establishment and inspired a whole new breed of portfolio manager."

Comments from Warren Buffett during the late 1960’s:
Warren Buffett was experiencing a frothy market since early 1968. Investors, it seemed paid less attention to underlying companies earnings and more to the surging stock prices. Buffett commented as follows-
July 1968 letter quote:
“I believe the odds are good that, when the stock market and business history of this period is being written, the phenomenon described in Mr. May's article will be regarded as of major importance, and perhaps characterized as a mania. You should realize, however, that his "The Emperor Has No Clothes" approach is at odds (or dismissed with a “SO What?” or an "Enjoy, Enjoy”) with the views of most investment banking houses and currently successful investment managers. We live in an investment world, populated not by those who must be logically persuaded to believe, but by the hopeful, credulous and greedy, grasping for an excuse to believe.”

The discomfort kept on increasing through 1968. While he delivered an exceptional 58.8% return compared to 7.7% for the Dow, he was nervous. He penned his thoughts as follows-
January 1969 letter quote:
“Some of the so-called “go-go” funds have recently been re-christened “no-go” funds. For example, Gerald Tsai's Manhattan Fund, perhaps the world's best-known aggressive investment vehicle, came in at minus 6.9% for 1968. Many smaller investment entities continued to substantially outperform the general market in 1968, but in nothing like the quantities of 1966 and 1967.
The investment management business, which I used to severely chastise in this section for excessive lethargy, has now swung in many quarters to acute hypertension. One investment manager, representing an organization (with an old established name you would recognize) handling mutual funds aggregating well over $1 billion, said upon launching a new advisory service in 1968:
“The complexities of national and international economics make money management a full-time job. A good money manager cannot maintain a study of securities on a week-by-week or even a day-by-day basis. Securities must be studied in a minute-by-minute program.”
Wow!
This sort of stuff makes me feel guilty when I go out for a Pepsi. When practiced by large and increasing numbers of highly motivated people with huge amounts of money on a limited quantity of suitable securities, the result becomes highly unpredictable. In some ways it is fascinating to watch and in other ways it is appalling.”

Finally on May 29th, 1969, Buffett ‘threw the towel’ and brought the curtains down on his investment partnership.
May 1969 letter quote:
The investing environment I discussed at that time (and on which I have commented in various other letters has generally become more negative and frustrating as time has passed. Maybe I am merely suffering from a lack of mental flexibility. (One observer commenting on security analysts over forty stated: “They know too many things that are no longer true.”)

Also, this was the first year since starting partnerships, in which Buffett would experience a poor investment result. To quote him from the same letter-
“I hate to end with a poor year, but we are going to have one in 1969. My best guess is that at year-end, allowing for a substantial increase in value of controlled companies (against which all partners except me will have the option of taking cash), we will show a breakeven result for 1969 before any monthly payments to partners.”


‘Constituents’ of the Nifty Fifty:
There is no official list of companies. Based on Wikipedia following were the ‘constituents’ of the Nifty Fifty mania:

American Home Products
AMP Inc.
Anheuser-Busch
Avon Products
Baxter International
Black & Decker
Bristol-Myers
Burroughs Corporation
Chesebrough-Ponds
The Coca-Cola Company
Digital Equipment Corporation
Dow Chemical
Eastman Kodak
Eli Lilly and Company
Emery Air Freight
First National City Bank
General Electric
Gillette
Halliburton
IBM
International Flavors and Fragrances
International Telephone and Telegraph
Johnson & Johnson
Louisiana Land & Exploration
Lubrizol
Minnesota Mining and Manufacturing (3M)
McDonald's
Merck & Co.
MGIC Investment Corporation
PepsiCo
Pfizer
Philip Morris Cos.
Polaroid
Procter & Gamble
Revlon
Schering Plough
Joe Schlitz Brewing
Schlumberger
Sears, Roebuck and Company
Simplicity Pattern
Squibb
S.S. Kresge
Texas Instruments
Upjohn
The Walt Disney Company
Walmart
Xerox

Lessons to be learnt:
Valuation matters.
That’s the most important lesson from the Nifty Fifty mania. A great company might mean a lousy stock investment and vice versa. Margin of safety is the most crucial principle of investing. As Buffett once said that the rule #1 of investing is don’t lose money and rule #2 is do not forget rule #1.


You can also read the chronicles of Seth Klarman during the Technology bubble in the late 1990’s by clicking here and here

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