Predictability and confidence could give rise to a modern day 'Nifty Fifty' index
TOUGH times make dependable excellence even more valuable, which is why we just might see the rise of a new "Nifty Fifty" of elite shares.
During their heyday in the 1960s and early 1970s the Nifty Fifty were a group of US large cap companies which managed a spectacular period of outperformance during a generally downbeat and low growth period.
Featuring such household names as IBM, Coca-Cola, Procter & Gamble and Disney, the Nifty Fifty delivered strong and dependable earnings and dividend growth during a period where those were in short supply.
They were rewarded by a fantastic run of outperformance and a dizzying re-rating, or expansion of price/earnings multiples, which eventually drove valuations well into bubble territory.
Similar to the 60s and 70s, the world is staring at structural problems that will make a recovery from the long secular bear market unlikely for quite a while.
Back then inflation and choppy economic growth sent the stock market on a volatile, largely sideways journey for several years.
Today we face perhaps deeper problems in the wider global economy, such as debt, deflationary forces and huge fiscal deficits. Expecting strong growth to lift all boats is not going to be a winning strategy.
We could easily be looking at a long period where stocks remain in a wide trading range, as often happens after extended bear markets. So if we can't get structural growth from the overall economy, best to find some structural growth stocks that will manufacture their own.
In a low growth, low return environment, companies with a sustainable growth or competitive advantage should significantly outperform, similar to the Nifty Fifty in the 1960/70s," Ronan Carr, an equity strategist at Morgan Stanley, wrote in a note to clients.
Carr, who specialises in European equities, thinks that a select group of companies in the region, many with strong exposure to emerging markets, will end up fitting the bill. My guess is that it will be a global phenomenon, with a small cadre of outperformers from a range of markets.
The Nifty Fifty beat the overall markets by 15 percentage points annually for eight years from 1964 to 1972. It was a dual effect; the companies were able to increase earnings steadily and pleasingly predictably, beating their peers, and at the same time investors began to re-rate them, driving price/earnings multiples higher as confidence in the Nifty Fifty grew.
That very predictability was a big part of the brand; almost none of the stocks had cut their dividends since World War II.
That kind of growth and predictability will be in short supply in coming years, and companies that produce consistency will see their brands grow and their shares go up.
Not all will be dividend stocks, though the very low interest rate environment we will have to live with will put a premium on income, especially for the growing cadre of retired or semi-retired affluent investors.
Apple, which pays no dividend, is a great example of a stock that has turned itself into virtually a one company Nifty Fifty. (A "One and Done" Nifty Fifty, if you will.)
Apple displays a lot of the characteristics to look for -- it harnesses emerging technologies to give it a dominant franchise and as a result, pricing power.
Others will doubtless emerge, some as emerging market success stories (and that may include Western companies selling into EM), some will benefit from new technologies, such as companies that do well out of the ocean of natural gas that has now become exploitable in the US.
In some ways, the better choice might not be to make big bets on finding the Nifty Fifty, but rather wait until the market identifies them and then ride their coat tails.
The important fact is that in a world of lousy growth and high uncertainty, growth and the whiff of certainty will be in huge demand.
The Nifty-Fifty phenomenon was also partly psychological. As the years rolled on and the results stayed strong, investors became increasingly confident about making very long-term earnings assumptions about their favoured stocks, as hedge fund legend Michael Steinhardt, a veteran of the period, pointed out in an interview on CNBC last week.
No one makes those sorts of forecasts today, partly because we live in a quarter-by-quarter world. The more confident investors become in future income streams the higher the valuation they will be willing to assign them, especially given the dearth of confidence everywhere else.
Remember too, how badly the Nifty Fifty period ended for many investors. A mix of institutional and individual money drove valuations sky-high, to 80 and 90 times earnings in some cases. When the bear market and inflation of the mid-70s hit, they de-rated severely, burning many of the last-minute investors.
Still, it was a good ride while it lasted, and the kind we will be lucky to find in the coming decade.
At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. James Saft is a Reuters columnist.