AI stocks and the dot-com bubble: is history repeating?

The excitement around artificial intelligence has supercharged a rally in specific US tech stocks. Traders and investors who jumped on the AI train early saw massive growth, in some cases over 700%. In general, anything directly connected to AI technology has been rocketing, but analysts are now seeing a parallel between the AI boom and the dot-com bubble.

Traders who shorted the crash that started in March of 2000 had the opportunity to make significant gains, profiting from the unexpected collapse of the biggest buzz on the planet. Most of us were caught by surprise and missed out, but this time, we will be watching and waiting.

Is such an incredible shorting opportunity on the horizon for AI asset traders? Let’s dig deeper.

The rise of artificial intelligence and AI stocks

Known as the Magnificent Seven, these popular tech stocks have been rallying since AI hit the headlines.

1. Apple (AAPL)
2. Microsoft (MSFT)
3. Amazon (AMZN)
4. Alphabet (GOOGL)
5. Meta Platforms (META)
6. Nvidia (NVDA)
7. Tesla (TSLA)

AI enthusiasm, combined with strong earnings reports across the board, has propelled the S&P 500 (US500) index to new records this year, with a gain of more than 50% from its October 2022 low. The tech-heavy Nasdaq Composite index (USTEC) has surged over 70% since the end of 2022.

Nvidia's shares have soared nearly 4,300% in a recent five-year period, echoing how Cisco surged about 4,500% over five years leading up to its peak in 2000. It seems the only way for AI stocks is up… but for how long?

The concern remains whether the AI-driven surge will end like the dot-com boom—with an epic crash. The Nasdaq Composite, which quadrupled in just over three years, plunged almost 80% from its March 2000 peak to October 2002. The S&P 500, which doubled in a similar timeframe, fell nearly 50% in that period.

Some internet stocks like Amazon survived and thrived, while others never recovered. The uncertainty about the eventual long-term winners of AI mirrors the unpredictability of the dot-com era.

The information technology sector has swelled to 32% of the S&P 500's total market value, the largest since 2000. Just three companies—Microsoft, Apple, and Nvidia—represent over 20% of the index. However, tech stocks today are more modestly valued than during the dot-com bubble, trading at 31 times forward earnings compared to as high as 48 times in 2000.

In other words, the dot-com burst was even more inflated than the AI revolution, so making a comparison shows few similarities. Having said that, the US economy is struggling and the Fed debt is rising. A correction is inevitable, although don’t expect anything until after the elections in November.

Depending on the outcome, we might see a massive shift.

Conclusion

While Nvidia trades at 40 times forward earnings estimates, Cisco reached a level of 131 in March 2000. Current tech rally drivers are fueled more by solid earnings outlooks rather than growing valuations, indicating that fundamentals are stronger this time.

The S&P 500's price-to-earnings ratio of 21 is above its historical average but below the roughly 25 level of the late 1990s. The American Association of Individual Investors survey shows bullish sentiment at 44.5%, compared to 75% in January 2000.

An AI bubble isn't inevitable, but many investors are wary that metrics could become even more stretched if US growth remains robust and tech stocks continue to rise.