‘Very, very concerning’ echoes of the 90s dot-com bubble are being heard loud and clear by nervous market experts.
A 12-year old bull market; SPAC mania; IPOs that more than double on the first trading day; an army of amateur traders and GameStop mania. It certainly feels like irrational exuberance–and it triggers alarms for those who remember the dot-com bubble of the late 1990s. “The parallels we have today are historically very, very concerning,” notes Jim Stack, president of Whitefish, Montana’s InvesTech Research and Stack Financial Management. “The current froth is the icing on the cake, and when you look through it, you see a lot of other underlying issues.”
Despite a steep 30% market correction last year, the longest bull market on record has helped the S&P 500 surge nearly 300% over the past 10 years–roughly in line with the growth in the 10 years preceding the dot-com crash in 2000, after which stocks plunged 40% over two years. Forbes analyzed 11 key market metrics that flashed warning signs just before the stock market crashed in March 2000. Bearish signals outweigh bullish ones, but contrarian investors should take comfort in the old adage that stock markets tend to climb a “Wall of Worry.”
S&P 500 Shiller CAPE Ratio
In Yale economist and Nobel laureate Robert Shiller’s book Irrational Exuberance, he introduced a price-earnings ratio for the S&P 500 that averages inflation-adjusted earnings over the prior ten years in an effort to eliminate cyclical swings. Though not as steep as the peak PE ratio leading up to the dot-com bubble crash in March 2000, today’s Shiller PE multiples are the highest they have been in two decades. “Valuations on Wall Street are in the stratosphere,” says Stack.
American Association Of Individual Investors’ Sentiment
In the months leading to the dot-com bubble crash in 2000 bullish sentiment peaked at about 75%, compared to 46% last week, according to the AAII’s weekly survey, which simply asks its members whether they are bullish, bearish or neutral on the stock market’s outlook for the next six months. Savvy investors view this retail investor barometer as a contrarian indicator so high bullish ratings are bearish.
Volatility: The VIX
Bullish sentiment is likely taking a hit as a result of the market’s massive volatility, at least according to the Cboe VIX Index, a measure of expected volatility known as the “fear gauge.” The index averaged nearly 30 last year, compared to about 25 at the height of the dot-com bubble. Its peak so far this year–of about 37–has already eclipsed a high of 33 in 2000.
S&P Market Cap Concentration
Thanks to surging tech stocks, S&P market concentration is at an all-time high, making index-tracking funds, which represent trillions of dollars in market value, extremely vulnerable to swings in just a few companies. Today, the top five, Apple, Microsoft, Amazon, Tesla and Facebook–make up 21% of the index’s total market capitalization–even more than the 18% of market value commanded by the five biggest in 2000, when Microsoft, Cisco, General Electric, Intel and ExxonMobil were on top. Notes Stack, “Investors are climbing on the same momentum bandwagon, driving up a narrower concentration of big-cap stocks.”
Personal Savings Rate
Given the lack of spending opportunities brought on by pandemic lockdowns, the savings rate among Americans has surged to 13.7% of annual disposable income, compared to just 4.5% in March 2000. Once Covid subsides and life returns to normal, consumer spending could snap back with a vengeance, which bodes well for the economy and possibly the stock market, though it is already benefiting from increased consumer wealth.
A bullish stampede of initial public offerings—many with names ending in “.com”—was a hallmark of the late 1990s technology bubble’s speculative frenzy, with an average 500 public-market debuts each year from 1995 to 1999. In 2020, there were 538 IPOs, including 248 SPACs, themselves a frothy indicator. Average first-day returns in 2020, including the likes of Uber and AirBNB, were 35%, compared to 75% average first-day boost in 1999. However, the first day returns of SPACs, which are shell companies in search of business, may have muted last year’s average.
Warren Buffett’s favorite valuation metric, a simple ratio of the total U.S. stock market capitalization to annual gross domestic product, effectively giving market watchers a reference point for current prices, not unlike the S&P 500 PE ratio. The current stock market value of $42 trillion, compares to annual GDP of $21 trillion. One year after the dot-com bubble popped, Buffett said the unprecedented highs should have served as a strong warning signal. “If the ratio approaches 200%–as it did in 1999 and a part of 2000–you are playing with fire,” said Buffett.
Among stock market indicators the put/call ratio measures the weekly volume of put options, which are purchased when investors think stocks will fall, divided by the call option volume, contracts purchased by bullish investors. Unfortunately options buyers are notoriously bad investors, and according to the Cboe, some 90% of options buyers lose money. Hence, the put/call ratio is seen as a contrarian indicator. Thus if bullish call option volume far outweighs bearish put volume, it sends the ratio down. Currently the put/call ratio is 0.4, nearly identical to the 0.39 it registered in March 2000, at the peak of Internet stock buying mania.
Margin Debt to Cash
Thanks in part to low rates, margin debt balances have exploded on Wall Street, recently hitting an all time high of $778 billion–nearly 37 times the $21 billion investors held in March 2000. However, the more important metric to focus on is margin debt to cash in customer accounts. It’s currently at 72% more debt than cash, versus 79% at the peak of the dot-com bubble. “Speculation is contagious,” says Stack, noting that margin debt helped drive GameStop’s price surge.
Federal Reserve Assets
Thanks to Jerome Powell’s damn-the-torpedoes approach to stimulating the economy during the pandemic, the Federal Reserve’s balance sheet assets have skyrocketed by more than $3 trillion to an all-time high that’s nearly nearly 13 times assets held during the dot-com bubble. Today, Fed assets amount to 35% of GDP compared to less than 4.5% of GDP twenty years ago. The Fed has been purchasing Treasurys and mortgage-backed securities to the tune of $120 billion per month, in an effort to boost households, businesses, which of course, lubricates the stock market. So far inflation has remained in check.
Federal Funds Rate
Economics 101 dictates that interest rates are inversely correlated to stocks. And there is no question that the Fed’s steadfast commitment to keeping interest rates low has helped to push the stock market higher—nearly uninterruptedly— for more than a decade. With the 10-year Treasury note at 1% and the Federal Funds at 0.25%, lowering rates from here may be difficult. Says Stack,“The difficulty today is that we have the most interest rate sensitive stock market in Wall Street history.”