Beware the ghost of markets past
The stock market is at a record high. Investors are chasing a handful of hot stocks. Geopolitical tensions threaten to upend the rally.
I’m referring, of course, to 1972. The S&P 500 closed at a record high of 119.12 on Dec. 11. It was the height of the Nifty Fifty (not to be confused with the Nifty 50 Index of India stocks), the idea that investors needed only to buy 50 of the most popular growth stocks and hold them forever.
Historians credit the Nifty Fifty craze for driving the market to new heights in the early 1970s, and the numbers bear it out. There was never an official list of 50 stocks, but a frequently cited one was compiled by Morgan Guaranty Trust. The average P/E ratio of Morgan’s 50 stocks was 41.9 in 1972, according to University of Pennsylvania professor Jeremy Siegel’s calculation, compared with an 18.9 ratio for the S&P 500.
Investors’ confidence in the Nifty Fifty turned out to be ill-timed. The S&P 500 tumbled 17% in 1973 and 30% in 1974. Many of the Nifty Fifty fared far worse.
Markets only seem to care about politics when it drags down the economy, and unfortunately for investors 1973 was such a time. War broke out between Israel and its neighbors in October 1973. The Organization of Arab Petroleum Exporting Countries responded with an oil embargo targeting countries it believed were supporting Israel, including the U.S.
A month later, the U.S. slipped into recession. The embargo was a chief contributor. The price of oil more than doubled to $10 a barrel from $4 by the time the embargo ended in March 1974. And when the U.S. recession ended in March 1975, GDP had declined 3.2% from peak to trough.
It’s impossible to know how investors who managed to hang on would have fared because many of the Nifty Fifty didn’t survive. Sure, some turned out to be enduring bets, such as Walt Disney and Coca-Cola. But others didn’t live up to their promised growth, such as Eastman Kodak and Sears Roebuck (now Sears Holdings). And still others vanished from public markets, such as Emery Air Freight and Simplicity Patterns.
But it’s hard to imagine that the Nifty Fifty would have kept up with the broader market given that many of those companies failed to perform. Despite the brutal 1973-1974 bear market, the S&P 500 has returned 10.4% annually from its peak in December 1972 through November, including dividends.
If all of this sounds eerily familiar, it should. The S&P 500 reached a record high of 2,690.16 on Monday. And investors are once again chasing a select group of highflying companies.
The so-called FAANG stocks — Facebook, Amazon, Apple, Netflix and Google parent Alphabet — are fetching prices that would make the Nifty Fifty blush. Their average P/E ratio is a whopping 115, compared with 22.5 for the S&P 500.
It’s not just the FAANGs. The average P/E ratio of the 50 largest stocks by market capitalization in the S&P 500 Growth Index is 32, or 42% higher than the P/E ratio of the S&P 500. By contrast, the average P/E ratio of the 50 largest stocks in the Growth Index was 15.2 when the market began to recover in March 2009, only 5% richer than the S&P 500 at the time.
Meanwhile, geopolitical tensions are as high and numerous as they’ve been in decades. The market has shrugged off the risks so far. But if those tensions were to ding the U.S. economy, the market would undoubtedly rethink its lofty level.
History rhymes, as Mark Twain is purported to have said, but the market tends to repeat itself. And this market feels a lot like it’s setting up for a repeat of 1972.