NEW YORK — In 1996, then-Federal Reserve chairman Alan Greenspan wondered aloud how we could know when “irrational exuberance” had gripped financial markets, comments that led many to later describe him as a sage who anticipated the dotcom boom and bust.
Now, when markets repeatedly peak as the prospects of artificial intelligence lift valuations of several technology heavyweights including Nvidia, Microsoft and Oracle, similar warnings are stacking up.
International Monetary Fund chief Kristalina Georgieva warned on Wednesday about the risks to the world economy from potentially large corrections in lofty stock markets.
Meanwhile, JPMorgan Chase CEO Jamie Dimon warned of a heightened risk of a significant correction in the U.S. stock market within the next six months to two years, the BBC reported.
“Jamie Dimon is like the Greenspan of today,” said Mark Malek, chief investment officer at Siebert Financial, who back then was working on multiple acquisition deals on behalf of Lucent Technologies, which itself went from being an internet market darling to a poster child for Greenspan’s irrational exuberance.
In December 1996, Greenspan posed a seemingly innocuous rhetorical question during a dinner speech: “How do we know when irrational exuberance has unduly escalated asset values?”
The market reaction was immediate. Asian stocks fell three per cent; those in Europe followed suit and the next morning, the S&P 500 tumbled two per cent. But within days, those losses had evaporated, and within a few weeks, stocks had not only regained all that lost ground but were trading 10 per cent above the levels they were when Greenspan spoke.
It would take more than three years for the dotcom bubble to burst and give Greenspan the reputation of possessing uncanny foresight, even though anyone who heeded his dinner warning bell would have forfeited gains of more than 100 per cent over that time period.
Bullish behaviour on display
Investors draw both parallels and divergences with the current market, where the S&P 500, Nasdaq and the Dow have hit new heights this year. The S&P 500 and the Nasdaq hit fresh record highs on Thursday and are up about 15 per cent and 19 per cent, respectively. The Dow has gained about 10 per cent year-to-date.
In the U.S. equity options market, with one measure of bullish trading near four-year highs, much of the bullish options flow concentrated in high-flying tech names, particularly those exposed to the AI investment theme.
“That’s kind of the epicenter of it … people chasing tech upside,” Greg Boutle, head of U.S. equity & derivative strategy at BNP Paribas, said.
The S&P 500’s price-to-earnings ratio, based on expected 12-month earnings for its constituents, last stood at around 23 times, according to LSEG Datastream. That level is near its highest in five years and well above its 10-year average of 18.7, although the P/E ratio reached around the 25 level in 1999 and 2000, the data showed.
The heavyweight technology sector .SPLRCT was trading at 30 times forward earnings estimates, above its long-term average of 21.4. The sector’s valuation surged as high as 48 times during the dotcom era.
Today’s bull market again brings fears about over-exuberance surrounding artificial intelligence may lead to a significant correction in the broader market, some warn.
In 1996, “we were all blinded to the reality of what was happening, and some would argue we’re in the same situation today,” said Malek.
Malek said that today he still carries with him the memory of those years and that he tries to remain aware that this time, too, he could be wrong in believing that the stock market’s remarkable AI-fueled gains are all justified.
“I know I need to keep my pencil sharp,” he said.
But other investors maintain an optimistic outlook. Goldman Sachs analysts argued that while history suggests that bubbles are driven by exuberance that builds around transformative technology, the current market rally is different because it seems to be driven by “fundamental growth rather than irrational speculation” and AI has been dominated by a few incumbents.
Comparisons to 1996 and the dotcom bubble fall short on several fronts, said Art Hogan, market strategist at B. Riley Wealth in Boston. Back in 1996, he was a trader specializing in technology stocks, watching the dotcom boom explode in front of his eyes.
“Hundreds of companies that had dreams in place of business models came public and saw their stock prices double or triple overnight,” Hogan said. “Today, the companies that are leading this revolution already existed before AI began dominating the market chatter, and had significant businesses and growth. And those valuations today aren’t as ridiculous.”
(Reporting by Chibuike Oguh and Suzanne McGee in New York; Additional reporting by Saqib Iqbal Ahmed, Lewis Krauskopf and Chuck Mikolajczak; editing by Alden Bentley, Megan Davies and Nick Zieminski)