The Zhitong Finance App learned that excitement about artificial intelligence has driven a sharp rise in the US stock market. This makes people compare it to the internet bubble 20 years ago, and question this: whether optimism about this revolutionary technology has once again caused a bubble in the stock market.

There are similarities

The boom in artificial intelligence, combined with economic resilience and stronger corporate profits, raised the S&P 500 index by more than 50% from its low in October 2022 and reached a new record high this year. Since the end of 2022, the Nasdaq Composite Index, which is dominated by technology stocks, has also risen by more than 70%.

Although various indicators show that stock valuations and investor enthusiasm have yet to reach their peak at the turn of the century, there seem to be quite a few similarities between the two. Today, a small number of large technology stocks, such as NVDA.US (NVDA.US), the leading artificial intelligence chip manufacturer in the US, are reminiscent of the “Four Horsemen” of the late 90s: Cisco (CSCO.US), Dell (DELL.US), Microsoft (MSFT.US), and Intel (INTC.US).

Among them, Nvidia's stock price has risen by nearly 4,300% in the last five years. In contrast, network equipment manufacturer Cisco soared about 4,500% in the five years before reaching its peak in 2000.

Valuations have also increased, although many tech giants seem to be in a much better financial position than their internet peers in the late 90s and early this century.

Investors are worried that the AI-driven surge may increase the risk that this round of gains in US stocks will end in the same way as the internet boom — ending in an epic crash. During the internet bubble, the Nasdaq Composite Index nearly tripled in just over three years, then plummeted by nearly 80% from its peak in March 2000 to October 2002. The S&P 500 index, which doubled in the same period, plummeted by nearly 50% during the same period.

Although several internet stocks such as Amazon (AMZN.US) survived and eventually boomed, others never recovered.

“No one knows for sure what will happen with artificial intelligence,” said Sameer Samana, senior global market strategist at Wells Fargo Investment Research Institute. He pointed out that there is the same uncertainty about the ultimate long-term winner.

According to LSEG Datastream data, in line with the internet bubble, the share of the IT sector in the total market value of the S&P 500 index has swelled to 32%, the largest percentage since 2000, when this ratio rose to nearly 35%. Only three companies, Microsoft, Apple (AAPL.US), and Nvidia, account for more than 20% of the index.

There are also significant differences

However, according to Datastream data, the current valuation of technology stocks is more moderate than during the peak of the internet bubble, with a forward price-earnings ratio of 31 times compared to 48 times in 2000.

The difference in valuation between Nvidia and Cisco is also evident. Cisco is a key supplier of Internet infrastructure support products, and its stock price has yet to return to the peak of the Internet boom.

Data from Datastream shows that although both stocks are soaring, Nvidia's forward price-earnings ratio was 40 times, while Cisco reached 131 times in March 2000.

Kaitou macro analysts pointed out that the current rise is more driven by steady profit prospects than growing valuations, which indicates that fundamental factors are driving factors to a greater extent this time.

An analysis by Kaitou Macro shows that since the beginning of 2023, the expected earnings per share in industries where today's market leaders are located, such as technology, communications services, and non-essential consumer goods, have grown faster than in other sectors of the market. By contrast, in the late 90s and early this century, the expected earnings of these industries grew at a similar rate to the rest of the market, while their valuations soared faster than other stocks.

Lei Qiu, portfolio manager for disruptive innovation equities at investment management firm AllianceBernstein, notes in a blog post that many large companies that build AI-enabled cloud infrastructure are generating “significant” revenue as customers seek increased productivity. She wrote, “Rather than looking forward to the next big product — which was a failed strategy during the internet boom — today's profitable AI backbone is mainly investing in cloud infrastructure to improve efficiency.”

Data from Datastream shows that from a broader perspective, the S&P 500 price-earnings ratio of 21 times is far above the historical average, but below the level of about 25 times in 1999 and 2000.

“Our basic prediction is that this tech bubble will not burst until the entire market's valuation reaches the level of 2000,” a macro analyst at Kaitou said in a report.

Judging from some indicators, investors were also much more bullish during the internet bubble period. In the widely watched American Association of Individual Investors survey, investor bullish sentiment reached 75% in January 2000, a few months before the market peaked. Recently, the ratio was 44.5%, and the historical average was 37.5%.

Lethal power or greater

Although an AI bubble is not inevitable, many investors worry that if the US economy remains strong and tech stocks continue to rise, these indicators may become more tense in the next few months, or even more lethal in the event of a collapse.

“There are a lot of similarities,” said Mike O'Rourke, chief market strategist at JonesStrading. “When a bubble appears, it's usually rooted in... some real, positive, fundamental development behind it, which fuels people's enthusiasm to pay for anything.”

Erik Gordon, a professor at the University of Michigan's Ross School of Business, said the internet is revolutionary, and so will artificial intelligence.

“Both of these topics are correct. But that doesn't mean that companies whose valuations are based on these themes were or are good investments,” Gordon said. “Many online companies that are driving the transformation of the internet have gone bankrupt as a result. And many artificial intelligence companies driving such huge changes are also likely to go bankrupt or lose half of their value.”

In other words, even if artificial intelligence is the next big event, AI company valuations may still be abnormal, and pioneers in the field may still collapse.

Gordon emphasized that most of the pioneers of the Internet are small startups, while leaders in the field of artificial intelligence include established profit giants such as Microsoft and Google (GOOGL.US).

“They can lose billions of dollars and not go bankrupt,” Gordon said.

On the other hand, though, internet upstarts don't have a huge shareholder base, so when they go out of business, “only brave or stupid investors get hurt.” In contrast, the big tech companies that dominate artificial intelligence account for a large portion of the market value of the US stock market and are the backbone of pension funds and retirement portfolios.

“The pioneering giants of artificial intelligence will not go bankrupt,” Gordon said, “but if the loss of artificial intelligence causes their stock prices to fall, many investors will lose money.”

“This isn't a fake corporate bubble, it's an order of magnitude overvalued bubble,” Gordon warned.