AI.com

After further consideration, I believe I have identified a way to convey the core concepts of the perspective I alluded to on Sunday without disclosing any proprietary information. Let’s proceed.

The term "bubble" often fuels heated debates within the financial world. "Perma-bears" consistently predict market crashes, while "perma-bulls" maintain an unwavering optimism. These opposing viewpoints represent the spectrum of market sentiment, with bears instilling fear and bulls fostering excessive greed.

Instead of succumbing to either of these extremes, a more objective approach is typically crucial. By focusing on analysis and sound investment strategies, we can derive better perspectives. 

While I did not personally experience the oil price crash of the 1980s, there are striking parallels between that period and the market downturn of the early 2000s. Based on these observations, my friend pointed to a few sectors of the current market that may exhibit similar vulnerabilities. The following analysis explores the parallels he brought to my attention. 

To start the conversation off he started firing off some fundamental ratios from the 00s technology downturn:

1. The average price/book of technology stocks in the 00s was = 13.9x

2. The price/book ratio of technology stocks to the S&P 500 = 2.5:1

Some within the financial community may dismiss traditional financial metrics like price-to-book ratio as outdated. However, the emphasis placed on fundamentals by historically successful investors suggests otherwise. While short-term momentum can yield significant returns for some, long-term success often correlates with a focus on underlying business fundamentals. This is because market valuations tend to converge with intrinsic value over time, even if temporary periods of exuberance may occur.

His first suggestion was to compile some data behind the current composition of the S&P 500, specifically in the technology sector. I’ve provided that below. 

The technology sector's weight within major market indices has significantly increased since 2010, rising from approximately 20% to over 33% – the highest level observed in my historical data. While innovation is often cited as the primary driver of this growth, a critical examination is warranted. Despite the popular presence of "AI" in headlines, a clear and concise definition of AI, along with its practical applications and underlying mechanisms, remains elusive for many companies. This raises concerns about potential hype surrounding the technology. Historical precedents, such as the dot-com bubble of the late 1990s and early 2000s, where companies simply adding ".com" to their names saw substantial stock price increases, may serve as a cautionary tale against excessive market enthusiasm.

His next observation was to take the ratios discussed above and compare them to where we are today. While he has a more accurate breakdown using all the individual companies, I compiled factors for what I believe show a parallel comparison to this perspective. 

2000s tangible data:

-The price/book of technology stocks in the 00s was = 13.9x

-The price/book ratio of technology stocks to the S&P 500 = 2.5:1

Today’s tangible data: (As of 11/30/2024)

-The price to book of “technology” as of 11/30/24 was 11.1x

-The price to book ratio of “technology” to the S&P 500 is 2.22:1

-The price to book ratio of “technology” to the Equal Weight S&P 500 is 3.83:1

The best way I found to present the data was using a couple Vanguards ETFs. More specifically the VOO, VOOG, and Invesco’s RSP. The VOO is a fairly direct comparison to the S&P 500 while I believe the composition of the VOOG and RSP correlate well with depicting “Technology” and an Equal Weighted S&P 500.  

The market is currently trading at a price level very close to that observed on November 30, 2024, suggesting that these valuation ratios may provide a relatively accurate assessment of current market conditions.

Since the S&P 500's technology sector now constitutes 33% the concentration may skew traditional metrics such as the P/B ratios above. 

A more accurate assessment of market valuation may be derived by analyzing the price-to-book ratios of a technology-focused basket relative to an equally-weighted S&P 500 basket. This analysis reveals a price-to-book ratio of 3.83:1 for the technology sector, indicating a significant premium compared to the broader market.

The current valuation appears elevated. I’m sure you can guess what I asked next, What about the state of the IPO market, given the potential parallels to the early 2000s. He provided a unique perspective that I had not previously considered. 

During the dot-com bubble, IPO activity surged, reaching approximately $2 trillion or more. While the current market may not exhibit the same level of IPO activity, a similar dynamic is evident. For example, Nvidia's market capitalization has experienced substantial growth in two years, mirroring the speculative exuberance observed during the dot-com era. This suggests that while the manifestation may differ, the underlying market psychology – characterized by excessive optimism and a focus on speculative growth – may exhibit striking similarities. Given the current market dynamics, it's crucial to consider the broader impact beyond Nvidia. A significant number of semiconductor and technology companies have leveraged the term "AI" to drive substantial increases in their market capitalization. I could not compile the exact calculation but the swelling in market capitalization of all these companies has greatly surpassed the 2 trillion from the dot.com air pocket. 

As an investor, I had begun to observe concerning valuations in certain sectors. While I hadn't explicitly drawn parallels to the dot-com bubble due to my limited experience during that time, further investigation revealed a compelling resemblance. The evidence presented, supported by tangible data, strongly suggests that the current sectors in the market may exhibit characteristics reminiscent of the dot-com era.

What are the implications of this data? Does it necessitate immediate portfolio liquidation? Absolutely not.

The current market presents opportunities for portfolio rebalancing. Maybe consider reducing exposure to the technology sector, which may be overvalued, and increasing allocations to other sectors. Portfolio management principles emphasize risk mitigation by diversifying across undervalued sectors. If the S&P 500 serves as your benchmark, the technology sector's 33% weight may not be optimal for diversification. While investors heavily invested in the Nasdaq may have experienced significant gains in two years, these gains could be at risk if the technology sector experiences a downturn.

Outperforming the market is a common investment goal. However, successful portfolio management involves more than simply seeking higher returns. True skill lies in the ability to dynamically adjust risk exposure. This entails reducing risk within sectors exhibiting signs of overvaluation and simultaneously increasing allocation to sectors with promising growth prospects.

While I do not believe a global economic meltdown is imminent, the data suggests a need for careful consideration of current market conditions. My research aims to share a unique perspective, previously unconsidered by myself, to inform prudent portfolio decisions. Specifically, it highlights opportunities to capitalize on companies and sectors that may not receive the same level of media attention as the technology sector does. 

My friend's insights were informed by Ken Fisher's book, 'The Only Three Questions That Still Count.' I believe some of the data presented aligns with Fisher's historical analyses. Having begun reading the book myself, I can attest to its valuable insights. I highly recommend it to anyone seeking to enhance their investment knowledge. 

One last thing: huge props to AI for the unintentional self-burn. I asked it to design a logo for 'AI dot com,' and it spit out 'AI.con' instead. The irony is almost too delicious to bear. Bravo, AI! You've outdone yourself.

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