The Blubber

A team of quantitative strategists at J.P. Morgan has drawn comparisons between the current stock-market rally, which has propelled the S&P 500 to six consecutive record closing highs since the start of 2024, and the dotcom bubble.

Led by Khuram Chaudhry, the analysts highlight the growing concentration in the U.S. stock market as a significant risk for investors in 2024. Despite the notable differences between the dotcom era and the present, Chaudhry and his team argue that there are more similarities between the two periods than commonly acknowledged.

"In historical context, parallels to the 'Dotcom Bubble' era are often dismissed due to the 'irrational exuberance' that characterized that period. However, we demonstrate in this note that there are numerous similarities between these two periods," stated Chaudhry and his team in a note seen by MarketWatch on Tuesday.

The analysis comes amid a market environment where returns have heavily favored shares of the largest U.S.-traded companies, dubbed "the Magnificent Seven." These stocks, which drove much of the S&P 500's 24.2% gain last year and have continued to outperform in 2024, have led to a concentration in the U.S. market approaching levels not seen since 2000.

According to J.P. Morgan's data, the top five stocks now make up 21.7% of the MSCI USA Index as of the end of 2023, while the top 10, including all of the Magnificent Seven, account for 29.3%. This concentration is nearly at the highest level since March 2000.

The analysis delved into various factors, including sector representation among the top 10 most valuable companies. It found that there are now fewer sectors represented compared to the dotcom bubble peak, with information-technology companies holding the largest share of total market capitalization during both periods.

In terms of valuations, there's a notable disparity between the dotcom era and today. While forward price-to-earnings for the top 10 largest companies peaked at 41.2x expected earnings during the dotcom era, the current valuation stands at 26.8x.

However, the strategists highlighted an intriguing observation. They measured the spread between the top 10 stocks and the rest of the index in terms of forward earnings yield and found that the top 10 stocks had commanded the highest premium to earnings relative to the rest of the index on record as recently as October, although this premium has since decreased significantly.

Furthermore, the share of overall earnings-per-share growth contributed by the 10 largest stocks was higher during the dotcom era, challenging the perception of complete detachment from fundamentals during that time.

"While we hesitate to label the current levels of the Top 10 as a bubble, it appears that the Top 10 in the Dotcom era had stronger earnings fundamentals," remarked the J.P. Morgan team.

Lastly, the strategists observed the difference in price returns between the top 10 stocks and the rest of the U.S. index, noting that periods of strong outperformance are typically followed by mean reversion.