When I started working on Wall Street about a generation ago, it was a pivotal moment for the economy and was during what was then termed the Information Revolution, when new forms of internet-driven entertainment, commerce, research, work, and communication were becoming commonplace. That period was also characterized by a stock market bubble bursting that was so pronounced that many investors still live in fear of such history repeating itself. In hindsight, it is easy to understand why investors were so ebullient back then—who wouldn’t be excited about technology that changed almost every aspect of our lives? Of course, on the other hand, a viable business model and path to profitability were very important too, and these details were too often ignored during the height of that fervor.
Fast forward to the present, and this current economic cycle is clearly unique in many ways, but there are some interesting parallels between now and the 1990s. In early 1994, the economy was in its third year of an expansion and unemployment was falling dramatically. Alan Greenspan, the Federal Reserve chair at the time, was concerned about the economy overheating and began to raise interest rates. By the end of that year, the Federal Reserve had raised interest rates seven times, doubling the Fed Funds rate from 3% to 6%. By the following year, the economy began to soften and interest rates were lowered three times while the economy remained relatively healthy. Alan Greenspan had engineered what some referred to as the “perfect soft landing” and he considered it to be the proudest moment of his tenure as Federal Reserve Chair. While we still don’t know exactly how this current economic cycle will play out, it appears as though there is a high likelihood of another successful soft landing.
Moreover, the parallels between now and then extend beyond the Federal Reserve’s actions. The 1990s were also a time of significant technological innovation that had a profound impact on our everyday lives and the way that we do business. While we once relied on the daily newspaper, the nightly news, the encyclopedia, and our local library as essentially our only sources of information, we suddenly had the world at our fingertips in what had evolved into more data than we could likely need or possibly consume. This contributed to the environment we find ourselves in today where it is easy to get sucked into the news of the moment and lose sight of the big picture. This is especially true right now given the unsettled political and social environment we are living in. However, as challenging as the current environment seems to be, it isn’t likely to change the direction of a new wave of technological innovation going on right now.
Artificial Intelligence (AI) is the promise of the moment, and it appears set to improve efficiency and hone data into something far more relevant and manageable, not only for large companies but for individuals as well. While still early, we are already seeing AI in our everyday lives. Shopping assistants such as Amazon’s Rufus can help customers wade through the vast number of products and reviews on its site, general internet searches are becoming more customized and accurate, and the next generation of smart phones hint at simplifying life by allowing individuals to better utilize their own personal data. In the business world, the applications are vast as AI will allow companies to more easily utilize their proprietary data which should lead to the pace of innovation accelerating and labor productivity increasing. According to some estimates, AI could contribute more than $15 trillion to the global economy by 2030, which is almost 15% of current global GDP. Pretty impressive.
Of course, at this early stage, we can only point to estimates and predictions of AI’s economic impact. There are still many questions about how impactful it will be given the high cost to implement it, plus the risks that AI presents are also concerning. Interestingly, many of these same types of concerns were also top of mind as the internet initially became more accessible and widely used. We expect there will be bumps along the way as we learn more and observe examples of successes and challenges along the way. Still, we think this is a very interesting moment in history that is remarkably similar to the 1990s.
This may leave you wondering if we are also predicting a stock market bubble, or if we are already close to being in one. Even though stocks have staged an impressive recovery since October of last year, the price-to-earnings ratio of the S&P 500 is at 21 times the next 12 months’ earnings forecast—a level that is above historical averages but not considered unreasonable. This compares to 30 times at the height of the internet bubble. Furthermore, 550 IPOs were sold to investors in 1999 and the average first day stock price gain was almost 70%. As of this writing, there have only been 105 IPOs this year and the early results have been mixed. The valuation of some stocks, most notably several mega-cap technology stocks, is admittedly high but in most cases the contribution to S&P 500 earnings growth from these same stocks is real and significant. In general, investors have been favoring profitable companies, and that is a big departure from the overly euphoric environment in 1999.
Given investors’ natural proclivity to become exuberant—remember Greenspan’s famous Irrational Exuberance remark—we have no doubt that there could be a moment when valuation eventually becomes overly stretched and investors begin to care more about growth potential than earnings. Being able to recognize this and stay disciplined by trimming equity along the way is important, yet often difficult for many market participants when everything seems to be going so right. It is exactly moments like these when having discipline and a trusted, objective Wealth Manager can be so valuable.
Over the next six months, we anticipate that there could very well be heightened volatility related to the general political environment, geopolitical risk, and inherent risk of a Federal Reserve or other central bank mistake. Striking a balance between managing these possible near-term risks while appreciating the big picture view is important and is something that we are always keenly aware of. Given the potential technological changes in our near future, we recognize that this is an important moment in history and one where taking a moment to dwell on that big picture consideration is also critical.
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