Market Commentary

• Investors are trying to understand the similarities and differences between now and the internet-fueled bubble that reached its high in March 2000 before stumbling.
• Over the last 150-plus years, new technologies have attracted investor funds and commanded high valuations.

As the S&P 500 Index (SPX) keeps hitting new record highs on a regular basis and valuations rise, especially for the mega-cap market leaders, investors are trying to understand the similarities and differences between now and the internet-fueled bubble that reached its high in March 2000 before stumbling.

Over the past 150-plus years of American evolution and innovation, new technologies like railroads and automobiles have attracted investor funds at one point or another and commanded high valuations. The dot-com bubble wasn’t much different. When the technologies are new and world-changing, investor behavior and investment flows are often similar.

Sitting back and taking a broad view of the early stages of internet technologies and company stock performance and comparing it to the current AI boom, there are a number of similarities. To begin, a small handful of stocks and sectors carried the S&P 500 to new record highs. By March of 2000, the Information Technology and Telecom (the earlier version of today’s Communication Services) sectors represented nearly 50% of the total capitalization of the index.

Today, the quick math shows us that the Technology, Communications Services, and Consumer Discretionary sectors, all dominated by tech and tech-like mega-valuation companies, make up just over 55% of the SPX’s total capitalization. And just like back then, 5 to 10 companies have really been the drivers carrying the index to a series of new record highs over the past two years. And all of these companies have some tie to AI, just as the market drivers in the dot-com bubble were virtually all tied to the development of the internet.

In addition, both periods saw massive valuation increases in terms of price-to-earnings (P/E) multiples as large-capitalization growth stocks tied to the new world-changing technology pushed the SPX to record highs and record valuations.

But there are important differences between then and now. Perhaps most important, the mega-cap stocks driving the AI boom have strong revenues and balance sheets along with robust cash flows. During the dot-com boom, many high-valuation large-cap companies leading the index higher were priced on potential future revenues and cash flows rather than current performance.

The S&P 500 Index broadly includes companies with strong balance sheets and resilient growth potential. We believe the AI trend will continue, but the slowing economy and rising inflation could weigh on some index sectors in the coming quarters. Our August and September equity-sector guidance changes kept a favorable rating on large-cap exposure but incrementally trimmed exposure by downgrading where we see rich valuations or more fundamental weakness.

We favor reallocating from these downgrades into less expensive AI-related sectors, for example, Information Technology (favorable rating) or Industrials (upgraded to favorable). We are most favorable on the Financials sector where falling interest rates should support the sector. The intent is to keep a favorable view of AI-related trends but to protect capital by trimming and reallocating selectively. 

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Communication Services companies are vulnerable to their products and services becoming outdated because of technological advancement and the innovation of competitors. Companies in the Communication Services sector may also be affected by rapid technology changes, pricing competition, large equipment upgrades, substantial capital requirements and government regulation and approval of products and services. In addition, companies within the industry may invest heavily in research and development which is not guaranteed to lead to successful implementation of the proposed product. Risks associated with the Consumer Discretionary sector include, among others, apparel price deflation due to low-cost entries, high inventory levels and pressure from e-commerce players, reduction in traditional advertising dollars, increasing household debt levels that could limit consumer appetite for discretionary purchases, declining consumer acceptance of new product introductions, and geopolitical uncertainty that could affect consumer sentiment. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector. There is increased risk investing in the Industrials sector. The industries within the sector can be significantly affected by general market and economic conditions, competition, technological innovation, legislation and government regulations, among other things, all of which can significantly affect a portfolio’s performance. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market.

An index is unmanaged and not available for direct investment.

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