The recent fashion for momentum investing, with investors piling into expensive growth stocks, is nothing new, says Merryn Somerset Webb. And the dangers are the same, too.
Kodak was once a stockmarket giant Back in 1967 a man calling himself Adam Smith wrote a wonderful book called The Money Game . Smith – actually a professional investor called George Goodman writing under a pseudonym – devotes one chapter to what he called “The Cult of Performance”.
In it, he describes the shift that took place in fund management in the 1960s. Before then, portfolio management was not an “Instrument of Personality”. Funds were instead run by a “Prudent Man” – the kind who “died with an estate that won the admiration of the lawyers for its order and efficiency”.
His portfolio had around 200 stocks in it – the 200 biggest companies in the US. These made up two-thirds of the assets – bonds made up the rest.
This was straightforward, formulaic stuff. If our man was to make a radical move, he might “reduce Steels from 3.3% to 2.9% and buy a little more Telephone” (Smith was an enthusiastic user of capital letters).
Then something changed; where there hadn’t been much money, there was suddenly a great deal of money. Momentum investing takes off
In 1946, $1.3bn was invested in mutual funds. By 1967 that number was $37bn (plus another $150bn in pension funds). Seven times as many Americans held shares by the end of the 1960s as had during the height of the 1929 bubble.
At the same time, a new group of managers arrived. These were “tigers” not remotely scarred by the horrors of 1929 . They saw that the best capital gains weren’t coming from America’s big old companies, but newer growth companies – Xerox, Disney, Polaroid, Eastman-Kodak and IBM. The stage was set for The Cult of Performance.
Fund salesmen found people weren’t interested in “nice balanced diversified funds” any more. They wanted the funds that had gone up the most – and that they thought would continue to go up the most. Initially that mostly meant the Fidelity Trend Fund (up 56% in 1965) and the Dreyfus Fund (the first to run a real retail advertising campaign – featuring a real lion emerging from a subway station on Wall Street).
But soon the method was jammed with Instruments of Personality – Fidelity’s Gerry Tsai raised $274m in a day for his Manhattan performance fund against an original target of $25m – and everyone was getting into the growth game.
Even the head of the supposedly conservative Ford Foundation was muttering about caution costing more than risk taking. Look at how the performance managers are doing, he said, and surely funds such as his should be changing direction: “The true test of performance in the handling of money is the record of achievement not the opinion of the respectable.” I imagine that in later years he filed this under things he wished he had never said in public.
“It may all go too far”, said Smith in 1967; the respectable “may be right”. It did and he was.
The performance stocks, which became known as the Nifty Fifty, went nuts, with price/earnings (p/e) ratios hitting 50-plus across the board; Polaroid was the winner on 94.8 at its peak.
Then oil prices, inflation and interest rates all rose fast, the Bretton Woods system came to an end and it all came tumbling down. By 1974 Polaroid was down 91%. The Fidelity Trend Fund fell 23% in 1973 and 31% in 1974. The FAANG stocks take over where the Nifty Fifty left off
This will all sound familiar. Replace Fidelity with Baillie Gifford, performance with growth and Polaroid with Netflix and you will see the story is very much the same.
This brings me neatly to what Ed Yardeni of Yardeni Research calls the MegaCap-8: Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Netflix, Nvidia and Tesla.
Until very recently this lot were treated just as the performance stocks were in the 1960s. They were where the growth was – you bought them and you held them forever. Price was irrelevant.
In a low growth world you didn’t need prudent men, or those looking for what we used to call GARP (growth at a reasonable price). You needed those who would buy growth at any price (GAAP).
Tesla peaked on a price/earnings ratio of 163 in August 2020, says Yardeni, while Amazon hit 85 and Netflix 66. It went too far. Then oil prices, inflation and interest rates began to rise – and […]
source Momentum investing – and why price matters more than anything else
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