LESSONS FROM THE PAST: WHAT THE NIFTY FIFTY AND THE DOT.COM BUBBLES TAUGHT US
Posted on January 27th, 2025
With the US equity market hitting a new high and the “Magnificent 7” continuing to grow in importance, we wonder whether history has any lessons for us. The 1970’s and 2000’s teach us that concentration in equity markets should not be ignored, and today’s technological leaders might not always be the best investments for the long term. Balancing the opportunity these investment offer with the risks they present is the challenge we currently face.
In 1932 Edwin Land established Land-Wheelwright Laboratories to commercialise his groundbreaking technology, a filter that could polarise light. A few years later it was renamed Polaroid Corporation and it became a poster child for technological innovation.
Throughout the 1950’s and 60’s, household names like McDonald’s, Johnson & Johnson, PepsiCo and Gillette saw their share prices soar. Investors fell in love with a small group of stocks that they believed were so attractive they only had to make one decision, to buy and then hold. The hubris that drove Polaroid’s share price to over 90x earnings and the S&P500 to a peak of 19x in 1972 were testament to the times. Polaroid’s popularity only peaked in 1977 when it dominated the instant camera market with nearly two thirds of all sales, and yet in 1974 its share price collapsed by over 90%.
Polaroid’s story is far from unique. Its collapse in share price was more closely linked to its high valuation, investor concentration and a seismic shift in the market environment.
“The hubris that drove Polaroid’s share price to over 90x earnings and the S&P500 to a peak of 19x in 1972 were testament to the times.”
As evidenced by its continued revenue growth, it was only three years later that its revenue peaked and started its gradual decline as its technology and competitive position were surpassed. The 1970’s were marked by high inflation, the collapse of Bretton Woods, the 1973 Opec oil embargo, and then Federal Reserve Chairman Arthur Burns hiking rates from 5% to 13%. These factors, combined with the high valuation and concentration in the stock market, all compounded to create the stock market crash of 1973.
Fast-forward twenty years
In the 1990’s the market was gripped by a different fever. This was the time of the internet, the dot.com bubble, financial deregulation and Federal Reserve Chairman Alan Greenspan’s “easy-money” policies. We have different protagonists, but a very similar story. In this case, the poster child was Cisco Systems Inc, a US giant that made network systems and switches, the backbone to the internet. They didn’t achieve Polaroid’s 2/3rds market share, but 40% of such a high growth market and a technological leader had afforded it an iconic status in the eyes of investors. Its market capitalisation overtook that of General Electric at half a trillion dollars and at its peak it traded on 272x earnings. From its peak in 2000, to its trough in 2002, as the dot.com bubble burst, it declined 90%.
A sign of our times
Our aim is not just to illustrate the parallel between these two historical examples and Nvidia – the modern-day equivalent – but also to try and provide a framework to analyse our current market environment and what these companies might tell us. They are, after all, a sign of their times.
There are two interlinking points that we wish to highlight – those of the inter-relationship between market concentration and valuation. When Polaroid soared, the Nifty-Fifty traded on 42x compared to the S&P500 on a more manageable 19x. Over the subsequent years, the highest valued companies, almost without exception, performed the worst. Furthermore, the top half of the Nifty Fifty materially underperformed the broader S&P500 index over the following 30-year period (ref: Jeff Fesenmaier and Gary Smith 2002). This parallel can also be drawn in 2000 when the top 10 companies in the S&P500 index represented 27% of the total market capitalisation and the S&P500 reached a non-recessionary peak of over 30x earnings.
Source: Data from Macrotrends.net
The impact of the combination of high valuations and concentrated equity positioning can be seen clearly from change in leadership in the equity market following the burst of the dot.com bubble. From 1999 through to 2014 the Russell 2000, an index of small and mid-sized companies in the US, outperformed the large cap S&P500 by 5% per annum.
Source: Copyright. Bloomberg Finance L.P
Will history repeat itself?
When we look at the current market conditions, history’s warning signs are starting to flash amber. Market concentration is at an all-time high and darling stocks such as Nvidia are trading on expensive valuations (120x price to last year’s earnings) with optimistic expectations. We do not doubt that Nvidia is truly unique and an essential part of the current artificial intelligence boom. Its future growth will rapidly make its valuation appear more palatable (35x next year’s earnings). It is also highly unlikely that the mistakes made by Alan Greenspan or Arthur Burns are to be repeated.
“As long-term investors, we look for a nuanced approach and seek to balance the opportunities available in markets with the risks that they entail.”
When looking at the S&P as a whole, the valuation appears high but not unreasonable. The strength of the US economy is supportive of earnings growth as is the current Chairman of the Federal Reserve Jerome Powell’s commitment to the dual mandate of maximising employment whilst maintaining price stability. Though it remains too early to tell, it is plausible to suggest President Trump’s focus will encourage deregulation and lower taxes, all of which are likely to be supportive of small and mid-sized companies.
As long-term investors, we look for a nuanced approach and seek to balance the opportunities available in markets with the risks that they entail. We remain optimistic for the outlook for US equities and, by default, global equities – but within that, we have tempered our enthusiasm for the largest companies that have been moving markets higher. We believe better opportunities may lie in other smaller, lower profile and less loved parts of the market.
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