Second Thoughts On The New Nifty 50
Veteran observer Ray DeVoe of Legg Mason Wood Walker in New York City wonders if we are heading for a major top in the stock market. He doesn't like to sound ominous, but the 50 companies with the largest market caps account for most of the gains. Smaller stocks are in meltdown.
A story attributed to a heavyweight boxer fighting the late Rocky Marciano for heavyweight champion would be appropriate for what is taking place in Nasdaq stocks. Marciano was one of the most punishing fighters of all time. Even if he didn't land a di rect punch the heavily muscled arms would also inflict pain on an opponent. He would literally wear down the other fighter. One opponent kept coming back to his corner after the end of each round to hear his manager tell him "You're doing great -- he's not laying a glove on you." This went on for several rounds, until the bloody and battered fighter could take if no longer. He said to his manager, "If Rocky's not laying a glove on me, you better watch that referee, because someone's pounding the (expletive deleted) out of me."
I've never been a fan of a sport where the intent of each participant is to separate the opponents' brain from the lining attaching it to the skull, causing unconsciousness and a near-death experience. But something is going on comparable to that outside the mainstream stocks, and they are being pounded mercilessly. A month ago I made up a list of 165 stocks that were off at least 60 percent in the last year -- the other requirements were that I know the stock and that it must have sold for at least $10 during the last year. The average decline of those 165 stocks was 74 percent. That's in the last 52 weeks -- some of them sold higher prior to that.
Since then I have been adding to the list daily on file cards, checking my monitor for "largest percentage downs" on the New York Stock Exchange and Nasdaq. And every day there are a few stocks off at least 50 percent, and frequently the 10 stocks on the largest percentage down list are off at least 25 percent. My list of "off at least 60% stocks" now includes at least 500 issues. The "champion" is Objective Systems Integrators, Inc (OSII) which sold at 56 1/3 a share last June and now trades around $4 -- that's a loss of 92/9 percent. I haven't figured out the median decline but the arithmetic average is still around 74 percent. There may be some "fallen angels" in this list of 500 stocks, but many of them clearly are in trouble and possibly are doomed.
[Meantime, if you were to take] out the 100 largest cap stocks in the S&P 500 [for 1996 you would reduce] the return of the remaining 400 stocks to below what can be earned on Treasury bills -- or "peanuts" as some refer to non-stock market returns. But, T-bills have no risk, and, stocks? The results from the first quarter were even more distorted. Take out the 50 largest cap issues and the remaining S&P 450 is virtually flat. The Wilshire 5000 index with the S&P 500 stocks removed was actually down.
The reasons for the divergence of large cap stocks with the rest of the market would be attributable to indexing and "closet indexing." Mutual fund sales of index funds have soared and Vanguard's index fund is closing the gap with Fidelity's Magellan fund as the industry's largest mutual fund. Many people have decided that mutual funds managed by humans cannot match the performance of index funds, and go to index funds for "performance." In addition, many investors seem to think that index funds are safer than actively managed funds. Other portfolios are "closet indexed" now. They may not all have all 500 stocks in the portfolio, but computer-generated mixes of lesser numbers of stocks can replicate the action of all 500.
The [earlier] "two-tier" market [of the late 1960s and early 1970s] was one that I am extremely familiar with. It may be better known as the "Nifty-Fifty" era, "one-decision" or "desert island" stocks, but these were the large capitalization growth stocks you would buy if you knew you were going to be marooned on a desert island for a few years. When you returned they would be significantly higher than when you left. They were "one-decision" stocks because the only decision you had to make was which ones to buy -- and never ever sell them.
My firm, Spencer Trask, had analysts covering about half of the 50 stocks in that group. A listing of those issues will be included in a subsequent report. I was the firm's stock market analyst, and I felt that a market made up of 50 stocks selling at roughly 50 times estimated earnings, with the rest of the market generally under 10 times earnings was absurd. I felt that either the "Nifty-Fifty" would have to come closer to an overall market multiple, or the rest of the stock market would have to be valued higher than it was.
The "Nifty-Fifty" were all good companies at the time. My contention was that people were confusing good companies with good investments. I included in reports the 1929 advertisements reading "No price is Too High to Pay for Good Stocks." The results were also a disaster. Some of the "Nifty-Fifty" developed problems with earnings, but the shakeout of 1973-74 brought them down dramatically. Many were off more than 50 percent within two years.
I don't know whether this market is another "Nifty-Fifty" where the 50 largest S&P stocks are supporting the averages just under all-time highs, of whether it is 100 stocks -- or 1000. As in the earlier periods, the money was confined to certain privileged issues -- and the rest of the stocks deteriorated. However, it looks to me like a broad stock market top was made in mid-1996, and the 500 plus stocks that are off roughly 75 percent -- plus countless others have been drifting downwards. At the same time that money flow has supported a very narrow group of stocks that gave the illusion in the indexes that a broadly based bull market was underway. I don't mean to sound ominous, but this is one characteristic of a major top being formed in the stock market. They may not be laying a glove on the N-50 (or N-100? or N-1000??) but a lot of stocks are taking a terrific pounding.
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