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By Louis Krauskopf
NEW YORK (Reuters) – A rally in U.S. stocks driven by excitement over artificial intelligence is drawing comparisons to the dot-com bubble two decades ago, raising the question of whether prices have once again been inflated by optimism about a revolutionary technology.
The AI fever, coupled with a resilient economy and stronger earnings, has lifted the New York Stock Exchange index to new record highs this year after rising more than 50% from its October 2022 low. The tech-heavy index has gained more than 70% since the end of 2022.
While various measures show that stock valuations and investor enthusiasm have yet to reach their turn-of-the-century peaks, it’s easy to spot the similarities. A handful of mega-cap tech stocks, including chipmaker Nvidia (NASDAQ:), symbolize today’s market, reminiscent of the “Four Horsemen” of the late 1990s: Cisco (NASDAQ:), Dell (NYSE:), Microsoft (NASDAQ:), and Intel (NASDAQ:).
The astonishing rise in Nvidia shares, which have gained about 4,300% in the past five years, has evoked memories of how networking equipment maker Cisco shares rose about 4,500% over five years before peaking in 2000, according to a comparison by BTIG of the two stocks.
Valuations have also risen, though many of the tech giants appear to be in much better financial shape than their Internet peers were in the late 1990s and early 2000s. Other measures, such as investor optimism, have yet to reach the dramatic heights of the early 2000s.
Indeed, the fear is that the AI-driven rally could end the way the dot-com boom did – with an epic crash. After nearly quadrupling in value in just three years, the Nasdaq Composite Index fell by 80% from its peak in March 2000 to October 2002. The S&P 500, which doubled in a similar time frame, collapsed by 50% in that period.
While many internet stocks like Amazon (NASDAQ:) survived and eventually thrived, others never recovered.
“Nobody knows exactly what will happen with AI,” said Samir Samana, chief global market strategist at Wells Fargo Investment Institute, citing the same uncertainty about the ultimate long-term winners.
Like the dot-com boom, the information technology sector has ballooned to 32% of the S&P 500’s total market value, the most since 2000 when it rose to nearly 35%, according to LSEG Datastream. Only three companies, Microsoft, Apple (NASDAQ:) and Nvidia, account for more than 20% of the index.
However, technology stocks are now more modestly valued than at the height of the dot-com bubble, trading at 31 times future earnings, compared with about 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 the Internet’s infrastructure, whose shares have yet to regain their peaks from the dot-com boom.
While both companies’ shares have risen, Nvidia is trading at 40 times forward earnings estimates, compared with 131 times Cisco’s in March 2000, according to Datastream.
Capital Economics analysts also point out that the current rally is being driven more by strong earnings expectations than growing valuations, a sign that fundamentals are the bigger driver this time around.
An analysis by Capital Economics shows that expected earnings per share in today’s market leaders — technology, communications services and consumer discretionary — have been growing faster since early 2023 than the rest of the market. By 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 rose faster than other stocks.
More broadly, the S&P 500’s price-to-earnings ratio of 21 is well above its historical average but below the level of about 25 it reached in 1999 and 2000, according to Datastream.
“Our base case is that this tech bubble will not burst until the overall market valuation reaches the same level it reached in 2000,” analysts at Capital Economics said in a note.
Dot-com investors were much happier by some measures. Positive sentiment in a survey by the American Association of Individual Investors, often seen as a worrying indicator at high levels, reached 75% in January 2000, just a few months before the market peaked. It recently stood at 44.5%, compared with a historical average of 37.5%.
While an AI bubble is not a foregone conclusion, many investors warn that metrics could tighten in the coming months if U.S. growth remains strong and tech stocks continue to rise.
“There are a lot of similarities,” says Mike O’Rourke, chief market strategist at Jones Trading. “When a bubble develops, it’s usually rooted in… some real positive, fundamental development behind it that creates this enthusiasm for people to pay whatever price for things.”
