AI bubble is nowhere near a peak. It's only at 'base camp': Jen

(The views expressed here are those of the author, the CEO and co-CIO of Eurizon SLJ asset management.) By Stephen Jen LONDON, Oct 22 (Reuters) – Has the buoyant U.S. stock market near the peak scaled back in the run-up to the dotcom bubble? Rising market anxiety might suggest “yes,” but a comparison of current prices with the late 1990s suggests that US stocks may only be in the “base camp” – far from reaching a summit. Since 2011, US stocks have risen strongly, with the total market increasing sevenfold in nominal terms and fivefold in real terms. Moreover, the technology sector rose 16 times in nominal terms and 11 times in real terms. This has led many investors to worry about a repeat of the dotcom bubble that burst in 2000. While the overall U.S. stock market certainly isn’t cheap today, tech stocks — which now make up 38% of the S&P 500 — actually don’t look that expensive compared to the late 1990s, suggesting this rally may still have a long way to go. RELATIVE GREATNESS The “Magnificent 7” US tech companies – Microsoft, Amazon, Apple, Alphabet, Meta, Tesla and Nvidia – have been on a tear since the end of 2022, rising by around 300%. As a result, the unweighted average price-to-earnings ratio of the Mag-7 is currently around 70x, and the median Pv is 36x, both above the historical averages for the S&P 500 and Nasdaq. Still, while these numbers may seem high, they are nothing compared to the valuations of the top seven tech companies in 2000. At the height of the dotcom bubble, the unweighted average PE ratios across the seven largest tech companies – Microsoft, Amazon, Cisco, Intel, Oracle, AOL and Yahoo! – was 276x, and the median PE was 120x. One point to note, Amazon’s PE is not included in that average because the company was reporting annual losses of more than $1 billion at the time, a far cry from how it is performing today. CONCENTRATION RISK? Another common investor fear is that today’s US stock rally may be more dangerous than during the dotcom era because the current market has become so concentrated. On its face, this point about concentration is true. Today’s Power 7 companies account for 35% of the S&P 500. In contrast, the “Power 7” companies in 2000 represented only 15% of the index. But is concentration always dangerous? Not necessarily, especially if the leading companies have strong earnings – and all of today’s tech giants have ample, diversified earnings. Moreover, many of these companies also have a lot of cash and are therefore in a strong position to invest and increase their earning power. Things looked a lot different in 2000. At the time, most of the top seven tech firms’ value was based on expected future earnings from businesses that had yet to be developed. And since most of the companies generated little, if any, cash, most of this investment had to be financed by debt. RETREAT PREVIEW? So what does all this say about the risk of another dotcom-style correction? The retreat after 2000 was brutal. Microsoft’s stock price fell as much as 65%, and Amazon lost almost all of its value at its lows. Meanwhile, Cisco, Intel and Oracle were down an average of 86%. It took 17 and 7-1/2 years for Microsoft and Amazon, respectively, to regain their peak nominal prices, while the other three took an average of 20 years to recover. It’s unlikely we’ll see a repeat of this, based on my estimates. Today’s leading technology companies are more mature, have lower average valuations and, relatedly, much higher earnings. Moreover, market structure is very different today, with more significant retail and private equity participation. Investors also now have a better historical perspective on many of these tech companies and will most likely have a strong appetite to “buy the dip” if and when a selloff occurs. There is good reason for this. Even though AOL and Yahoo! eventually met their demise, most of the other big tech companies of 2000 not only survived the crash, but thrived and still dominate today. BUT IS IT A BUBBLE? I’m not saying the current AI bubble isn’t a bubble. There are indeed many parallels between today’s market and the run up to 2000. I’m just pointing out that the size of the bubble in 2000 was huge, measured both in terms of the increases in stock prices and PV ratios. A fix will probably come at some point. But if we use the dotcom experience as a benchmark, the summit is pretty far above where we are now, and even if we get there, the fall may be much less severe. (The views expressed here are those of Stephen Jen, the CEO and co-CIO of Eurizon SLJ asset management). Enjoying this column? Check out Reuters Open Interest (ROI), your essential new source for global financial commentary. ROI delivers thought-provoking, data-driven analysis on everything from exchange rates to soybeans. Markets are moving faster than ever. ROI can help you keep track. Track ROI on LinkedIn, and X. (Writing by Stephen Jen; Editing by Anna Szymanski and Jamie Freed)