From Dot-com to AI: Is History Repeating Itself?

In The monthly update On July 3rd, we spoke with Frank Knopers about the records on the S&P 500 and Nasdaq. According to Frank, there is currently a lot of savings looking for yield flowing into the stock market because saving no longer pays off due to inflation. As long as profits continue to rise, he still sees some logic in these record highs in the stock market. He does think that technology stocks have risen too fast, but he doesn't want to call it mania just yet. The American Crescat Capital is a lot more negative. What is their analysis of the situation?

Frank says that for the masses, stocks are the first alternative to saving. Indeed, stock ownership is once again extremely popular among Americans. Currently owns 62% of adults there shares. For the first time, this is back to the level before the crisis in 2008 and the dot-com bubble of 2000. It is therefore perhaps not surprising that asset manager Crescat Capital is involved in a Recent Analysis make a comparison with that period.

Percentage of U.S. adults owning stocks (source: Motley Fool)

2024 vs. 2000

Advances in AI technologies, like the internet, promise growth in 2000 through significantly higher productivity. The valuations of the leading technology companies are even higher today than they were then. This implies future earnings growth rates that Crescat believes will be impossible to achieve. They make the comparison between the most valuable company then and now.

Cisco Systems was the most valuable company in the world during the height of the Internet bubble in 2000. At the time, the company was worth $548 billion, 37 times the company's revenue, and 5.5% of U.S. GDP.

Nvidia recently achieved the status of the world's most valuable company with a value of $3.3 trillion, a multiple of 41 times revenue and an all-time high of 11.7% of total U.S. GDP, more than twice the performance of Cisco in 2000.

Nvidia vs. Cisco (Source: Crescat Capital)

It's not just Nvidia that's overvalued, according to Crescat. If you look at the combined value of the ten largest tech stocks relative to U.S. GDP in 2000 and today, the current valuation is about twice as large. The peak in 2000 was 30% of GDP, now it is 60%. This is a relevant number because the economy can only grow to a limited extent and there are limited resources available to drive the profits and multiples of competing companies. Many companies compete for the same market share.

AI is a disruptive technology that offers opportunities to new companies at the expense of established (tech) giants. This process, which Joseph Schumpeter Creative Destruction Crescat said it could trigger a significant bear market for big tech stocks and the S&P 500. For example, they cite the threat posed by the use of AI as a search engine for Google's business model.

10 largest tech stocks by US GDP (Source: Crescat Capital)

A common argument against the idea of a bubble in tech stocks is that the underlying fundamentals are much stronger now than they were at the height of the bubble in 2000. However, Crescat points out that investors should be suspicious about the sustainability of profit margins and earnings growth rates. They think the situation is untenable. A lot of investments are going into AI infrastructure without a viable business model. It's going to be difficult to make a return on those investments. This is comparable to the investments in Internet infrastructure in 2000. In fact, many valuations relative to fundamentals such as earnings, cash flows, income and book value for the entire S&P 500 are at record highs, just as they were in 2000.

Historical valuation S&P 500 (Source: Crescat Capital)

Tipping point?

According to Tony Pasquariello of Goldman Sachs the likelihood of a downturn in the market increases. He advises reducing portfolio risk, but also writes that as long as the economy is growing and profits are growing, significant sales are very rare. Crescat sees problems related to that economic growth and therefore believes that the market is at a tipping point.

An important factor is the current inflation cycle, which Crescat says is much stronger than it was in 2000. Structural sources of inflation, such as irresponsible government spending and central banks, are causing inflation expectations to rise continuously. The Fed is increasingly losing control of this crucial, self-fulfilling inflationary factor. The US trade balance shows a sustained and significant decline and there is a fiscal deficit of more than 6% of GDP. These deficits increase financing risks for U.S. Treasuries and force the Fed to resume its role as a financier of government debt, despite inflationary pressures.

This is also exacerbated by a tight supply side in the commodity market, which further pushes inflationary pressures. The demand for metals is increasing due to developments such as the energy transition. There are not enough (critical) raw materials available to meet all future demand. The supply of these cannot easily be increased. It has now taken almost 16 years to open a new mine. This is expected to increase further due to higher costs and ESG regulation. We previously wrote an article about the battle for Critical Raw Materials.

Low unemployment rates combined with high valuations in the financial markets are often the prelude to financial crises and recessions due to the cyclical nature of the economy. When the unemployment rate rises above the two-year moving average, Crescat says it's time to be alert.

Unemployment Rate Indicator (Source: Crescat Capital)

The asset manager believes that we are on the eve of a 'Great Rotation'. They expect capital to flow from overvalued financial assets into undervalued commodities, especially the energy and metals markets. U.S. family offices currently invest only 1% of their assets in commodities, including gold. We previously wrote an extensive article about their analysis of why this is going to change. Read the article New "Big Short Scenario Drives Investors Towards Gold and Commodities".

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On behalf of Holland Gold, Paul Buitink interviews various economists and experts in the macroeconomic field. The aim of the podcast is to provide the viewer with a better picture and guidance in an increasingly rapidly changing macroeconomic and monetary landscape. Click here  to subscribe.