Dot-Com Déjà Vu: Is AI Next?

Echoes of the Dot-Com Bubble: An Investor’s Warning on the AI Craze

This week marks the 25th anniversary of the peak of the dot-com bubble, a time of frenzied optimism that ultimately ended in market collapse. The Nasdaq-100 took over 15 years to recover its dot-com-era highs. Now, one investor who foresaw the crash believes today’s AI-driven market may be following a similar path.

Signs of Trouble

In hindsight, warning signs of the dot-com bust were visible. Former Federal Reserve Chairman Alan Greenspan famously cautioned against “irrational exuberance” as early as 1996. However, investors ignored the concerns, focusing on the transformative promise of emerging technology rather than financial fundamentals like revenue and earnings.

The S&P 500 hit its dot-com peak on March 24, 2000, closing at 1,527.46. The Nasdaq-100 followed closely, peaking at 4,704.73 on March 27. The Nasdaq Composite had reached its own record high on March 10, while the Dow Jones Industrial Average saw its peak earlier in January.

The Aftermath

When the bubble burst, it triggered a bear market that lasted more than two-and-a-half years, erasing trillions in market value. The Nasdaq-100 plunged over 80% from its peak. Events like the September 11, 2001 attacks and corporate scandals, including the collapse of Enron, further weakened market confidence.

Unchecked Optimism

During the dot-com era, everyone from cab drivers to newspaper vendors buzzed about stocks. Sam Stovall, Chief Investment Strategist at CFRA, recalls the sentiment:

“Everyone believed it was a new era, where valuations didn’t matter. The only thing that mattered was how much money you had invested.”

The Federal Reserve’s interest rate hikes in 1999, followed by a mild recession in 2001, accelerated the market downturn. Companies that had focused on metrics like website traffic instead of profitability faced harsh realities as revenue projections fell short.

A Long Recovery

The S&P 500 reclaimed its dot-com-era highs in May 2007. However, the Nasdaq-100 and Nasdaq Composite needed over 15 years to make a comparable comeback.

High-profile failures like Webvan, Pets.com, and Boo.com highlighted the risks of the speculative frenzy. Even established companies weren’t immune. Cisco Systems, once the most valuable public company, has yet to return to its dot-com-era valuation. Other telecom giants like WorldCom and NorthPoint Communications collapsed under the weight of unsustainable business models and accounting scandals.

Parallels to Today’s AI Market

James Stack, president of InvesTech Research, accurately predicted the dot-com crash. Today, he warns of striking similarities between the AI hype and the dot-com bubble.

“While we don’t see the extreme valuations of small startups, large companies like Cisco lost 60% to 70% during the dot-com crash,” Stack explained.

The launch of ChatGPT in late 2022 has fueled massive gains for AI leaders like Nvidia. The Nasdaq-100’s trajectory since then closely mirrors its growth from the mid-90s to the dot-com peak. Although valuations have eased, Stack remains cautious, holding nearly 50% of his clients’ portfolios in cash.

“The complacency and confidence today are concerning. There’s a belief that the market can’t fall,” Stack noted. “That’s when the average investor is most vulnerable.”

As history has shown, unchecked optimism can lead to painful corrections. While the AI revolution holds promise, Stack’s warnings serve as a reminder that fundamentals still matter.