Is the AI boom another internet bubble?

The lesson of the dot-com bubble warns investors to be cautious of stock market rallies driven by technological trends. This year, the AI boom has propelled the prosperity of the US stock market, raising concerns of a bubble.

As the core of the AI frenzy, NVIDIA, the leading provider of AI computing power and chip giant, has seen its stock price nearly double this year. During the same period, the Nasdaq 100 index rose by 38%, while the S&P 500 increased by 16%.

The market is full of expectations for the potential of the AI frenzy, but some warn of a bubble burst.

As pointed out by Kai Wu, the founder and chief investment officer of Sparkline Capital, in a report by The Wall Street Journal:

The AI explosion has attracted some who are eager to invest at all costs, while others are sounding the alarm, believing that it may ultimately end in tears. Investors can benefit from growth driven by innovation, but they must be cautious of paying too high a price for it.

The AI frenzy is surging

NVIDIA, the chip giant, is at the center of this AI wave. According to its earnings report released in May, it achieved a record-breaking $11 billion in sales in the just-ended quarter, shocking the entire market.

Since then, the market's enthusiasm for AI has truly heated up. Ryan McCormac, a senior ETF strategist at Invesco, pointed out:

This hype has driven up the stock prices of tech companies like Meta, which saw a 154% increase in 2023, and Microsoft, whose stock price has risen by 35%. The company has invested billions of dollars in OpenAI's ChatGPT.

It is worth mentioning that these stocks have long been the driving force behind the market, but their skyrocketing performance has also raised concerns about excessive concentration of power.

According to Dow Jones market data, the top 10 stocks in the S&P 500 index now account for more than one-third of the market share, compared to just 27% at the beginning of this year and less than a quarter in 2000.

Mike Edwards, Deputy Chief Investment Officer at Weiss Multi-Strategy Advisers, warned that the market story that rhymes the most with the dot-com bubble is the concentration of power.

Can the high valuations be sustained?

Currently, investors are buying NVIDIA's stock at a high price. According to FactSet data, NVIDIA's current stock price is 41 times the expected earnings for the year, which is a high valuation compared to the S&P 500's 2.4 times.

However, history also warns us that if a company's growth does not align with its stock price, the stock price may experience a significant decline. For example, during the dot-com bubble in 2000, overvalued internet stocks plummeted by 80% within the next two years. Wu believes that valuation is crucial. Investing in rapidly growing tech stocks only works when the growth is not yet priced in. Unfortunately, during prosperous times, the market tends not only to price in potential growth but also to greatly exaggerate it.

It is worth looking forward to Nvidia's upcoming second-quarter earnings report, which will reveal whether the stock price increase truly reflects chip demand or is driven by hype.

The Differences in this Round of Stock Market Prosperity

Although Nvidia's stock market boom may seem similar to the dot-com bubble on the surface, the difference lies in the fact that the core beneficiaries of this boom are already shining large tech companies.

Edwards pointed out:

Unlike in 1999, when investors were chasing after hot IPOs that couldn't make any money, today's winners are large-scale companies that have moats and accessible datasets.

In addition, tech companies are also benefiting from the expectation of the end of the Federal Reserve's interest rate hike cycle and the recovery of consumer spending. As concerns about an economic recession gradually fade, cyclical sectors are also catching up.