Analysis-Echoes of dotcom bubble haunt AI-driven US stock market

In the current financial market, there is a significant surge in U.S. stocks, particularly those focused on artificial intelligence (AI), leading some to draw comparisons with the dotcom bubble of the late 1990s and early 2000s. This stock rally, fueled by AI enthusiasm, a resilient economy, and strong earnings, has propelled the S&P 500 and the Nasdaq Composite to new record highs.

A notable aspect of the current market is the dominance of a small group of tech stocks, with AI chipmaker Nvidia symbolizing this trend, similar to the “Four Horsemen” (Cisco, Dell, Microsoft, and Intel) during the dotcom boom. The astronomical growth of Nvidia’s shares, gaining nearly 4,300% over a five-year period, bears resemblance to the network equipment maker Cisco’s surge of over 4,500% in the same timeframe leading up to the 2000 peak.

Although valuations have grown and investor sentiment has become more optimistic, today’s tech champions seem to be in better financial health than their dotcom counterparts of the late 1990s and early 2000s. However, there are concerns that the AI-driven rally could end in a similar manner to the dotcom boom, with an epic crash. After nearly quadrupling in just over three years, the Nasdaq Composite plummeted almost 80% from its March 2000 peak to October 2002, and the S&P 500 collapsed nearly 50% in the same period.

The sector with the most significant growth in the current market is information technology, which constitutes 32% of the S&P 500’s total market value, the highest percentage since 2000. Just three companies, Microsoft, Apple, and Nvidia, represent over 20% of the index. However, tech stocks are currently modestly valued, trading at 31 times forward earnings compared to as high as 48 times in 2000.

The current rally seems to be driven more by solid earnings outlooks rather than inflated valuations, suggesting that fundamentals are more of a factor this time. Forward earnings per share in tech, communication services, and consumer discretionary sectors have been growing faster since early 2023 than the rest of the market, in contrast to the late 1990s and early 2000s when expected earnings in these sectors grew at a similar pace but valuations soared faster.

The difference between the current market and the dotcom bubble is clear in the valuations of companies like Nvidia and Cisco. While both stocks have soared, Nvidia trades at 40 times forward earnings estimates, compared to Cisco’s 131 level reached in March 2000. Some analysts predict that this tech bubble may not burst until the valuation of the overall market reaches the level it did in 2000.

However, it’s important to note that dotcom investors were much more euphoric, with bullish sentiment reaching 75% in January 2000, just months before the market peaked. Currently, bullish sentiment stands at 44.5%, compared to its historical average of 37.5%. Despite these comparisons, whether an AI bubble is a foregone conclusion remains to be seen, and many investors remain wary that metrics could become even more stretched if U.S. growth remains robust and tech stocks continue to rally higher.

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