The internet was the big story at the end of the last century, with the web expected to change the world. It did change the world, but not before Wall Street’s enthusiasm created a massive bubble that, eventually, burst in dramatic fashion. Given the massive excitement around artificial intelligence (AI), investors shouldn’t ignore the similarities between today and what has now been dubbed the dot-com bubble. Here’s why and one move you should make right now.
Valuation and breadth
When the dot-com bubble burst, the S&P 500 Shiller CAPE Ratio had hit an all-time high of roughly 44x. That ratio is back above 40x, hitting its highest level since the dot-com bubble period. The S&P 500 Shiller CAPE Ratio is basically a P/E for the S&P 500 that smooths earnings, adjusted for inflation, over a 10-year period. Since earnings can be volatile over short-term periods, this index can provide a more accurate view of valuation.
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On top of that, in recent trading, more stocks have hit 52-week lows than 52-week highs. That’s occurred even on days when the S&P 500 has risen. That’s something that last happened just before the dot-com bubble burst. Given that investors have been talking about the risk of an artificial intelligence bubble, another new technology expected to change the world, now is not the time for complacency.
The one move you should make right now
It is appropriate to be concerned about the risk of a bear market right now. However, you shouldn’t panic and sell everything. What you need to do is assess your risk tolerance. During the dot-com bubble, the S&P 500 index (SNPINDEX: ^GSPC) fell by nearly 40%, while the technology-stock-heavy Nasdaq Composite (NASDAQINDEX: ^IXIC) dropped by nearly 80%. Worse, the bear market lasted for roughly three years. It was brutal to live through that.
Could you live through a downturn like that and still own the portfolio you currently own? If the answer is no, then think about making changes now. Consider allowing cash to accumulate rather than investing it all right away. Contemplate shifting into sectors that are more resilient to adversity, such as consumer staples and utilities. And give serious thought to paring back some of your biggest winners and most aggressive bets (especially if they are in the AI sector).