By Lewis Krauskopf
NEW YORK (Reuters) - A rally in U.S. stocks fueled by enthusiasm for artificial intelligence is drawing comparisons to the dot-com bubble of two decades ago, raising the question of whether prices have been inflated again by optimism about a breakthrough technology.
The AI โโrush, coupled with a resilient economy and stronger earnings, has driven the S&P 500 to new records this year after rallying more than 50% from its October 2022 low. The tech-heavy Nasdaq Composite Index has gained more than 70% since the end of 2022.
While various metrics show that stock valuations and investor exuberance have yet to reach the peaks seen at the turn of the century, the similarities are easy to spot. A small group of big tech stocks, including artificial intelligence chipmaker Nvidia, symbolize todayโs market and are reminiscent of the โFour Horsemenโ of the late 1990s: Cisco, Dell, Microsoft and Intel.
Nvidia's soaring stock, which gained nearly 4,300% over a recent five-year period, evoked memories of how networking equipment maker Cisco rose about 4,500% in 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 indicators, such as investor optimism, have yet to reach the exultant levels 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 over three years, the Nasdaq Composite plunged nearly 80% from its March 2000 peak to October 2002. The S&P 500, which doubled in value over a similar period, has plunged nearly 50% in that time.
While several Internet stocks like Amazon survived and eventually thrived, others never recovered.
โNobody knows exactly what will happen with artificial intelligence,โ said Sameer Samana, senior global market strategist at Wells Fargo Investment Institute, pointing to the same uncertainty about eventual long-term winners.
Following the dot-com example, the information technology sector has grown to account for 32% of the S&P 500's total market value, the highest share since 2000, when it rose to nearly 35%, according to LSEG Datastream. Just three companies โ Microsoft, Apple and Nvidia โ account for more than 20% of the index.
Yet tech stocks are valued more modestly now than at the peak of the dot-com bubble, trading at 31 times forward earnings, compared with as much as 48 times in 2000, according to Datastream.
The difference is clear in the valuations of Nvidia and Cisco, a key supplier of products that support internet infrastructure, whose shares have yet to recover their dot-com boom peaks.
While both stocks have soared, Nvidia is trading at 40 times forward earnings estimates, compared with the level of 131 that Cisco hit in March 2000, according to Datastream.
Capital Economics analysts also point out that the current rally is being driven more by solid earnings prospects than rising valuations, a sign that fundamentals are a more important factor this time around.
According to an analysis by Capital Economics, forward earnings per share for sectors that include the current market leaders (technology, communication services and consumer discretionary) have been growing faster since early 2023 than the rest of the market. In contrast, expected earnings in the sectors grew at a similar pace to the rest of the market in the late 1990s and early 2000s, while their valuations soared faster than those of other stocks.
More broadly, the S&P 500's price-earnings ratio of 21 is well above its historical average, but below the level of about 25 reached in 1999 and 2000, according to Datastream.
โOur baseline scenario is that this tech bubble will not burst until the broader market valuation has reached the level it was in 2000,โ 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 worrying indicator at high levels, hit 75% in January 2000, just months before the market peaked. It recently stood at 44.5%, compared with its historical average of 37.5%.
While an AI bubble is not a foregone conclusion, many investors fear that metrics could stretch even further in the coming months if U.S. growth remains strong and tech stocks continue to rally.
โThere are a lot of similarities,โ said Mike OโRourke, chief market strategist at JonesTrading. โWhen thereโs a bubble, itโs usually rooted in โฆ some fundamental, positive, true development thatโs behind it that creates this enthusiasm on the part of people who are willing to pay any price for things.โ
(Reporting by Lewis Krauskopf; editing by Ira Iosebashvili and Richard Chang)
