A Review of the characteristics of the "Beautiful 50" Market of US stocks

In the early 1970s, there was nothing more famous in the US stock market than the "beautiful 50" market.

• The specific time and target of the "beautiful 50" market

When discussing "Beautiful 50", many viewpoints do not clearly give the specific target and time of "Beautiful 50". Generally speaking, "beautiful 50" (Nifty Fifty) is a specific technical term in the history of securities investment, which generally refers to the 50 blue chip stocks widely sought after by market investors in the late 1960s and early 1970s. "

As a result, the discussion about "Beautiful 50" is often only general, which probably means "blue chip stocks have risen very well for a period of time" and cannot be studied further.

For the "beautiful 50" market occurred in the specific period of time, the relevant research literature does not have a unified view. The market usually ends with the high point before the market fell at the end of 1972, while the starting time of the market varies.

From the comparison between the "beautiful 50" index calculated according to the aforementioned "beautiful 50" combination and the S & P 500 index, the "beautiful 50" market mainly occurred between the low point in June 1970 and the high point in December 1972. During this period, the "beautiful 50" stocks significantly outperformed the S & P 500. Therefore, this report takes the period from June 1970 to December 1972 as the period when the "beautiful 50" market occurred.

For the "beautiful 50" specific corresponding stock target, foreign research generally uses Morgan Guaranty Trust Co. The list of stocks provided (Forbes. "The Nifty-Fifty Revisited." December 15, 1977 and Jeremy Siegel, "The Nifty-Fifty Revisited: Do Growth Stocks Ultimately Justify Their Price", Journal of Portfolio Management, 1995).

• The three Macroeconomic background characteristics of the rise of "Beautiful 50"

Generally speaking, we believe that there are three main macroeconomic background characteristics of the rise of the "beautiful 50" market in US stocks, namely, the decline of the long-term growth center, the recovery of the short-term economy, and the decline of inflation compared with the same period last year. This means that during this period, the overall stability of the US economy is good, because the short-term economic growth rate picks up, so the economy is resilient, because the inflation growth rate has dropped. So the nominal economic growth rate is not too high.

From the perspective of macroeconomic aggregate, the characteristics of the changes that have taken place in the US economy before and after the occurrence of the "beautiful 50" market are as follows:

First, the center of long-term economic growth has declined significantly, and the center of US economic growth has declined significantly in the 1970s. The average GDP growth rate in the 1950s, 1960s and 1970s was 4.3 per cent, 4.5 per cent and 3.2 per cent respectively.

Second, short-term economic growth has bottomed out after two consecutive years of decline. In 1968 and 1969, the US economic growth rate continued to decline for two consecutive years, and since 1970, the GDP growth rate has rebounded significantly.

Third, inflation has dropped significantly. During the "beautiful 50" market of US stocks from 1970 to 1973, the growth rate of CPI in the United States decreased significantly compared with the same period last year, and the main reason for the drop in inflation was that President Nixon implemented the "New Economic Policy" and exercised administrative control over wages and prices in the United States.

Short-term real GDP growth rate rebounded, while inflation growth rate fell, corresponding to the nominal economic growth rate is not so high, which means that the economy is good but not so good during this period of time, and the overall economic stability is strong.

In addition, from the perspective of changes in the economic structure, the US economy experienced a sharp decline in the growth rate of government spending during the period when the US stock market "beautiful 50" occurred, while the growth rate of private sector consumption and investment rebounded rapidly.

In 1965, the United States formally sent troops directly to the outside world to participate in the Vietnam War, and at the same time began a vigorous "Great Society Program" at home. As a result, the growth rate of US government spending rose rapidly and sharply from 1965 to 1967. Since 1968, the growth rate of government spending in the United States has slowed down significantly, and the growth rate of government expenditure began to turn negative in 1970. From 1970 to 1973, the growth rate of US government spending remained negative throughout the "beautiful 50" market.

While the growth rate of US government spending has slowed to negative year-on-year, there has been a marked rebound in private sector consumption and investment growth since the second half of 1970. Among them, the growth rate of consumption rose from 2% to nearly 7%, while the growth rate of investment rebounded from-6% to about 12%. In terms of time, the growth rate of consumption and investment has rebounded in line with the "beautiful 50" market.

The logical story behind the "Beautiful 50" market

When it comes to "beautiful 50", Lenovo is the most "blue-chip white horse", so there are many views in the market that "beautiful 50" is the blue-chip white horse market. We believe that there is an understanding error in this view. "Beautiful 50" is not equal to blue-chip white horse. Although it is difficult to give a clear definition of what a "blue-chip white horse" is, one of the strongest evidence is that the Dow Jones Industrial average (the 30 most representative blue-chip white horse stock index) actually significantly outperformed the S & P 500 during this period.

In the time range of the aforementioned "beautiful 50", from a low in June 1970 to a high in December 1972, the portfolio of "beautiful 50" stocks rose 92%, the S & P 500 rose 62%, and the Dow Jones Industrial average rose only 49%.

And from the perspective of specific stocks, some blue-chip white horse stocks that we are familiar with, such as AT&T Inc, General Motors Co, and American Iron and Steel, do not appear on the list of "beautiful 50" companies. And during the period when the "beautiful 50" occurred, the stocks of these companies actually outperformed the market significantly.

So what is the story behind the "Beautiful 50" market? In our opinion, there are two main logic.

• The first logic is that the "Beautiful 50" industry has a significant increase in industrial concentration.

First of all, from the "beautiful 50" company's industry distribution. In general, the "beautiful 50" companies are mainly concentrated in the "manufacturing industry", and 38 of the 50 companies are concentrated in the manufacturing industry, accounting for 76%. It's actually retail, accounting for 8%. Transportation, communications, mining and other major industries all account for about 4%.

In terms of specific industry composition, among the 38 manufacturing "beautiful 50" companies, the pharmaceutical industry accounts for the largest proportion of 10 companies (27%), followed by 5 companies in the beverage industry (13%). Other industries with a relatively large proportion are daily chemical (8%), medical devices (8%), computer equipment (5%), construction machinery (5%) and photographic equipment (5%).

The common feature of these "beautiful 50" companies is the rapid increase in industrial concentration. According to the statistics of the US Economic Census, when the "Beautiful 50" market appeared in 1972, the concentration of the pharmaceutical and beverage industries increased significantly.

In the beverage industry, for example, the number of companies in the industry has fallen by more than 2/3 in 20 years or so since the 1960s, and the market share of the top 20 companies has increased by nearly 20 per cent. A similar situation can be seen in the pharmaceutical industry, where the number of companies has nearly halved.

On the other hand, if we look at the industry performance of the blue-chip companies that are not on the "beautiful 50" list, we can find that there is no increase in concentration in the industries in which these companies are located. Instead of increasing, the market share of the top four companies in the US steel industry is declining, while the number of companies in the industry is also increasing. From 1967 to 1977, the number of steelmaking enterprises in the United States rose from about 150 companies to nearly 400 companies, while the combined market share of the top four companies fell from 48% to 45%.

The same is true of the automobile industry, the number of enterprises in the industry is increasing. From 1967 to 1977, the number of automobile manufacturers in the United States rose from about 100 companies to nearly 300 companies. On the other hand, the market share of large companies is close to saturation and cannot be further improved. The combined market share of the top 20 auto manufacturers in the United States has remained at around 92% to 93%.

So we see that people like American Steel and General Motors Co are not in the "Beautiful 50". This is even more true when Bell founded AT&T Inc Company. At that time, the telecommunications industry in the United States was basically in a state of complete monopoly. Whether it was local or long-distance calls, before the US Department of Justice split AT&T Inc, it was basically concentrated in AT&T Inc Company, and its market share was already impossible to rise.

• The second logic is that the growth of "beautiful 50" companies is average, but their ROE is significantly higher than that of their peers.

In addition to the above industry-level characteristics, we can take a look at the characteristics of enterprises in the "Beautiful 50" list at the company level.

The growth of the performance of the "beautiful 50" company during that period was not very outstanding. An important fact that has been overlooked is that the net profit growth of the "beautiful 50" companies over the same period was significantly lower than the S & P 500 average.

In 1972 and 1973, the average net profit growth rate of the S & P 500 was nearly 20%, and the "beautiful 50" companies were by no means high-growth companies during that period. Therefore, we think that "Beautiful 50" was by no means a growth story even at that time.

However, the biggest feature of "beautiful 50" companies is that they are all high-quality leading companies in the industry and have strong profitability. We use the ROE level of an enterprise to measure its profitability. Comparing the ROE of "Beautiful 50" companies with other companies in their industry, it is obvious that the ROE of "Beautiful 50" companies is significantly higher. The ROE of all the "beautiful 50" companies was about 20%, while the "ROE" of all the other companies in the market was about 12%.

The same is true in terms of different industries. The ROE of "Beautiful 50" companies is significantly higher than that of other companies in each industry. The ROE levels of "Beautiful 50" companies in beverage, pharmaceutical, information technology, raw materials, finance and other industries are 18%, 18%, 19%, 18% and 24% respectively, while the ROE of other companies in the corresponding industry are only 11%, 15%, 12%, 12% and 11%.

To sum up, we find that the stocks in the "beautiful 50" list have two characteristics: one is the obvious increase in industrial concentration in their industry, and the other is that the company's profitability is very strong, and its ROE level is significantly higher than that of its peers. Therefore, we believe that "Beautiful 50" is a logical story of the revaluation of high-quality leading enterprises (high ROE) in the process of (1) increasing industrial concentration.

In essence, it was in the economic environment at that time that the market gave these leading companies a performance stability premium.

How did "Beautiful 50" finally end?

During the "beautiful 50" market, the market gave this batch of leading companies with average growth but strong profit stability a high valuation premium. But because of the first oil crisis, the US economy experienced a short-term recession in 1974, which brought the "beautiful 50" group to an end.

In hindsight, the performance of many "beautiful 50" companies is as stable as the market had hoped, but valuations can never go back. A short-term economic fluctuation ended the high valuation premium of the leading company's earnings stability, and the overvaluation could not withstand the short-term fluctuation of earnings.

• The "beautiful 50" market ends with short-term fluctuations in earnings.

What is the reason for the end of the "beautiful 50" market? From the perspective of historical data, the high valuation of "Beautiful 50" is on the one hand, but it may not be a direct cause. If the valuation is high, it can be higher. The direct reason is the emergence of a downward inflection point in the macro-economy, which leads to a wave of short-term fluctuations in the profits of leading companies.

The following chart reports the comparison between the stock price trend and the year-on-year trend of the US industrial production index during the "beautiful 50" market. It is obvious that during that period, the "beautiful 50" combination, the S & P 500 index and the year-on-year trend of industrial production were almost in sync. The "Beautiful 50" market ended in early 1973, when the first oil crisis broke out, which triggered the US economy into recession.

As a result of the first oil crisis, the US economy was followed by a short-cycle recession, which led to a short-term negative profit growth of leading companies. Instead of choosing to stick to it when short-term profits are down, the market has abandoned these companies with high valuations.

• Valuation level of "Beautiful 50" and follow-up Market performance

Judging from the final valuation of the "beautiful 50" company, by the peak of the market in December 1972, the valuation of the "beautiful 50" company was already very high. In December 1972, the "pretty 50" company had a price-to-earnings ratio of 41.9 times PE, while the average US stock price-to-earnings ratio was only 19.3 times. Polaroid had the highest price-to-earnings ratio of 94.8 times earnings.

Judging from the follow-up market performance of the "beautiful 50" company, Jeremy Siegel summarized the yield performance of the "beautiful 50" company from December 1972 to May 1995 in the article "The Nifty-Fifty Revisited: Do Growth Stocks Ultimately Justify Their Price" (Journal of Portfolio Management, 1995).

In the medium and long term, the follow-up rate of return of the "beautiful 50" company is basically the same as that of the market. From December 1972 to May 1995, the annualized rate of return of the "beautiful 50" company was 11.0%, while the overall rate of return of the market at the same time was 11.2%.

In other words, after the end of the "pretty 50" market in December 1972, these targets did not earn excess returns again on average, although their subsequent fundamentals were indeed very good in hindsight. The market has completed a revaluation of these leading companies during the "beautiful 50" market with a high valuation premium.

• Specific cases: Coca-Cola Company, Merck, IBM

In addition to the description of the total amount mentioned above, here we list a few more cases of specific companies to observe the changes in the valuation and performance of these leading companies before and after the "beautiful 50" market, in order to have a more visual and concrete understanding of what happened at that time.

The first example of a "beautiful 50" company is Coca-Cola Company, which is a leading company with standard standards. In the case of Coca-Cola Company, it is clear that there was a short-term fluctuation in the company's profit growth between 1974 and 1975, but then rebounded quickly.

In fact, if we take 1974-1975 as the boundary, we can find that the profit situation of the company before and after is basically similar, and there is not much change, but the valuation is really very different. After Coca-Cola Company's high valuation fell, I can never go back.

For the second example of a "beautiful 50" company, we are looking for Merck, a pharmaceutical company. As can be seen from the data, in fact, the company's earnings performance was very stable and good throughout the 1970s. During the "pretty 50" market between 1970 and 1973, the company's valuation soared, with its price-to-earnings ratio (ttm) rising from less than 30 times to nearly 50 times earnings.

With the recession of the US economy from 1974 to 1975, Merck's performance growth also fluctuated to some extent, but the company's valuation level showed a trend decline. and although the fundamentals are still sound (basically the same as before), the valuation has gone down systematically.

The third example of a "beautiful 50" company is IBM in the information technology sector. The overall performance of the technology sector in the 1970s was mediocre. During the "beautiful 50" period, IBM did not have a sharp rise in valuation like Coca-Cola Company or Merck, and its price-to-earnings ratio basically maintained a high level of about 40 times earnings.

But the same remains true of the company's valuation, which fell sharply around 1974, from 40 times earnings to about 15 times earnings, and never returned to high valuations after that, although it did well afterwards in terms of growth.

Great reversal of the style of American stocks in the post-"beautiful 50" era

Very often, many things, it is very reasonable to look at the words beforehand, and it is also very naive to think about it in hindsight. The great reversal after the "beautiful 50" market of the US stock market is such a story. After the "beautiful 50", US stocks walked out of the longest and largest wave of "small ticket market" in history.

The "beautiful 50" market in the United States roughly ended in 1973, and after the 1974 US economic recession, US stocks plummeted, and the stock market rebounded from 1975, when the market style changed greatly. from the previous "beautiful 50" big ticket market suddenly switched to the growth stock "small ticket market", and this wave of "small ticket market" lasted for a very long time until 1983.

Incidentally, it can be mentioned here that the "small market capitalization company premium" (one of the Fama-French three-factor model factors) that we are familiar with in academic research is officially proposed by Banz in 1981. The time point of this proposal is just the pinnacle of the small note style of American stocks. (Banz RW (1981) The relationship between return and market value of common stocks. Journal of Financial Economics 9: 3Mui 18.)

So what is the main reason for such a long round of ticket-style cycle after "beautiful 50"? An important change is the emergence of the new technological revolution (the third scientific and technological revolution).

Since the early 1970s, there has been a new technological revolution marked by microelectronic technology, bioengineering technology and new material technology. This is another major leap in the field of science and technology after the steam technology revolution and the power technology revolution in the history of human civilization. It is mainly marked by the invention and application of atomic energy, electronic computer, space technology and bioengineering. it involves an information control technology revolution in many fields, such as information technology, new energy technology, new material technology, biotechnology, space technology, marine technology and so on.

The third Industrial Revolution also gave birth to IT companies that people can still be familiar with today, such as Intel Corp (founded in 1968), Microsoft Corp (founded in 1975), Apple Inc Company (founded in 1976), Oracle Corp (founded in 1977) and so on. They still occupy the mainstream of people's life and work, even Alphabet Inc-CL C who was born in 1998 and Amazon.Com Inc who was founded in 1995 is the product of the third technological revolution.

Another important reason is that enterprises begin to attach importance to scientific and technological innovation and research and development. It can be seen that the proportion of American enterprises'R & D expenditure in GDP has increased rapidly since the end of 1977. Although the R & D cycle of enterprises has a certain lag relative to the beginning of the technological revolution, the sharp increase in R & D investment is also an important boost in the later stage of this round of small ticket market. The peak of this round of R & D spending basically ended in 1984, which basically coincided with the end time of the small ticket market.

We can also look at the market characteristics after the "beautiful 50" in the 1970s from another point of view, that is, the only part of the technology stock industry.

The trend of American technology stocks in the 1970s is very interesting. Judging from the market capitalization-weighted average index, technology stocks as a whole are significantly outperforming the market as a whole. This result is not very acceptable intuitively, because the economy of the United States in the 1970s was not very good, but it was an era of great technological innovation.

Further analysis shows that the main reason for the poor performance of the information technology sector as a whole is the poor performance of those weighted stocks with large market capitalization, while the performance of small market capitalization companies in the sector is very good, significantly outperforming the market, so the performance structure of the internal rate of return of technology stocks is very different.

The above chart reports this result. We have constructed two stock price indices of the information technology sector, both of which are calculated on the basis of market capitalization weighted average. We can see that the yield performance of this sector is significantly lower than that of the market as a whole.

In addition, we have also constructed a stock price index of the information technology sector excluding the S & P 500 sample, which can be understood as the stock price index of small market capitalization companies in the information technology sector. The yield of this index is significantly better than that of information technology (all) and the market as a whole.

The large market capitalization information technology companies in the United States did not perform well in the 1970s. If you take a closer look, you will find that, with the exception of a few companies such as IBM, most of the companies classified as information technology at that time were mainly concentrated in the field of electronics and black home appliances. The stock prices of familiar companies such as IBM, Kodak and Xerox all lagged behind the market as a whole in the 1970s.