The U.S. stock market is getting close to dot-com bubble peak valuations

U.S. stocks are trading at valuations close to dot-com bubble extremes, a period that ended in a sharp market collapse in 2000.

A cyclically adjusted price-to-earnings ratio measure known as the Shiller P/E ratio rose as high as 42.18 this month, just below the 44.19 observed at the height of the dot-com era that marked the growth of internet companies based on the then-nascent worldwide web.

The S&P 500 slumped 50% between March 2000 and October 2002, and did not regain its peak until 2007. The ratio — which smooths short-term profit swings to provide a long-term picture — suggests that U.S. equities, led by mega-cap technology stocks benefiting from the artificial intelligence boom, are now trading at their richest valuations in over 25 years.

Several observers have recently said that valuations in the U.S. stock market appear stretched. An analysis from Vanguard showed that equity valuations at the end of the first quarter remained elevated relative to historical averages, particularly in growth-heavy segments.

Both the S&P 500 and Nasdaq 100 have risen further since then, adding 14% and 24%, respectively.

Shiller P/E. (multpl.com)

As for bitcoin, it is difficult to assess in traditional Wall Street terms because cryptocurrencies do not generate cash flows, making frameworks like the Shiller P/E inapplicable.

Still, from a price perspective, bitcoin appears cheaper than U.S. stocks and far from stretched in the same way. It is trading well below its record high of around $126,000 reached last year, while the Nasdaq 100 and S&P 500 are at record levels.

This leaves room for bulls' view that, in periods of equity volatility or valuation compression, some diversification flows could rotate into the relatively cheap crypto assets, though that outcome is far from certain.

Moreover, bitcoin's growing institutionalization in recent years has strengthened its links to sentiment on Wall Street, meaning instability in equities could spill over into crypto.

While the Shiller P/E reading does not necessarily imply an imminent correction or crash in stock prices, when viewed against the backdrop of the dot-com era, it suggests that the room for disappointment on the earnings or economic front is narrowing. Even a slight disappointment could trigger an outsized negative reaction.