It’s Nothing Like 1995 – The AI ​​Bubble Appears Near Its Peak (SP500)

Bullish thesis like 1995

Stock market bulls say that the current environment is similar to that of 1995, when the dot-com bubble started, and continued to grow until March 2000.

gave The bullish thesis is that the current AI-bubble is similarly at a very early stage, potentially years away from bursting.

A parallel with 1995 is based on the Fed’s policy path. The Fed was removing easy monetary conditions after the 1991 recession, and was raising interest rates in 1994. However, the Fed was able to stop the hike and cut interest rates in 1995 – without a recession. The “soft-landing” or no-landing result of the Fed’s tightening cycle led to a big rally in the stock market.

The chart below shows the Fed’s policy path (red line) and the Nasdaq 100 (QQQ).) (blue line).

Similar to 1995, the market is currently predicting a soft-landing or no-landing outcome of the Fed’s recent hiking cycle, and as a result, AI fueled a long-term rally in stocks.

But, let’s look at the macro environment during the 1990s.

Goldlocks of the 1990s

• Geopolitical context.

The United States entered the 1990s as the ultimate geopolitical victor with the collapse of the Soviet Union. The 1990s ushered in a trend of privatization in emerging markets, and accelerated globalization – all under the full control of the US.

• Real economic growth.

After the 1991 recession, U.S. real GDP grew by more than 4 percent, prompting the Fed to tighten monetary policy. After a brief decline of 2.5 percent, GDP returned to an annual growth rate of 4–5 percent for the remainder of the 1990s. The point is that US real GDP growth was very strong during the 1990s.

After the 1991 recession, the unemployment rate was above 7 percent, but it continued to fall steadily in the 1990s, falling to 3.8 percent by 2000.

Inflation, as measured by core PCE (the Fed’s preferred measure), was above 4% entering the 1990s. However, it reached a level of 2% in 1994/1995 and gradually declined in the 1990s, falling to 1% in 1998, and then gradually increasing to 2%. The point is that inflation was low and never a problem after 1995.

What did the Fed worry about during the 1990s?

The 1990s had an excellent macro environment.

• The geopolitical situation was favorable and supported high growth and low inflation.
• GDP growth peaked with increases in exports, production and consumption.
• With unemployment falling, the employment situation was about right, but not too low to trigger inflationary pressures – until the late 2000s (when things changed).
• Thus, the inflationary situation was perfect – low and stable inflation, helped by globalization.

So, what was the Fed worried about during the 1990s? Here are the main FOMC statements during this period.

• Last addition in 1995 – The “moderation in growth” statement signaled a pause. The Fed was concerned about strong growth and rising resource utilization (falling unemployment rates and rising capacity utilization). But inflation never really increased. This started the dot.com bubble.

• First cut in 1995 – Beginning of normalization: “Inflationary pressures have subsided enough to accommodate modest adjustments in monetary conditions.” Despite very strong growth, inflation was never an issue.

• The Fed raised interest rates in 1997, citing “sustained strength in demand” as implying strong economic growth, but inflation remained low.
• The Fed cut interest rates in 1998 in the wake of the emerging markets financial crisis, which fueled a speculative dot-com frenzy as US growth remained strong with little inflation.
• First Hawkish hike in 1999 And the beginning of the end – reference to a “tight labor market” (the unemployment rate was already below 4%), and “continued strength in the economy over productivity gains.”

• Several douche flip-flops – The Fed said at several meetings in 1999 that “productivity gains may contain inflation, and even have been held back by Y2K problems.
• The hawkish pivot of February 2000 and the bursting of the dot-com bubble – The Fed finally decided to burst the bubble and said, “The weight of risks is primarily toward conditions that could increase inflationary pressures in the near term.”

• Last added in May 2000 – a 50bpt increase – is still “concerned about potential supply-driven gains in demand outstripping the pace.” The unemployment rate was 3.8% but core PCE inflation was still below 2%!

• Conclusion – December 2020 recession warning and signal of monetary easing – “Risks are weighted primarily towards conditions that could create economic weakness in the near future.” References to “decreasing consumer confidence” and “decreasing sales and profits”.

The Fed was primarily active during the 1990s, viewing strong economic growth as a threat to inflation, but it became seriously concerned about inflation when unemployment rose in 1999/2000. The rate fell to 3.8 percent.

Important to note is that the Fed never inverted the yield curve in 1994-1995, as the graph below shows. Thus, the Fed saw no need to induce a recession to control inflation.

The Fed inverted the yield curve in 2000, and that triggered the recession and the bursting of the dot.com bubble.

How does this match the current situation?

Let’s start with the geopolitical context. The world is in the process of de-globalization with the emergence of bipolar governance. This is a return to the Cold War setting of the 1970s, and a complete reversal of the situation in the 1990s.

Thus, the current macro environment favors high inflation and low growth – due to de-globalization. Again, this is a complete reversal of the 1990s.

US growth is currently strong, still driven by post-pandemic spending and government spending. Nevertheless, no one expects 4-5% annual growth over the next 5 years. Other major global economies are currently in recession or borderline recession.

More importantly, as the US government ran into budget surpluses during the 1990s, it now faces unsustainable increases in debt and deficits – and this is putting more pressure on inflation.

Specifically, regarding the bullish thesis of 1995 – the yield curve is now deeply inverted, and it wasn’t inverted in 1995 – but it was inverted in 2000. Thus, the current situation is more similar to 2000, especially given the unemployment rate at the same level of 3.7/3/8%.

Implications

The AI ​​bubble is currently in full swing, largely led by Nvidia (NVDA) However, based on the macro environment, the current situation is more similar to 2000 than 1995, suggesting that the AI ​​bubble is nearing its peak. .

The bubble will likely burst with the Fed’s eventual unpredictable turn, as in March 2000. But given the mounting inflationary pressures, it’s likely that the pivot is near – and with it the bursting of the AI ​​bubble.

The broad market index S&P500 (SP500) is now heavily concentrated in big tech, and Nvidia is the third-largest stock in the index. Thus, index investors are exposed to deep selling during the 2000-2003 bear market. Given that the bubble is still high, my recommendation is still Hold, with a focus on the March FOMC meeting for a possible hawkish pivot.