Alan Deans
New York View
The people who backed the Nifty 50 during the past few years have made buckets of money. No, it is not a sporting team or a gaming system, but refers to the fastest-growing companies listed on the Standard & Poor's 500 stock index. They are the nimblest of the blue bloods.
As an investment strategy, it sounds as sensible as any other. Companies enjoying fast sales and earnings growth rates obviously are doing something right. Chances are they have a hot new product, operate in a newly deregulated industry or have revamped management.
In America, the Nifty 50 is synonymous with listings like Microsoft, Dell Computer, Intel Corp and MCI Worldcom. Each of these four operate at the vanguard of the information revolution by producing software, selling computers, making silicon chips or operating phone systems.
The focus on these companies has intensified during the past couple of years, partly because they have been insulated from troubles in the world economy. Demand for their products was bolstered by weaker interest rates, and people were not willing to risk moving into areas where returns were less certain. It times of trouble, it was natural to stick with the best.
So severe did this contraction become that 75 per cent of all US listings this year have been selling at 20 per cent below their 52-week highs.
That means the vast majority of stocks were suffering a bear market while the Dow Jones Industrial Average, the S&P 500 and other big market indicators were marching to record highs. The spectacular performance of a mere handful has papered over the woes of the masses.
But life changes.
Many in the Nifty 50 are now priced sky high. Turn the clock back four years, and they could be bought when their price earnings multiple was around the same level as their revenue growth rate. They were good buying. Now, they sell at double that rate or more - going at 70 to 80 times current earnings levels when they are growing at just 35 to 40 per cent.
Microsoft and the other 49 might all still be top-line companies but few represent value any longer. This is a point that more and more American investors are coming to realise, and the result threatens to have a far-reaching impact on US equity markets.
The fact is that the global economy is recovering. That means prosperity is being bestowed upon many more companies in many more industries and countries.
A whole new world of investment opportunity is opening up, even in battered emerging markets such as Thailand and South Korea, where people lost huge amounts only two years ago.
In the words of Merrill Lynch's Richard Bernstein, the Nifty 50 are now facing a challenge from the Not-So-Nifty 450. It seems natural to Bernstein and many other Wall St gurus that investors will cast their net wider in good times, and that means looking for better comparative value than they have in the past.
Plenty of American savings have recently been diverted into European and Japanese markets, both areas believed to have stronger growth potential than the US during the medium term. There are others who say that domestic bonds look pretty tasty, particularly in the riskier markets such as junk bonds and lowly rated corporations.
Similar methods are being applied to stocks. Bernstein says that listings who have S&P stock ratings of C and D have grown in value by nearly 50 per cent this year, compared with 1.25 per cent for those rated A+, minus 5.8 for A and minus 1.9 per cent for A-.
Commentators often call periods such as these ones of rotation. They advise clients to bale out of one industry and into another, or out of a sector leader and into ones of lower rankings. Smaller capitalised companies often can do better than their big-named competitors.
There is a danger, however, that while the market broadens and prepares for a significant advance, leading indices suffer a slump. If enough investors switch from holding Nifty 50 stocks and go into the bottom 450, then the S&P 500 could drop temporarily. The same could be true of the Nasdaq Composite index, which is crammed with technology highflyers.
But investors who keep their heads stand to make good gains in any new era that emerges for the stockmarket.
* Alan Deans is New York correspondent for the Australian Financial Review.
