A US stock rally supercharged by excitement over artificial intelligence reflects comparisons with the dotcom bubble twenty years ago, raising the question of whether prices have once again been inflated by optimism over revolutionary technology.
AI fever, coupled with a resilient economy and stronger earnings, has lifted the S&P 500 index to a new record this year after rising more than 50% from its October 2022 low. The tech-heavy Nasdaq Composite Index has gained more than 70% from the end of 2022.
While various metrics show stock valuations and investor exuberance haven’t reached their peak at the turn of the century, the similarities are easy to spot. A small group of big tech stocks including AI chip maker Nvidia dominate the market today, reminiscent of the “Four Horsemen” of the late 1990s: Cisco, Dell, Microsoft and Intel.
Nvidia shares, which have gained nearly 4,300% in the recent five years, are reminiscent of how network equipment maker Cisco rose about 4,500% in the five years to its peak in 2000, according to a BTIG comparison of the two stocks.
(For today’s top tech news, subscribe to Cache’s current tech newsletter)
Valuations have also been on the rise, although many tech champions looked better than their dot-com counterparts in the late 1990s and early 2000s. Other measures, such as investor bullishness, have not yet reached the frothy heights of the turn of the century.
The worry is that the AI-driven boom will end the same way the dot-com boom did — with an epic crash. After nearly quadrupling in just three years, the Nasdaq Composite fell nearly 80% from its March 2000 peak to October 2002. The S&P 500, which doubled in the same period, fell nearly 50% in that time.
While some internet stocks such as Amazon survived and eventually thrived, others never recovered.
“Nobody knows what’s going to happen with artificial intelligence,” said Sameer Samana, senior global market strategist at Wells Fargo Investment Institute, noting similar uncertainty about long-term winners.
Echoing the dot-com boom, the information technology sector has swelled to 32% of the total value of the S&P 500 market, the largest percentage since 2000 when it rose to nearly 35%, according to LSEG Datastream. Only three companies, Microsoft, Apple and Nvidia, represent more than 20% of the index.
However, tech stocks are now cheaper than at the peak of the dot-com bubble, trading at 31 times forward earnings, compared to 48 times in 2000, according to Datastream.
The difference is clear in the valuations of Nvidia and Cisco, a major provider of products that support internet infrastructure, whose shares have not yet recovered from the peak of the dotcom boom.
While both stocks have soared, Nvidia is trading at 40 times forward earnings estimates, compared to Cisco’s 131 level reached in March 2000, according to Datastream.
Capital Economics analysts also noted that the current rally is being fueled by solid earnings prospects rather than rising valuations, a sign that fundamentals are more of a driver this time.
Forward earnings per share in the sectors that contain the current market leaders – technology, communications services and consumer discretionary – have grown faster since early 2023 than any other market, Capital Economics analysis shows. In contrast, the expected earnings in the sector grew at the same pace for the rest of the market in the late 1990s and early 2000s, when valuations sored faster than other stocks.
More broadly, the S&P 500’s price-to-earnings ratio of 21 is higher than the historical average but below the 25 levels reached in 1999 and 2000, according to Datastream.
“Our base case is that this tech bubble will not burst until the overall market value has reached the level it did in 2000,” Capital Economics analysts said in a note.
Dotcom investors are more euphoric by some measures. Bullish sentiment in the American Association of Individual Investors survey, often seen as a disturbing indicator at high levels, reached 75% in January 2000, just a month before the market peaked. It recently stood at 44.5%, compared to the historical average of 37.5%.
While the AI ​​bubble is not a foregone conclusion, many investors are wary that the metric could be longer in the coming months if US growth remains strong and tech stocks continue to charge higher.
“There are a lot of similarities,” said Mike O’Rourke, chief market strategist at JonesTrading. “When you have a bubble, it’s usually in … some real, positive, fundamental development that’s behind it and it’s encouraging people to pay whatever the price is.”