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

NEW YORK (Reuters) – A rally in U.S. stocks fueled by excitement over artificial intelligence is drawing comparisons to the dotcom bubble of two decades ago, raising the question of whether prices have been inflated again by optimism over a revolutionary technology.

Artificial intelligence fever, along with a resilient economy and stronger earnings, have lifted the S&P 500 (^GSPC) to new records this year after a more than 50% run from the October 2022 low. The tech-heavy Nasdaq Composite (^IXIC) has gained more than 70% since the end of 2022.

While various metrics show stock valuations and investor abundance have yet to reach turn-of-the-century peaks, the similarities are easy to spot. A small group of massive tech stocks, including AI chipmaker Nvidia, typify today’s market, reminiscent of the “Four Horsemen” of the late 1990s: Cisco, Dell, Microsoft and Intel.

Nvidia’s ( NVDA ) stock’s dizzying run, which gained nearly 4,300% over a recent five-year period, evoked memories of how network equipment maker Cisco rose nearly 4,500% over the five years to its peak in 2000 , according to a BTIG Comparison of the two stocks.

Valuations have also risen, although many tech champions appear to be in much better financial shape than their dot-com counterparts of the late 1990s and early 2000s. Other measures, such as investor bullying, have not yet reached the frothy peaks of the turn of the century.

The worry is that AI-fueled growth will end the same way the dot-com boom did—with an epic crash. After nearly quadrupling in just over three years, the Nasdaq Composite plunged almost 80% from its March 2000 peak to October 2002. The S&P 500, which doubled in a similar time frame, plunged nearly 50% in that period.

While some Internet stocks like Amazon survived and eventually thrived, others never recovered.

“Nobody knows exactly what’s going to happen with artificial intelligence,” said Sameer Samana, senior global market strategist at Wells Fargo Investment Institute, noting the same uncertainty about potential long-term winners.

Echoing the dot-com boom, the information technology sector has grown to 32% of the S&P 500’s total market value, the largest percentage since 2000 when it rose to nearly 35%, according to LSEG Datastream. Just three companies, Microsoft (MSFT), Apple (AAPL) and Nvidia, represent over 20% of the index.

Still, tech stocks are more modestly valued now than they were at the height of the dot-com bubble, trading at 31 times forward earnings, compared with 48 times in 2000, according to Datastream.

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The difference is clear in the valuations of Nvidia and Cisco ( CSCO ), a major provider of products that support Internet infrastructure, whose stock has yet to recapture its dotcom boom peaks.

While both stocks have risen, Nvidia trades at 40 times forward earnings estimates, compared with Cisco’s level of 131 reached in March 2000, according to Datastream.

Capital Economics analysts also note that current growth is being fueled more by solid earnings prospects than rising valuations, a sign that fundamentals are more of a driver this time around.

Future earnings per share in the sectors containing today’s market leaders – technology, communications services and consumer discretionary – have grown faster since the start of 2023 than the rest of the market, a Capital Economics analysis showed. In contrast, expected earnings in sectors rose at a rate similar to the rest of the market in the late 1990s and early 2000s, while their valuations rose faster than for other stocks.

More broadly, the S&P 500’s price-to-earnings ratio of 21 is well above its historical average, but below the roughly 25 reached in 1999 and 2000, according to Datastream.

“Our base case is that this tech bubble will not burst until the valuation of the overall market has reached the level it reached in 2000,” Capital Economics analysts said in a note.

Dotcom investors were much more euphoric by some measures. Bullish sentiment in the widely followed American Association of Individual Investors survey, often seen as a worrisome indicator at high levels, reached 75% in January 2000, just months before the market peaked. It recently stood at 44.5%, compared to its historical average of 37.5%.

While an AI bubble is not a foregone conclusion, many investors are cautious that the metrics could expand further 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 rooted in … some real, positive, underlying development behind it that creates that enthusiasm for people to pay any price for things.”

(Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili and Richard Chang)