Are We Partying Like It’s 1999?
Quick Take
The global stock market has seen significant gains to the start of the year. While gains are still concentrated in the largest companies, there are signs the rally is broadening.
The rise in AI stocks is reminiscent of the internet bubble of 1999 and 2000. However, unlike the 90s, investors are favoring large, profitable companies over the young and unproven.
Stay balanced and stay diversified when others in the market are tempted to chase the latest technological innovations.
The stock market has had an excellent run lately, so much so that global stocks hit record highs in the first quarter of this year.
Large US stocks led the global indices. The S&P 500 gained 10.6% to start the year. Last year, the Magnificent 7 (Apple, Amazon, Google, Meta (the parent of Facebook), Microsoft, NVIDIA, and Tesla) accounted for most of the gains in the S&P 500 and broader stock market.
The Magnificent 7 parted ways in the first quarter. NVIDIA continued its strong performance, gaining 82% in the first quarter, followed by Meta, which returned 37%. In comparison, shares of Tesla and Apple fell 29% and 11%, respectively.
Stock market gains have broadened to start this year. Energy returned 13.7% on the back of higher oil prices. Banks and other financials gained 12.4% while real estate and other interest-rate sensitive stock sectors lagged as bond yields increased. Shares of mid-sized US companies were up 10%. Shares of small-cap stocks trailed with a still respectable 5.2% return in Q1.
International markets participated as well. In local currencies, international equities gained 8.2%, but a stronger US dollar offset some of those returns, with the index gaining 4.7% in dollar terms. Japan, one of the largest stock markets by size outside the US, surpassed its 1989 high. Many value-oriented investors have been waiting for the resurgence of the Japanese stock market.
The renaissance in artificial intelligence was not the only narrative driving stocks higher. The recovery in stocks that started in the fall of 2022 has been as much about the sustained economic gains. So far, the Fed has managed to thread a needle to bring inflation down with minimal costs to growth.
Still, the Fed has some work to lower inflation to its 2% target. The pace of progress has recently slowed, which has weighed on bonds. At the start of the year, bond market investors expected the Fed to cut interest rates about six times. Now, investors expect fewer rate cuts this year, and bond yields moved higher in Q1.
Corporate bonds added return over US Treasuries. The market for corporate debt absorbed $542 billion in new issuance. While absolute yields are historically high, the added yield over US Treasuries has continued to tighten.
1999 All Over Again?
The gains in shares of Artificial Intelligence companies—NVIDIA being the posterchild—are reminiscent of the internet bubble of 1999 and 2000. 1999 reminds us that enthusiasm for new industries can reach exuberant levels. However, there are some critical differences between the excitement for AI and the late 1990s tech bubble.
Back then, new internet companies popped up overnight, and clicks and eyeballs determined valuations. Corporate earnings were not considered important. Now, investors scrutinize initial public offerings more thoroughly.
Today, the companies leading this surge in AI are some of the most profitable. Shares of NVIDIA, the primary supplier of chips used in processors for artificial intelligence, have gained over 740% since mid-October 2022 and shares trade at a lofty 38 times next year's expected earnings. NVIDIA has delivered on these growth expectations, with revenue doubling and earnings quadrupling over the last year.
During the 90s tech boom, the market enthusiastically embraced shares of lower-quality, riskier, small-cap stocks. Today, investors shun small-cap stocks in favor of large, profitable tech companies.
Other indications suggest the market hasn't reached excessive ebullience yet. Margin debt, often an indicator of bullishness, has been falling relative to the market size. Cash balances also remain high, enticed by short-term interest rates.
As the adage goes, the trees don't grow to the sky. Undoubtedly, the internet revolution changed lives, but chasing many of the hottest internet stocks in the 1990s ended in disappointment. Other examples of old-economy technologies proving to be better investments than new-economy tech—airlines vs railroads—offer caution. Without any historical anchors, there is little basis for judgments on the future of new technologies, which can lead to resounding miscalculations.
What It All Means
The consensus was that the economy would enter a recession by the end of 2023. That hasn't happened. Profits and job gains have exceeded expectations despite raising the Fed Funds rate to 5.25% in rate hikes in 18 months.
AI may be transformational, but are the AI stocks in a bubble? It will only be apparent in hindsight. Terms like "bubble" are often used to grab attention and headlines. However, disciplined and prudent portfolio management is not about grabbing headlines. It is about imposing a structure that keeps a portfolio diversified and grounded in the face of the wild swinging sentiment.
At the core, we believe that market forces are powerful; there is valuable information in prices. The collective wisdom of the crowd is smarter on average than any individual investor. Few investors (if any) know the future, and it isn't easy to improve upon the market's assessment. During periods of exuberance, staying grounded and resisting the urge to dramatically alter the investment risk in your portfolio is essential.
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