Vijay Chandar, Market Strategist
Given the recent downturn in tech stocks, it’s not surprising that some investors are drawing parallels with the late 1990s, when dot-com darlings collapsed and the broader market fell along with them. But while there are several similarities, there are also some important differences now from the market of two decades ago.
Just as they did in the last five years of the 1990s, tech stocks have dramatically outperformed the broader market over these past five years. Also, growth stocks more generally outperformed the broader market during the dot-com run-up, as well as during this past decade’s bull market. On a relative basis vs. value stocks, growth stock returns are the highest they have ever been, except for the late 1990s. In valuation terms, using a forward price-earnings ratio, growth stocks are more expensive now than they have been in 17 years.
In the same vein, U.S. stocks outperformed non-U.S. stocks in the 1990s and in this decade. Currently, the relative performance of U.S. stocks vs. non-U.S. stocks is at its highest level in history, driven by U.S. earnings growth, which has far outpaced the rest of the world. Plus, trade tensions, a strengthening dollar and currency crises in certain emerging-market nations have impeded global growth.
Here’s a revealing fact: The ranking of total returns across select major market indices in the past five years is almost identical to the last five years of the 1990s.
While major indices rank in a similar fashion, the current bull market hasn’t been as extreme as the dot-com bubble. In 1995 to 2000, the S&P 500 gained 28% and the Nasdaq gained 41% on an annualized basis, compared with “only” 16% and 19%, respectively, in this cycle.
Earnings growth has driven the recent bull market to a much larger extent than it did during the dot-com era. Back then, the rally was largely sentiment-driven, as investors proved willing to assign higher valuations to the stocks of companies that weren’t growing profits that fast—or in many cases, had no profit at all.
In the dot-com era, the forward price-earnings ratio on the S&P 500 climbed to 25 in 2000 from 12.5 in 1995, a far more extreme move than this cycle’s move to a high of 18 from 13 in 2012. Following the recent swoon in stocks, the S&P’s forward ratio was 15 nearing the end of November.
As happened in the dot-com era, the trends of the prior five years may reverse and leaders could become laggards. In fact, this shift may already be underway. Conversely, those areas of the market that have been out of favor may reverse in the coming year and outperform prior market leaders.
That scenario jibes with the views of Morgan Stanley Wealth Management’s Global Investment Committee (GIC), a group of the firm’s experts who collaborate on market analysis and investment advice. The GIC believes that going forward, value stocks are likely to outperform growth, and non-U.S. stocks could outperform U.S. stocks. From a valuation standpoint, I think international equities are compelling. While U.S. stocks aren’t as expensive as they were at the peak of the dot-com rally, the forward price-earnings ratio of non-U.S. stocks vs. U.S. stocks is at an all-time low.
For long-term investors, this could be an attractive entry point to add global diversification to a portfolio. Plus, a diversified portfolio, with exposure to several sectors and asset classes, can provide a welcome buffer against volatility that may continue into 2019.
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