P/E Ratios Now Top Fabled 'Nifty Fifty' Era
By ROBERT MCGOUGH
Staff Reporter of WSJ
February 24, 2000
You hear it all the time: The current stock market is like the crazed "Nifty Fifty" market back in 1972-1973.
That should stop, now.
After all, compared with investors today, those nifty-fifty folks were a bunch of small-timers. Stock valuations have blown right through the stratospheric level they reached back then.
Let's go to the calculator. In 1973, the cream of the market, the most expensive 20% of the Standard & Poor's 500-stock index, commanded a median price-earnings ratio that was 3.0 times the median P/E multiple for the remaining 80%. Those were legendary days of excess and outrageous valuations. In their wake was a 23-month-long bear market, which socked stocks by more than 45%.
But today, the top 20% of the S&P 500 commands a P/E multiple of a stunning 4.8 times the P/E ratio of the rest of the market -- way past the levels of speculation in 1972.
Says Sam Burns, an analyst at Ned Davis Research, which crunched the numbers: "The way the market is now is remarkably different from any time in the past 30 years."
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Now, this level of speculation doesn't necessarily mean you should go out and sell all your stocks. A stock-market crash doesn't have to be around the corner. We don't appear to have the looming economic catastrophes of deflation (1929) or inflation (1973-74) that helped knock the stuffing out of the market in those two famous bear markets.
Besides, most of the time -- though not always -- speculative momentum markets like this fizzle, rather than implode, according to research by the firm of Sanford C. Bernstein. Perhaps that process has started, now that the S&P 500 and the Dow Jones Industrial Average (if not the Nasdaq Composite Index, which soared to a record Wednesday) have been sliding.
But veterans of slow bear markets can tell you that a water-torture market decline -- where stocks slip a little bit each day, as they have for the Dow Jones industrials and S&P 500 in recent weeks -- can ultimately be as painful, if not as frightening, as sudden market downdrafts. Indeed, for most of its duration, the bear market of 1973-74 was of the water-torture variety.
Investors long have paid up for what they perceive to be the best stocks. Indeed, for the past three decades, with remarkable consistency, the top stocks have commanded about 2.2 times the price-earnings accorded to the remaining 80%. This two-times premium was steady through market tops and bottoms, and at various and sundry levels of interest rates, for much of the past 30 years.
The first big exception to that valuation rule was at the end of 1972. Then, the most expensive 20% of the S&P 500 commanded a median P/E ratio of 33.9, compared with a P/E ratio of 12.3 for the rest of the market. The end of 1972 roughly coincides with the peak of the Nifty Fifty era.
Today, the cream of the stock market is much more expensive -- in absolute terms, and relative to the rest of the market. The median P/E for the top 20% of the S&P 500 -- excluding companies that posted losses over the prior 12 months -- is 70.8. The median P/E for the remaining 80% of the market is 14.7.
But wait a second: Today's low interest rates argue for higher price/earnings ratios, no? Well, the yield on the 10-year bond at the end of 1972 -- before 30-year bonds were common -- was 6.41%, the same as the yield on 10-year Treasurys today.
Analysts and investors have invoked the Nifty Fifty era for several years now. At the end of 1997, for instance, some investors talked about parallels between the Nifty Fifty market and concluded that stocks couldn't keep climbing. They were premature, to say the least.
At the end of 1997, the median P/E being paid for the richest 20% of the S&P 500 had, in fact, risen to 2.4 times the median for the remaining 80% of the market. That figure was higher than the normal 1.9-to-2.2 times ratio during most other times. But, in retrospect, the market still had a long way to go, and worries about overpriced stocks at that point proved false.
How did Ned Davis arrive at its numbers? At selected points in time -- each one an inflection point in the stock market -- the research firm looked at stocks in the S&P 500 that had positive earnings in the prior 12 months. In its most recent figure, for Feb. 18, there were 471 stocks with positive earnings in the trailing 12 months.
The median P/E was taken for the expensive stocks and for the remaining 80%. A median, unlike an average, is the number in the middle of a set of numbers.
How will this expensive era end? The Bernstein research, which covers 45 years, says momentum markets usually fizzle slowly -- especially when technology stocks are leading the pack, as they are today. But the study warns: "The current era exceeds any in our database in both concentration and valuation, making the risk of this setting unprecedented."
Even the "cheap" part of the market looks pretty expensive by historical standards, notes Gus Sauter, head of stock-index investing at Vanguard Group. By his calculations -- using the Wilshire 5000 Index, which includes small and midsize stocks as well as large -- the most expensive 10% of that index sold for an average P/E of 41.2 near the end of January, and the remaining 90% carried a P/E of 22.6 -- no bargain, in his view.
Good indexer that Mr. Sauter is, he doesn't advocate market timing. "It's hard to say, 'Bail out of the stock market' " because of the high prices, he says. "Instead of a crash, it could just be we get 6% a year" for a long stretch.
But diminished expectations for stock returns are in order, Mr. Sauter says: "I do believe returns over the next 10 years will be much lower." |
