The dot-com bubble that burst, leaving trillions of dollars in losses for the investors, happened in March 2000. By October 2002, the Nasdaq had lost more than 80% of its value, and the S&P 500 had been slashed in half.
What led to the dot-com bubble? The dot-com bubble occurred in the late 1990s, when rapid price rises in internet-based stocks fueled by internet growth, venture capital, and investor enthusiasm, led to ludicrous valuations across the technology, media and telecom sectors.
The intensity of the stock market crash of 2000 was such that Amazon’s stock reached its peak in December 1999, but then experienced a 90% decline due to the burst of the dot-com bubble.
Why revisit the Dotcom Bubble today?
The S&P 500’s 72% surge from its low in October 2022 has added over $22 trillion to market value. This has been driven largely by the overenthusiasm around a new theme – Artificial Intelligence (AI). However, of late, signs of trouble are emerging as stocks begin to sink, with the Nasdaq 100 losing over 10% and the S&P 500 briefly dropping to that level.
So, are the markets overvalued now? According to FactSet Research, the S&P 500 is presently trading at 21.2 times forward earnings, which is higher than the five-year average of 19.3 times forward earnings and the ten-year average of 17.9 times forward earnings. However, circa 2000, the S&P 500 was valued at 25 times anticipated earnings.
Valuations of technology companies are higher than other stocks. According to Yardeni Research, technology firms in the S&P 500 trade at 29.7 times forward earnings now, compared to more than 55 times ahead earnings in 2000.
Although there is still a disparity among the megacap firms, some investors are also worried about market concentration. After accounting for their relative sizes, the five biggest dot-com firms in 2000—Microsoft, Cisco, Intel, Lucent, and IBM—traded at an average of 59 times anticipated earnings. These days, the average price of the top five AI stocks—Microsoft, Nvidia, Alphabet, Amazon, and Meta Platforms—is 49 times their projected earnings.
During the dot-com era, there was a high level of excitement surrounding Internet companies, despite their lack of profitability. However, today, the so-called magnificent seven stocks or the AI-led stocks have profits and lots of cash flows to talk about.
Even though Internet companies were not profitable at the time, there was a lot of euphoria surrounding them. However, the so-called magnificent seven stocks or the AI-led stocks now have profits and cash flows to report.
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Investors should prepare for any stock market downturn, likely triggered by AI stocks, as history demonstrates that market corrections and bear markets are inevitable. However, valuations are more reasonable today than during the dot-com bubble, reducing the likelihood of a severe collapse, like the one witnessed in 2000.