Occasional Daily Thoughts: Bubbles and Manias in Stock Markets

By LaRue Gibson on September 22, 2023

History doesn’t repeat itself, but it often rhymes.”

– Mark Twain

We have spent a great deal of time discussing the characteristics of the stock market in 2023 compared to two previous, well-known investment manias:

• The Nifty Fifty era of the late 1960s and early 1970s
• The 1990s Tech Bubble

Both market occurrences ended badly for investors caught up in the mania. Furthermore, avoiding the largest capitalization companies had performance consequences in the short term but were justified in the long term in hindsight.

With this special edition of Occasional Daily Thoughts, we attempt to provide context that illuminates the significant risks we observe in today’s highly concentrated stock market. As Mark Twain quipped, history may not repeat itself, but it often rhymes.

As of August 31, 2023, the five largest members of the S&P 500 Index by market capitalization (Apple $2.9 trillion, Microsoft $2.4 trillion, Alphabet $1.7 trillion, Amazon $1.4 trillion, Nvidia $1.2 trillion) represent nearly 25% of the value of this benchmark. Never has the S&P 500 Index had so much concentration in so few companies. Never!

Coincidentally, if one has not owned these companies in 2023 along with Tesla and Meta, which as a group are referred to as the “Magnificent Seven”¹, the performance of their portfolios has suffered greatly. More on that later.

Allow us to review the Nifty Fifty Era and the Dot-Com Bubble in some detail.

The Nifty Fifty Era

In the late 1960s, investors coined the moniker Nifty Fifty to describe “one-decision” stocks that one could buy and never sell. It was a list of 50 large-cap stocks in the U.S., particularly popular during the late 1960s and early 1970s. The Nifty Fifty included large, dominant companies like IBM in technology, Coca-Cola in beverages, and Johnson & Johnson in healthcare.

The 1960s represented a period of robust economic growth and low inflation, offering a fertile environment for equity investments. Investors, buoyed by optimism, gravitated towards these high-growth, economic stalwarts, pushing their price-to-earnings (P/E) ratios to extremely high levels. The idea was that these companies were so strong and resilient that they could and would grow irrespective of economic conditions.

As trees do not grow to the stars, stocks cannot climb in price regardless of valuation and the underlying financial fundamentals. As the oil crisis of 1973 ushered in rising inflation and buoyant economic growth brought increased interest rates, a severe bear market ensued. Many of the Nifty Fifty stocks were severely overvalued and, thus, saw declines of 40-90% from their peak valuations. For example, IBM saw its stock price reach approximately $375 before crashing down to around $100, a decline of about 73%. Xerox fell from a high of $160 to nearly $25, an 84% decline. The era ended with a painful realization: even blue-chip stocks are not immune to market cycles and economic downturns. The 1973-74 bear market eroded billions in investor wealth, and it took years for many of these stocks to recover. The Dow Jones Industrial Average, the predominate measurement of stock performance at the time, fell 45% from its 1973 peak, and the S&P 500 Index declined 48%.

The top Nifty Fifty companies all peaked in 1973. The following table illustrates the carnage that ensued:

Buy once and hold forever proved ill-advised and considered given the magnitude of these losses. Valuation and fundamentals matter.

The 1990s Tech Bubble

The 1990s Tech Bubble, also known as the Dot-Com Bubble, was characterized by soaring stock prices in the technology and internet sectors. Companies with little to no profits commanded sky-high valuations, buoyed by the promise of the Internet revolutionizing business. Even profitable companies like Microsoft, Cisco Systems, AOL Time Warner, and General Electric grew to valuations not justifiable by their underlying fundamentals during this well-chronicled mania.

In the late 1990s, the economy was strong, and interest rates were relatively low. The rapid growth of the Internet led to speculative investments in anything related to technology or the web. “New economy” theories posited that traditional valuation metrics like P/E ratios were obsolete, and as a result, stock prices soared to irrational
valuations.

When the bubble finally burst in 2000, markets and the leading stocks in the S&P 500 and NASAQ 100 Indexes experienced catastrophic damage. Many of the largest companies saw huge stock price declines. Cisco Systems’ share price fell by approximately 86% from its peak. Amazon.com, which survived the crash and later thrived, lost around 95% of its stock value during this period. The NASDAQ Composite, a tech-heavy index, reached a peak of over 5,000 in March 2000 and plummeted to nearly 1,100 by October 2002, a drop of about 78%! Even the less tech-heavy S&P 500 Index dropped from 1528 to 777, a drop of approximately 49%.

This bubble burst in 2000 when the Federal Reserve, recognizing the signs of overheating inflation and speculation, started to raise interest rates, making borrowing more expensive. Moreover, it became clear that many tech startups were not going to become profitable anytime soon. This led to a collapse in tech stock prices and the largest, “can’t lose” non-tech companies wiping out trillions of dollars in market value. Many companies went bankrupt, and investors suffered significant losses. As mentioned above, the carnage spread to non-tech leaders that represented the largest capitalization issues in the major stock indexes such as General Electric, Walmart, Exxon Mobil, and Amgen. Many of the late 20th century’s capitalization behemoths have not returned to their 2000 price levels today!

The Tech Bubble companies all peaked in late 1999 or early 2000. The below table tells a now recognizable tale of capital destruction:

Again, valuation and fundamentals matter, and rising interest rates pierce bubbles and weaken all companies.

The Magnificent Seven Era

What were/are the similarities between the Nifty Fifty Era, the Tech Wreck, and today?

• The Federal Reserve Federal Funds Rate rose/is rising aggressively.
• Inflation posed/poses a significant risk to sustainable economic growth.
• New paradigm ideas convinced/convince market participants that traditional fundamental analytical techniques were/are obsolete:
  • Conglomeration and the primacy of American capitalism
  • The internet revolution will remake businesses and markets.
  • Artificial intelligence represents a transformative technology capable of significantly altering many aspects of human life, business, and governance.

We admonish our clients often that “This time is different” may be the four most dangerous words for investors to utter. To us, history is at least rhyming if not repeating itself. 

Readers of this research product will remember our introduction in December 2021 of the mid-term election cycle theory. We invite people to review our December 2021 Occasional Daily Thoughts on our blog for the explanation of this theory that has played out as discussed.

The recovery from the lows of October 2022 has followed the mid-term election cycle historical context thus far; however, this rebound has been narrow with only seven to ten mega-cap stocks accounting for nearly all the performance of the S&P 500 Index. These stocks predominately hail from technology or technology-related industries. By some measures, the current narrow leadership within the U.S. equity market is the narrowest in history, including the record setting period of the late 1990s Tech Bubble. When we measure the performance of the NASDAQ 100 Index (a useful proxy for technology stocks and the mega-caps dominating performance today) versus the MSCI All-Cap World Index ex USA Index (a much less heavily technology influenced index), we observe how demonstrably the technology mega-cap stocks have outperformed non-technology equities recently. What astonished us is that when comparing the Technology Bubble of the 1990s to the narrow, technology dominated performance of 2023, we see similar outperformance.

What investors do not appear to appreciate is that the late 1990s period of relative strength was followed by approximately nine years of underperformance. Consider the following graphic that shows the Technology Bubble’s relative outperformance followed by an extended period of poor relative and absolute performance. Interestingly, the current period of technology relative outperformance makes the outperformance of technology companies in the 1990s appear mild in comparison. Caveat emptor!

Hip-hop, a rhyming musical genre, celebrates its 50^th anniversary in 2023.  Are the equity markets celebrating this American musical tradition by rhyming with the markets of the early 1970s and late 1990s?

Although often portrayed as optimistic and opportunistic, growth investing really implies a negative view of future economy-wide earnings growth, and extremely narrow leadership implies only a handful of companies will be able to grow. Today’s historically narrow markets suggest not only a deep profits recession, but even questions corporate survival for the broader global equity market. We do not share this morose view of the global economy. We have little doubt that a profits recession began in the second half of 2022, but we embrace a more traditional view that supports overweighting defensive sectors when the profits cycle decelerates.

Many investors today portray investing in technology stocks as both growth and defensive investing; however, data demonstrate that the profit cycle strongly influences technology companies making them more akin to cyclical sectors rather than growth sectors. Surprising to most of our audience, consumer staples companies, a historically defensive sector, have enjoyed superior profit growth in each of the last three quarters! The relative performance of the sectors does not reflect this fact.

The original Nifty 50 stocks of the late 1960s and the early 1970s subsequently underperformed because their universal acceptance as the only companies that offered earnings growth implied a dire economic forecast that proved incorrect. In fact, many non-Nifty 50 companies ultimately had significant earnings growth. Similarly, we expect today’s version of the Nifty 50, the Magnificent Seven, to underperform as the months and quarters and years unfold. Perhaps they will continue as great companies, but their value as great investment may cease.

Returns are greatest where capital is scarcest. It is hard for us to imagine that there are no other growth opportunities anywhere else in the world, and the concentration of capital in such few names offers opportunity for the discerning investor, in our opinion. History has borne this out after every speculative bubble.

Below we provide a chart that illustrates the relative price performance of the S&P Europe Technology Index to the European Equity Benchmark Index.  Despite the promise of artificial intelligence to “change” everything this time, European technology companies have not outperformed other types of companies.  Have European technology companies ceded artificial intelligence to American technology companies?  We find that difficult to believe.

Perhaps the answer lies in the slavish devotion to passive investing in the United States. The chart shows that U.S. investors began to abandon active portfolio management in 2008 for passive portfolio management.

Passive investing rewards large companies regardless of their underlying fundamentals.  Those companies receive their proportional share of each dollar invested.  The top five stocks in today’s S&P 500 Index represent over 24% of the market capitalization of the benchmark. This powerful flow of funds, in part, may have led to the unprecedented concentration we mentioned earlier.

In the face of a highly concentrated U.S. stock market in 2023, LRG Wealth Advisors draws comparisons to two previous investment manias: the Nifty Fifty era of the late 1960s and early 1970s and the Tech Bubble of the 1990s. Both ended disastrously for investors. Currently, the five largest S&P 500 companies—Apple, Microsoft, Alphabet, Amazon, and Nvidia—account for almost 25% of the index’s value, highlighting unprecedented concentration. Similarly, market dynamics of the past featured rising Federal Reserve rates, inflation risks, and paradigm-shifting technologies. History suggests that even iconic firms are not immune to market cycles, and the lack of broad participation of the “average” company in this stock market might present trouble. The concentration in technology stocks is a U.S. phenomenon that seemingly ignores economic growth in other sectors superior to that of the technology sector. The past is prologue.  We warn investors to avoid falling into the “this time is different” trap, as history has shown that fundamentals and valuations do matter.

¹ The Magnificent Seven is a term used by the media to refer to mega-cap companies Apple, Microsoft, Amazon, Google, Nvidia, Tesla, and Meta and is not an endorsement.