There were two things that were hard to believe this week. One is that Spring has started, even though for folks east of Vancouver, temperatures are in the minus category. Two, that today marks the four-year anniversary of the stock market low reached at the start of the pandemic, which was on Monday March 23^rd. In the space of just four weeks, the Dow and TSX had lost 37%, and the S&P500 had dropped by 34%.

 

 

The short-lived bear market in 2020 was unique in that it was driven by a virus but, at its core, it shared characteristics of past crashes, namely a sudden economic downturn caused investors to question the viability of corporate revenues and earnings. In those past episodes, there were strong policy responses, whether fiscal or monetary, which ultimately righted the ship and allowed markets to recover. In hindsight, history was a good predictor of what happened next, though there was never any guarantee. Similarly, when we look at markets today and how stocks continue to rally to record highs, despite ongoing challenges in the world, we intuitively want to go back to the history books to see if there are any clues as to what might happen next.

 

We have just experienced the most aggressive monetary policy tightening in North America in decades, so we can look at previous times when this took place. The problem is that the structure of the economy has changed so much that those periods aren’t very instructive. We were supposed to be in a recession by now, with unemployment rising significantly, but the numbers continue to show resilience.

 

The U.S. government yield curve has been inverted (meaning the 2-yr yield has been higher than the 10-yr yield) for almost two years – longer than what we saw from 1978 to 1980, yet it’s “prediction” of recession hasn’t come to fruition, at least not yet. Furthermore, over the last three months, market participants have had to revise their expectations of how much the Federal Reserve and Bank of Canada would lower rates this year by at least half. Still, the optimism visible in stocks today is as high, if not loftier, than what we saw in December when rate cut calls were at their peak. So, if economic fundamentals and interest rates aren’t going to trip up this bull market, is there something else and are there any past periods to help us?

 

Most analysts bring up the late-1990s as being the closest to the current environment in terms of the level of enthusiasm and what is driving it. In both cases, that driver was and is technology. Back then, Cisco Systems quickly became the darling of the internet and saw tremendous growth in demand for its routers and switching technology. From March 1997 to March 2000, its stock price had risen more than 1400%, giving it a market capitalization of over $550 billion, exceeding that of Microsoft, which had been the largest company on the S&P500. By March 2001, the stock had dropped more than 80% alongside many other big hitters in the tech sector. Even at its year-end peak in 2021, the stock remained below its 2000 high. It’s interesting that this day back in 2000 also marked the top of the market and the beginning of the tech bubble implosion.

 

This boom-bust-partial recovery story is now used by some as a comparison with Nvidia, which is still very much experiencing a boom. As of yesterday, the company had a market cap of $2.279 trillion – third in size on the S&P500 after Microsoft and Apple. Just as an anecdote, Microsoft didn’t escape the tech bubble plunge, losing more than 60% in less than a year. Unlike Cisco, Microsoft recovered its lost ground by 2015 and is now almost 650% above its pre-implosion high of 2000. But, back to Nvidia.

 

This month, the stock has traded north of $900, compared to around $130 three years ago, representing a 630% gain. Impressive, but less than half of the 3-year gain in Cisco before the bubble burst. The real difference between now and then and the one that analysts cite as a reason why history may not repeat itself is that the price/earnings multiple for Nvidia is only about 75x today. In fact, this is below its peak of 220x back last summer, when the AI craze started to gel.

 

On this day in 2000, Cisco’s P/E ratio was almost 400x. In other words, the company’s valuation that year was not only high, but completely out of whack. Its revenues were still growing, but competition was beginning to emerge and production had ramped up so much to meet growing demand that the ensuing recession eventually created a huge inventory overhang. For Nvidia, there will likely be increased competition and it’s entirely possible that we reach a point where initial demand for AI solutions has been satisfied and/or a weaker economic climate causes companies to rein in capital expenditures on technology.

 

This is why I don’t believe that 2000 is an accurate comparison, at least not in terms of the breadth or scale of a correction if it were to occur. That doesn’t mean that overvaluations can’t come to a halt, and it doesn’t mean that all companies this year, including Nvidia, are vulnerable to negative economic swings. If the Fed sticks to its guidance of lowering rates three times this year, then the odds of those swings could be reduced. For now, we will be happy when spring finally gets here and without any repeat of history.

 

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle

 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. Andrew and his clients may own securities mentioned in this column. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.

 

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