AI BUBBLE vs DOT COM BUBBLE

Recent patterns in the stock market are eerily similar to what happened in the late 1990’s during the dot-com bubble.  Look at this chart comparing the price movements for the Nasdaq in the last few years to the period from 1995 thru early 1998.

In both cases (1990s and now), the Nasdaq increased by about 150% in just a little over three years.  The similarity is pretty amazing, right?

Let’s now look at what happened to the Nasdaq in the 1990s in the subsequent two years.

The Nasdaq grew by another 150% in the two years from early 1998 to early 2000 – bringing the five-year total increase to almost 600%.  The price of the Nasdaq index increased from 743.6 at the beginning of 1995 to 5,048.6 in March of 2000 – a sevenfold increase.

We all know what happened next.  The Nasdaq dropped by almost 80% over the next 2.5 years – bottoming in late 2002.  It took until 2015 for the Nasdaq to recover its losses.

The question of everyone’s minds right now is “What happens next in this market”?

KEY DIFFERENCES NOW vs. THEN

The late 1990s period was a true bubble. 

• Prices rose solely based on the promise of the future of the internet. 

• Every dot-com stock was bid up to stratospheric heights.

• The price gains were NOT driven by profit growth. Profit growth in the late 1990s was only average.

  
  

The current period is being supported by exceptional profit growth.

• Corporate profit as measured by the S&P 500 grew at twice the normal rate in 2025 – mid-teens vs. the typical 8%.

• First quarter 2026 estimates for profit growth are expected to be 27% - three times the typical growth.

• Profit growth is being driven by the tech companies – their profit growth is much higher than 27%.

  
  

PROFITS DRIVE STOCK PRICES

In the long run, stock price increases follow along with increases in earnings.  The stock market is rational in the long term.

Most stock market valuation models (including mine) relate stock prices to earnings – the Price to Earnings ratio or multiple. 

Historically, the price of the S&P 500 index has averaged around 19 times earnings. 

When industry experts see the P/E multiple of the S&P 500 at a figure of 25 or higher, that is when you hear talk of the market being overvalued. 

But if earnings are growing at 20% per year, the math changes dramatically.  The typical P/E ratio of 19 corresponds to profit growth of roughly 8% per year.  People will pay much more for stocks whose profits are increasing by 20% per year vs. 8% per year.

The S&P 500 index was at 5,942 at the beginning of January of 2025.  If it was fairly valued at the start of 2025 (a big question), and profits grew by 15% we would have expected to see the price rise by 15% to 6,833.  The S&P 500 finished 2025 at around 6,920.  In that context, the market doesn’t seem so overvalued.

If S&P profits grow by 27% in 2026, it would not be out of the question for the S&P 500 to reach 8,671 by the end of the year.  The current price is 7,505.  Again, not so unreasonable.

Don’t get me wrong.  I am not saying that the S&P 500 is undervalued right now.  The final profit numbers are not even in for 2025, and the 2026 numbers are only estimates.  Also, two data points to not make a trend.  Profit numbers do tend to bounce around. 

What I am saying is that the current bull market cycle is very different than the one in the late 1990s. 

In the 1990s, there was a tremendous amount of hype and promise around the internet.  Now, we are seeing the same thing around AI.  Reality hit in the early 2000s when sales and profits did not live up to the dot-com hype.

There will be some disappointments in the next couple of years related to the promise of AI.  Many of the massive investments being made now to support the growth of AI will not pay off.  Some will, though.  The stock market will take some hits as reality settles on AI.

But, when profits are growing at two to three times the normal rate, stock prices should rise significantly. 

AI is already producing some large productivity gains in many sectors of the economy, and those gains should accelerate over time. 

WHAT HAPPENS NEXT?

Whether a particular market cycle is a bubble or a more typical bull market, the biggest gains always happen at the very end of the cycle.  This is simply the emotional reaction of investors who fear that they are missing out and more evidence of the typical herd mentality of the stock market.

Rapid run-ups like this recent trend do lead to corrections as the market needs to take a breather periodically.  But if profits keep growing at the current rate, those corrections will be short lived. 

My main point is that we are not at scary or irrational levels in the overall stock market.  In 1999, there was no justification for the crazy growth in the Nasdaq and the S&P 500.  It was all hype.

Keep your eyes on what really matters – profits.

I will keep my investors situated aggressively in stocks if the trends support it.  If and when the trend changes, we will adjust accordingly.  We will follow a data-driven, disciplined process that is not influenced by fear or greed.  You should too.

Stay Disciplined My Friends,

Phil

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