While the 1929 and Nasdaq stock market bubbles are very famous, little is known about the Nifty 50 Bubble. We analyze the massive bubble that took place in the 1960s, known as the Nifty 50 Bubble, and what we can learn from it.
Content
- Introduction
- Nifty 50 Stocks
- New Stock Market Investors
- Any Stock Multiples was justified
- Interest Rates and Inflation
- How the Nifty 50 Bubble Popped
- Conclusion
Introduction
The Nifty 50 were 50 of the most popular and high-growth stocks of the US stock exchange during the 1960s and early 1970s. Although no official stock market index existed for the Nifty 50, the financial press referred to them that way. Some of these companies are still very popular nowadays, such as Coca-Cola, McDonald’s or Johnson & Johnson.
The decade of the 1960s was one of great economic growth and optimism in the United States. In this context, a strong consumer society expanded. Companies like Xerox or McDonald’s enjoyed spectacular growth rates.
By the late 1960s though, the economy was overheating. Growth was getting weaker, inflation was rising, and interest rates were moving up for the first time in many decades. But optimism around the Nifty 50 prevailed as the investing public had the impression that those businesses would be robust enough to weather any macroeconomic scenario.
In 1971, the United States abandoned the gold standard. Uncertainty around monetary policy and the threat of high inflation rates made the Nifty 50 Bubble continue to grow. Since money was going to be worthless, investors piled up on these stocks.
Nifty 50 Stocks
As we have already mentioned, the Nifty 50 were relatively large companies enjoying high growth rates. If we had to summarize their characteristics in one word, we would say they represented quality.
Apart from being profitable and experiencing growth, they also had very strong balance sheets. Their low debt levels made them look immune to recessions. Some other corporations of the Nifty 50 group were IBM, General Electric and Xerox.
New Stock Market Investors
The Nifty 50 Bubble was also marked by the rise in popularity of stock market investing. Compared to 1929, and even though the population of the United States had grown significantly, the number of stock market investors in the 1960s was 7 higher than it had been four decades earlier. By 1970 there were more than 30 million shareholders in the United States.
As a result, the mutual fund industry grew dramatically. Those fund managers started to buy the best companies available in the stock market. And because stock prices were rallying, everyone wanted to join in and not miss out, pushing stock prices even higher. It became a self-fulfilling prophecy.
The euphoria around the Nifty 50 Bubble had not been seen since the crash of 1929. It had taken almost two generations to forget what had happened in the stock market a few decades earlier.
Any Stock Multiples was justified
The narrative around the Nifty 50 at the time was that those companies were bought and held for a lifetime. No one would ever want to sell them. They represented the best of the present and the future of the US economy. They were going to dominate their sectors forever. Hence, any price multiple was justified.
As in any bubble, future expectations, often irrational, meant that the disconnect between these companies’ businesses and their stock market valuations was immense. If we look at the P/E ratio reached by some of these corporations, we will realize how large the Nifty 50 Bubble got: Johnson & Johnson with a P/E of 57, McDonald’s and Coca-Cola with a P/E of 71, and Polaroid with a P/E of 95.
The following chart shows the price to sales ratio (P/S) that Xerox reached in the early 1970s, of almost 6. Although the business continued to grow for many years, its stock price went down, helping normalize the valuation multiples:
Interest Rates and Inflation
We have previously mentioned that inflation in the United States had been increasing since the mid-1960s. This inflation was mostly the result of very large budget deficits to finance the Vietnam war and large-scale social programs.
As expected, the public started to lose faith in the value of the US Dollar. That led to investors exiting the US Treasury market, pushing bonds prices down and interest rates up. Even as interest rates rose, investors remained skeptical about investing in bonds or holding cash as inflation continued to be elevated. For example, the official inflation rate rose from less than 4% in 1962 to more than 8% in 1970.
Because it was not legal for US citizens at the time to buy gold as an investment, the shares of the Nifty 50 companies acted as a safe haven asset, further growing the bubble.
How the Nifty 50 Bubble Popped
In October 1973, the first oil crisis began. In just a few months, the price of a barrel of oil had risen from $3 to $12. And it is worth remembering that the economy of the 1970s was a lot more dependent on oil than the economy of the 2020s.
The energy crisis triggered a severe economic downturn, which was accompanied by very high inflation rates. Inflation went over 14% at the end of the 1970s after the second oil crisis. This economic period became known as stagflation: economic stagnation, high inflation and high unemployment.
The stock prices of the Nifty 50 began to fall sharply. To put it in perspective, Xerox fell by 71% during this time, and Polaroid by 91%. Even Coca-Cola fell by 53%, and its highest level of 1973 was not reached again until 1985. After 12 years of heavy inflation, the nominal stock price was still flat.
Although the decade of the 1970s was negative for the stock market in general, it was especially bad for the Nifty 50. These stocks performed much more poorly than benchmark stock indices, such as the S&P 500 or the Dow Jones Industrial Average.
In fact, some companies that had been left behind during the 1960s enjoyed outsize returns during the 1970s, such as commodity producers.
Conclusion
The biggest lesson we can draw from the Nifty 50 Bubble is that the price at which we buy a stock does matter, regardless of how good the company is. A great company can still be a bad investment if we overpay for it.
This is why we should always diversify our asset allocation and avoid being in a position that can cause large losses to our portfolio.
Another important lesson to learn from past stock market bubbles is that the narrative is always the same. During the euphoria phase, the investing public believes that the leading companies will change the world and dominate the economy forever. And valuations become completely irrational.
It is interesting that the Nifty 50 Bubble started just over three decades after the 1929 crash. About three decades after the bubble started to pop, the US stock market was in the midst of the Nasdaq bubble. This proves that new waves of investors do influence market psychology, often forgetting many of the lessons of the past.
Lastly, it is worth highlighting that many of the Nifty 50 companies are still around today and dominating their sectors. Other have gone away. In any event, the price we pay for stock does and will always matter.
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And if you want to read about another massive stock market bubble, check out this link:
The Japanese Housing and Stock Market Bubble of the 1980s
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