The S&P 500's Shiller CAPE ratio is nearing a level reached only once before: during the 2000 dot-com bubble. The index has still climbed 13% this year, but Goldman Sachs data show the Nasdaq Composite cratered 77% from its peak by October 2002 after that bubble burst. Some investors now compare the AI infrastructure buildout to the internet spending that preceded that crash.
The S&P 500's Shiller CAPE ratio is approaching the level it reached only once before, in 2000, during the dot-com bubble. The ratio divides the index's value by its 10-year average inflation-adjusted earnings, smoothing out swings across a full economic cycle. The current reading sits well above its long-term average.
Despite that valuation warning, the benchmark S&P 500 has climbed 13% on the year as of Aug. 11, shrugging off the conflict with Iran, elevated inflation, and concerns tied to artificial intelligence. The index is up more than 100% since the start of 2023, and many now expect it to reach 8,000 this year.
What happened after the CAPE ratio last peaked
In March 2000 the dot-com bubble burst, and financial markets, particularly the tech-heavy Nasdaq Composite, imploded. According to Goldman Sachs, the IPO market froze, and the Nasdaq had cratered 77% from its peak by October 2002. Investors today see similarities between that period and now: then, the market was absorbing the internet; today, it's absorbing AI.
Companies also spent hundreds of billions of dollars building fiber-optic infrastructure for the internet back then. Now, a small group of large tech companies is spending hundreds of billions on chips and data centers to power AI.
Warning signs sit alongside a still-strong economy
The U.S. economy generally looks strong, though unbalanced, and unemployment remains low, even as inflation stays a concern. Still, many AI stocks trade at steep valuations, though several Magnificent Seven members that fund much of the AI infrastructure build-out don't trade far above their longer-term averages.
On the other hand, Magnificent Seven companies have begun to deplete their free cash flow as they spend and take on debt to fund AI infrastructure. Investors are also concerned that OpenAI and Anthropic are driving much of the hyperscalers' revenue growth by boosting demand for AI compute, making those companies' health important to the broader AI trade.
If history repeats, the AI trade could face a sharp correction before working out well over the long term. But big crashes often don't come from what everyone expects, so the next one may prove just as unpredictable.
Source: The Motley Fool
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