Broyhill Letter Highlights XI: Lessons From History

This is the eleventh piece in our Broyhill Letter Highlight series, highlighting our thoughts on what we can learn from history.  You can access other posts in the series here.

For those who would like to revisit our letters in full, we will also be gradually sharing them to our Research Studio throughout the series.

XI: Lessons From History

History provides a useful roadmap. Investors that bought the greatest companies in America at the height of the Nifty Fifty in the late 60s and held them for five years lost almost all of their money.

The “Nifty Fifty” captivated investors during the 1960s. These 50 “one-decision” stocks, identified by Morgan Guaranty Trust, represented the fastest-growing companies in the world. By 1972, when the S&P 500 Index's P/E stood at a then-lofty 19, the Nifty Fifty's average P/E was more than twice that, at 42. Among the most inflated were Polaroid, McDonald’s, Disney, and Avon, with P/E’s of 91, 86, 82, and 65. respectively. Then, as a Forbes columnist described it, the Nifty Fifty "were taken out and shot one by one." Xerox, Avon, and Polaroid fell 71%, 86%, and 91% from their respective highs.

In the early 2000s, a combination of optimism and passive investing led to a gross misallocation of capital, which facilitated the TMT bubble. A direct consequence of these distortions was a growing obsession with tracking error, which led to an absolute disaster for passive investors. In the twelve months after March 2000, the “least risky” and most widely owned stocks collapsed relative to the market. The ten largest companies underperformed the market by nearly 25%. The tech-heavy NASDAQ went on to lose nearly 80% of its value over the next three years.

The NASDAQ saw seven rallies greater than seventeen percent from 2000-2002. Some gained as much as 40% - 50%. Yet every single one of them was followed by lower lows, and ultimately the tech-heavy index declined by nearly 80% from peak to trough. Many investors were eager to call the bottom, but the beatings usually continued until retail speculators threw in the towel and completely capitulated. Or when there is hardly anyone left to sell.

Market tops are a process. They take time to unfold. They don’t happen overnight. Greenspan first warned of irrational exuberance in 1996, but the Nasdaq didn’t break down until four years later. Housing prices peaked in 2006, and Bear Stearns bailed out its related hedge funds in 2007. But the market didn’t completely break until Lehman’s failure in 2008.

We can’t predict when the herd will come to its senses. But we do know that bear markets typically begin well before a recession becomes obvious.

Investors would be wise to recall the sage advice of Bernard Baruch - “The main purpose of the stock market is to make fools of as many men as possible.”