Wall Street Bubble: Dotcom Comparison & Analyst Forecasts

If we listen to the British The EconomistAmerica would be close to a new speculative bubble, “worse than the one that burst in 2000 with the dotcoms”, since it could send 35 trillion of wealth up in smoke. The forecast is shared by another English analyst, Julien Garran of MacroStrategy, according to whom the bubble on artificial intelligence (AI) securities would be 17 times larger than that of 25 years ago and four times more destructive than the subprime mortgage bubble of 2008. While avoiding apocalyptic tones, the analyzes of the BoE and the IMF agree that AI securities are in a bubble or almost. But when this bubble is close to bursting is an unanswered question. Valuations can remain irrationally high for a long time, as stock markets demonstrated at the end of the last century. The approach of economists from large investment banks and management companies is more empirical. We’re not in the bubble yet, says Goldman Sachs; or, the stock markets still have a way to go, summarizes Ubs.

The comparison with dotcoms

It is not known how long this road will be, but, following the reasoning, we could say that Wall Street will end up in a bubble when valuations grow exorbitantly, compared to realized or simply expected corporate profits. Take Goldman’s October 8 study. The most appropriate comparison remains the dotcom bubble. The ratio between price and shares is high says Goldman, but at 27 (that of the Magnificent 7) it is half of what the seven most prominent stocks expressed in 2000 (52). Cash flow is now significantly higher, as are profit margins, and debt is much lower, so that the p/e compared to the earnings growth rate is at least double. We are probably in the initial stages of a bubble, Goldman argues, but, it seems, we will only experience the real danger if the Nasdaq were to double in a few months. As happened between August 1999 and March 2000. The Swiss Sarasin prefers to think about the S&P 500 index, since the Nasdaq p/e in 2000 (over 70 compared to the current 34) was inflated by a myriad of unprofitable companies.

The calculations to get close to the bubble

Now the S&P is valued at 23 times the earnings of the next 12 months, “not far from the multiple of 25 recorded at the time of the dotcoms”. At that time the economy was in much better conditions with the GDP growing over 4%, compared to the current 2%, but the equity risk premium (Erp, i.e. the ratio between the return on future earnings and that of the 10-year Treasury) had ended up well below zero. Even now it has returned to zero and suggests a stock return of “just 4% per year over the next decade”. “The market is moving towards a bubble, but that doesn’t mean it will burst immediately,” concludes Sarasin. The Swiss Pictet is also moving along the same line, but with a good dose of optimism. “To bring the S&P 500 index to speculative bubble levels would require a further increase in the 12-month price/earnings multiple above 27,” he argues. Let’s try to do some math. Imagining that the S&P grows by 30%, to 8710, in the next 9-12 months (not an absurd hypothesis, given that it has gained 35% in the last six months) and that the index’s expected earnings increase by 14% in the next two years, as Lseg estimates suggest, we would have a prospective p/e of 25.3, compared to 22 today. We would be close to the bubble.

The many “ifs”

But, since the profits expected a year later have always turned out to be at least four points higher than those subsequently realized (for 2025 they are now estimated to grow by 10.9 against 15% in October 2024), let’s imagine instead that they improve by only 10%. In a year we would find ourselves with a prospective p/e of 27, exactly like in the 2000 bubble. The limit of these reasonings evidently lies in too many “ifs”. But today it is not clear whether economic growth can accelerate or reduce in the coming months, whether inflation will fall below 3% (core inflation is now at 3.1%), whether unemployment will increase, whether the colossal investments of the Ai companies will bear the desired results. It is not even possible to estimate the effect of the duties, which should be felt in the coming months and, with it shutdown American, we don’t even have the numbers to understand how things went in the last month. The few and partial data that have been released suggest a slight slowdown in growth, a modest rise in prices, fewer people employed and slightly declining confidence.

Profits, taxes and rates

But, once again, quarterly profits are proving to be better than expected, at least those of the previous month. The Wall Street Journal notes how «the exuberance of the stock market is based on the idea that tax cuts and falling interest rates will reinvigorate the economy». It is President Trump’s idea that seems to have been warmly embraced by small investors and partly even by large ones. And it is precisely what worries Robeco’s managers so much, since the extent of the fiscal and monetary measures, combined with the negative effects of the duties (and with the turbulence that is already noticeable on the credit market, we might add) are creating “an economic pressure cooker without escape valves”. It will end with an “explosion, although we cannot say whether it will be in 2025, 2026 or later”. When in doubt, it is better to stay invested and ride the wave, the majority of investors reason: exiting the market too early means giving up future earnings. True, but only if there is the presumption of understanding whether the bubble has really burst and being able to sell in time.