The AI-driven stock rally over the past year has raised questions about whether the market is in a bubble on the verge of bursting. For now, Wall Street strategists say the answer is no.
Many believe it is premature to compare the current market rally to the dot-com bubble of the early 2000s or the meme stock mania of 2021. First of all, the current bull market has not been as sneaky as other bull markets that coincided with the late stages of past bubbles.
The stock price has increased about 31% over the past three years. This is roughly in line with the three-year average return, and is far from the 98% three-year return seen in early 2000 or the 90% return seen at the end of 2021.
“Even though the market is at an all-time high, we are still not close to that level,” Ross Mayfield, an investment strategy analyst at Baird, wrote in a note to clients Monday night. “There's room to run.”
The underlying dynamics of the current bull market also do not suggest that the market has reached the same level of euphoria as past bubbles.
Goldman Sachs used the enterprise value-to-sales ratio to analyze the percentage of U.S. stocks that have high valuations. The results showed that undervalued stocks currently account for 24% of the U.S. stock market, lower than 28% in 2021 and 35% during the tech bubble of the late 1990s.
Notably, there are also far fewer overvalued companies contributing to recent performance.
“If you look at the number of companies that are trading at very high multiples, it looks less extreme than in the past,” Goldman Sachs equity analyst Ben Snyder told Yahoo Finance. ” he said. “In effect, as you know, very large companies are trading at higher multiples today than they were just a few years ago in 2021, when euphoria seemed to be widespread across the market. There are a small number of companies.”
He acknowledged that the current lack of upside is similar to that of the dot-com bubble.but Snyder believes the key difference this time around is that many large-cap tech stocks have risen in value in line with earnings growth. Snyder says that wasn't the case with market darlings like Nortel Networks during the dot-com bubble.
For example, the stock price of AI leader Nvidia (NVDA) has soared more than 255% over the past year. But the company's revenue has followed a similar pace, with revenue increasing 288% in the last fiscal year, which the company just finished reporting in late February.
By comparison, Nortel's stock price rose more than 320% in 1999. Adjusted earnings per share rose about 94% that year, according to Bloomberg data. Nortel eventually filed for bankruptcy and is no longer a publicly traded company.
“In our view, this is not a bubble, and the simplest explanation is that the prices and valuations of these giant stocks, whether you call them mag-sevens or not, are actually driven by a combination of superior growth and strong balance. Both of these qualities have historically warranted premium valuations,” Snyder said.
John Higgins, a market economist at Capital Economics, takes a slightly different view. He believes the market is in a bubble, but only in its early stages. Higgins pointed out that in addition to the jump in stock prices, margin debt, which is the money investors borrow to buy stocks, has not yet increased.
This is the case in the moments of market frenzy we saw in both the dot-com bubble and the 2021 rally, where the bubble “ends in tears” as leverage is quickly undone by market declines and subsequent fiscal enforcement. It often means that there is a possibility. sale.
“The conclusion that can be drawn simply from this is that we are not in the later stages of a bubble, at least given that increases in margin obligations have been common with subsequent stages of bubbles in the past. That's going to happen,” Higgins said.
Higgins believes the S&P 500 (^GSPC) will rise to 6,500 by the end of 2025 as tech company valuations approach levels seen during the dot-com bubble. But even that, Higgins points out, is just an estimate based on how far investors were willing to expand the bubble of the early 2000s. This time it might be different.
“No one knows how big the bubble will get before it bursts, how long it will take to expand, or what will actually cause the bubble to burst eventually,” Higgins said. Told.
Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.
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