By: Kirk McCarty
Are we in an AI bubble? As the stock market reaches new all-time highs and concentration into tech stocks grows, this is the question many investors wish they could answer. Let’s dive into three of the most well-known bubbles in history and try to find out.
TULIP MANIA
The first well documented bubble was the Tulip Mania in the Dutch Republic in the early 17th Century. Although it was an off-exchange commodity bubble, the same principles of other bubbles still apply. The Tulip Mania bubble is probably the most unbelievable of all the bubbles. At its peak, a single rare tulip bulb could cost 10 times the annual salary of skilled worker in the Dutch Republic. At no point did Tulips have any utility other than their perceived value among traders. There was no promise of magical healing properties of Tulips or any real use case. The Dutch just really loved Tulips and were willing to do just about anything to get their hands on them. The frenzied trading of Tulips at ridiculous prices lasted from 1634-1637, but the peak of the frenzy that saw Tulips selling for more than houses was shorter lived over a few months from the backend of 1636 until February of 1637. Trading came to a rapid halt when a popular auction house failed to find bids at the inflated prices. Because there was no utility beyond its aesthetics, when prices started falling, there was no price floor in sight. During the frenzy, Tulips were bought with borrowed money and traded using futures contracts that, after the bubble burst, expired worthless. Within weeks of the collapse, prices were down 90% from their peak.
SOUTH SEA COMPANY
We often consider the dot-come bubble of the early 2000s to be the benchmark for bubbles in modern markets, but it wasn’t the first time the stock market experienced a bursting of a bubble. To find that, we’ll go all the way back to the 1720s when a British trading firm named The South Sea Company promised enormous profits from trade with South America. They partnered with the British government by assuming a large portion of Britian’s national debt and converting it into company shares. In return, they were granted a monopoly on trade with Spanish South America. The prospects of success were believable enough to fuel massive speculation that caused the stock to increase by a multiple of ten from January of 1720 to August of 1720. Throughout the speculation, The South Sea Company was actively encouraging investors to buy stock no matter the cost. They encouraged buying on credit and using installment plans to pay for shares. The Bank of England provided loans secured by South Sea stock. The shares were pledged as collateral for loans that were then used to buy more shares. I think we all see the issue in this and have a good idea how this all ended. As the company’s promises for growth turned into failure to meet expectations, the stock plummeted and wiped-out investors of all sizes along the way. The South Seas bubble was a textbook example of speculation fueled by government relationships and the dangers of debt-for-equity swaps.
DOT COM
Now, we’ll jump forward 275 years to 1995, which marked the beginning of the dotcom boom. Netscape held its IPO on August 9, 1995, and, after initially pricing at $28, closed at $58.25 on its first day of trading. By the end of 1995, the stock was trading at $174 a share with a $9 billion market cap even though the company was still unprofitable. Over the next 3 years, Netscape’s stock fell 75% from its peak before being acquired by AOL in 1998. For many, Netscape’s rise and fall marks the beginning of the cycle, but it was far from the last. Companies of all sizes came to market and saw massive rises in their stock price that was often disconnected from the business’s financial standing at the time. By 1999, the NASDAQ had a price to earnings ratio, or P/E, which surpassed 90 (although this is almost certainly understated due to so many companies having no earnings, therefore, no P/E). In comparison, S&P 500 had a P/E of around 32 in that same period. Eventually, multiple factors came together to cause selling at unprecedented levels. Consumer sentiment was exceptionally high from 1997 to mid-2000. In fact, the Michigan Fed Consumer Sentiment survey, which measures consumer opinions on their current and future financial standing and their outlook on the overall economy, has spent very little time over 100 in the 25 years since 2000.
Interest rates were cooperative in helping stock valuations early in the dot com craze. Rates dropped from just below 6% to 4.75% from 1995 to 1999 before inflation fears and the lowest unemployment rate in 30 years led Alan Greenspan and the Federal Reserve to hike rates six times from 4.75% to 6.50% from 1999 to mid-2000. Although Greenspan pulled off the soft landing in 1994-1995 with gradual rate hikes from 3% to 6%, his second attempt was not a success.
The increased cost of capital proved to be detrimental to companies that were already operating at a loss with lofty valuations. Investors also took the opportunity to take some of their money out of speculative assets into safter assets like treasuries that were now offering attractive yields. The NASDAQ peaked in March of 2000 and fell 70% over the next 12 months. The fall was quick and the recovery was long. The NASDAQ 100 didn’t retrace its peak until 2016.
WHERE DOES THIS LEAVE US TODAY?
Even in the worst of outcomes, AI has substantially more utility than Tulips, so I don’t think the party ends like the Tulip Mania. Markets have modernized and regulations surrounding leverage help give the market some feeling of protection that wasn’t had in the 1720s during the South Seas bubble. The dot com craze, however, has more similarities. Both are centered around a major technological advancement that promises to reshape industries and lead to significant productivity gains, which should, in theory, lead to more profits.
WHAT IS DIFFERENT THIS TIME AROUND?
For starters, the number of tech initial public offerings (IPOs) is drastically lower today than it was the 5-year period that marked the dot com craze. In the peak year of 1999, there were 547 IPOs. There were another 446 IPOs in 2000 before things came tumbling down. Many these were unprofitable “.com” companies that went public well before they would in a typical course of business. Today, there are still unprofitable companies that are going public, but at a much lower volume. Not only are there lower volume of companies going public, but a much smaller percentage are also tech companies compared to the dot com era.
The companies that have fueled much of the growth in the S&P 500 over the course of the last 3 years are not “AI” companies. While they have certainly invested heavily in AI (nearly $500 billion in 2025 alone from the Mag 7 Stocks), AI is not their core business. If AI turns out to give a bad return on their investment, there will be some short-term pain, but companies like Amazon and Google have other revenue streams to support their bottom line. This couldn’t be said for many of the “.com” companies that saw massive appreciation in their stock prices just because they were “.com” companies. Their success hinged strictly on the success of the world wide web. Oddly enough, the world wide web was a massive success and many of these companies still failed.
Consumer sentiment is also in a much different place. Sentiment at the peak (and the years leading into the peak) were at unprecedented levels that haven’t been repeated since 2000. From 1995 to1997, sentiment jumped from the low 90s to over 100 where it stayed at this level for the longest time in history. The consumer, and investor, had more confidence than ever about the economy. According to the University of Michigan Consumer Sentiment report, the avg level since its creation in 1978 is 84.2, consumer sentiment in October was well below the average at 53.6. So, while the NASDAQ has reached 47 all-time highs this year, it has done it on the back of a cautious, or even fearful, consumer.
Finally, and maybe most importantly, are interest rates. The dotcom bubble was a perfect storm of enormous speculation and exuberance into rate hikes. In a normal environment, rate hikes are typically a headwind for equities as higher rates often lead to higher bond yields. Those principles are amplified in environments where some investors have seen 20%+ annual returns from 1995-1999 and are itching to take some chips off the table. Today, we are in a different environment. We’ve seen two rate cuts in 2025 and have a high likelihood of another cut in December. When warranted, lower rates lead to lower borrowing costs and an increase in money in circulation. This is often directly a tailwind to equities as they are often the end of the line for these new dollars as institutions get their hands on new dollars. There is also less incentive to make new investments into bonds as interest payments are reduced.
WHAT COULD STOP THE TRAIN?
Uncertainty. This is almost always the answer. The market hates uncertainty. Uncertainty could come from a black swan event like COVID or from uncertainty in which way The Federal Reserve will take rates. Historically, it hasn’t been the rate cuts or hikes that have had short term impact on the markets, it’s been the unpredictability or severity surrounding them. The market feeds on stability and predictability. When we are forced to reason with data that we didn’t expect, the first response is often to exit the market and seek safety is less risky assets. History teaches us, however, that the best response is often to buy into that fear and practice patience while the economy (and stock market) sorts itself out.
"Be fearful when others are greedy, and greedy when others are fearful."
– Warren Buffett
For these reasons, we remain invested, but well diversified. While we are participating in the promise of new, transformative technology we continue to seek exposure in other markets that are not fully AI dependent. There will be a time when cracks begin to show in the AI trade and uncertainty will creep in. Some companies will fail, and some will succeed. While the path is not always straight, investing in strong companies with good fundamentals has rewarded those that chose to keep their dollars in the market. After all, if you stayed patient and weather the uncertainty of the dot com bubble (and Great Financial Crisis and COVID) the market has certainly rewarded your patience.
As always, thanks for your continued trust and support.
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