Advertisement

Are tech stocks the new Nifty Fifty?

The Nifty Fifty was a group of blue-chip stocks that investors thought would outperform the market, but didn’t. John Stepek asks if today’s tech stocks are the 21st-century version.

170606-tech-stocks-b2
Facebook, Amazon, Netflix, Apple &Google have accounted for the US market's strength for some time

© 2016 Bloomberg Finance LP

Today, we're going to talk about overvalued stocks.

We'll start with a cautionary tale from the dim and distant past.

Join me, as we journey back to the 1960s...

The rise and fall of the Nifty Fifty

Many of these stocks were indeedgreat companies and would stay that way Wal-Mart being one of the best examples. Trouble is, as any good value investor will tell you, a great company alone does not make for a great investment. There's the quality of the company and then there's the price you pay for it.

Advertisement - Article continues below

Share prices tend to exaggerate reality, because they represent an attemptto extrapolate from the present into the future. By definition, that is never going to be an exact science, and people being people, the tendency is to imagine that tomorrow will be like today only more so.

As a result, expectations are sometimes too high for good companies, and too gloomy for bad companies. You can often save money by avoiding the former and make money by buying the latter.

Investors forgot all of that with these particular companies. They acted as though no price was too high. They bid them up to stratospheric price/earnings ratios (p/e - the share price divided by earnings per share).Prices got too high, and then they crashed along with the wider stockmarket in the early 1970s.

Advertisement
Advertisement - Article continues below

As with many famous investment cautionary tales, the details are not cut and dried.For a start, no one agrees on exactly which stocks were in the Nifty Fifty, because there was never an official list (these days a Nifty Fifty exchange-traded fund would have been launched the instant the idea twinkled into a marketing man's eye).

Advertisement - Article continues below

This confusion has given rise to competing narratives. Jeremy Siegel an academic who is basically the anti-Robert Shiller wrote a paper in 1998 where he argued that many of the growth stocks in that era went on to justify their inflated values, particularly consumer-focused stocks such as McDonald's, Coca-Cola and PepsiCo. In other words, if you'd bought the Nifty Fifty and just hung on, then 30 years later, you would be little worse off than if you'd bought an S&P 500 tracker fund.

Problem is according to a later paper byJeff Fesenmaier and Gary Smith Siegel's version of events relies on using a Nifty Fifty list that includes several stocks that couldn't really be said to have had massively-inflated p/e ratios by the standards of the time.

Smith and Fesenmaier instead pull out a "Terrific 24" (I know, it's not as catchy) stocks, which appear on both Siegel's list and another that is regularly cited as the source of the Nifty Fifty. These significantly underperformed the S&P 500 over the next 30 years.

These stocks are expensive but when will they get cheap?

But the overall point is, it's possible even for good companies to become over-hyped and too expensive. And when people start saying that a company is a buy, no matter what, then warning bells should start ringing in your head.

Advertisement - Article continues below

So what stocks look a bit like the Nifty Fifty today? It won't surprise you when I say: the big tech players.

Advertisement
Advertisement - Article continues below

The "FAANG" stocks Facebook, Amazon, Netflix, Apple and Google have accounted for the US market's strength for some time. This year, US tech stocks are up around 20% the rest of the S&P 500 is up by just 5%, reports Tom Braithwaite in the FT.

These are great companies.And they've been written off as over-valued many times in the past (particularly Amazon).TV streaming service Netflix does seem like the odd one out, in that it looks very vulnerable to competition (I've often thought of cancelling Netflix now that Amazon provides a streaming service with Prime).But that aside, they dominate their niches.

However, they are starting to look a little overhyped. Their combined market value now roughly matches that of the FTSE 100. Reports Braithwaite, technology now accounts for 23% of the US index and more than a quarter if you include Amazon. "No sector has so dominated the market since the last dot com bubble."

Advertisement - Article continues below

Meanwhile, growth stocks (which are in turn mostly tech stocks) are more highly valued relative to value stocks than they were back during that same bubble.

So there are lots of signs and portents. But the question is when will investors come to their senses and why?

Higher interest rates might do it (when money stops being cheap, you demand a return on it). But it's not at all clear how quickly we'll see higher rates from here. More regulation might do it. But again, that's a slow-moving process.

The problem is, no one rings a bell at the top (or rather, sometimes they do Glencore going public beautifully marked the top of the commodities bubble in 2011 but you can't rely on it).For example, I'd love to see someone launch a FAANG ETF, with some marvellous pseudo-scientific rationale to back up the idea. I'm not ruling it out either. But we can't rely on it being that obvious. So this could continue for a while.

The nice thing about being a private investor, though, is that you can sit it out. You don't need to own these stocks to keep up in some sort of short-term performance relay race. So stick with cheaper stocks (I'll make some suggestions later in the week).

Of course, you might think I'm talking nonsense. And in the current issue of MoneyWeek magazine, my colleague Rupert Foster explains why he's much more keen on tech stocks (including a couple you might be less familiar with). If you're not already a subscriber, you can sign up here.

Advertisement
Advertisement

Recommended

Visit/517688/the-british-equity-market-is-shrinking
Stockmarkets

The British equity market is shrinking

British startups are abandoning public stockmarkets and turning to deep-pocketed Silicon Valley venture capitalists for their investment needs.
8 Nov 2019
Visit/514516/the-tech-stock-bubble-continues-but-wise-investors-should-look-for-value-elsewhere
Investment strategy

The tech stock bubble continues – but wise investors should look for value elsewhere

As tech stocks continue to soar, real value has been forgotten. It’s fine to hold tech, says Merryn Somerset Webb, but investors should look for value…
9 Sep 2019
Visit/511212/reasons-for-investors-to-be-bearish-but-stick-with-the-stockmarket-bulls
Stockmarkets

There are lots of reasons to be bearish – but you should stick with the bulls

There are plenty of reasons to be gloomy about the stockmarkets. But the trend remains up, says Dominic Frisby. And you don’t want to bet against the …
17 Jul 2019
Visit/510684/good-news-on-jobs-scares-stockmarkets
Economy

Good news on jobs scares US stockmarkets

June brought the best monthly US jobs growth of the year, but stockmarkets were not best pleased.
11 Jul 2019

Most Popular

Visit/economy/uk-economy/601427/covid-bounce-back-loans-and-inflation
UK Economy

What bounce back loans can tell us about how we’ll pay for all this

The government will guarantee emergency "bounce back loans" for small businesses hit by Covid-19. Inevitably, many businesses will default. And there'…
1 Jun 2020
Visit/investments/commodities/601433/commodities-possibly-the-biggest-opportunity-in-todays-markets
Commodities

This looks like the biggest opportunity in today’s markets

With low interest rates and constant money-printing, most assets have become expensive. But one major asset class hasn’t. John Stepek explains why com…
2 Jun 2020
Visit/investments/commodities/gold/601444/these-seven-charts-show-exactly-why-you-must-own-gold-today
Gold

These seven charts show exactly why you must own gold today

Covid-19 is accelerating many trends that were already in existence. The rising gold price is one such trend. These seven charts, says Dominic Frisby,…
3 Jun 2020