“We may not know where we’re going, but we better have a good idea where we are.”
Howard Marks
The debate regarding whether AI stocks are in a bubble has accelerated since we wrote our last newsletter on August 22, 2025, titled, “Everyone Knows It’s a Bubble.” As the headlines have proliferated, there are two arguments that we’ve heard repeatedly as to why investors should remain invested in large technology stocks such as Nvidia (NVDA) and Microsoft (MSFT). The first argument is, “it can’t be a bubble if everyone keeps saying it’s a bubble.” The second is, “while values may be a little ahead of themselves, we are in the early innings of a transformational technology, so it is worth investing despite valuations.” We write today to dispute both lines of reasoning.
First, the belief that, “it can’t be a bubble if everyone keeps calling it a bubble” is incorrect for two important reasons. On the surface, when financial bubbles have formed in the past, there are always people shouting from the rooftop that we’re in a bubble. All you have to do is go back and look at old newspaper articles to find countless examples. We’ve reviewed and saved many articles from 1999 & 2000 referring to the technology stock market bubble. There are also many examples from 2005 – 2007 of various experts warning of a housing bubble. One of the best examples can be found in Yale Professor Robert Shiller’s book, Irrational Exuberance, that was released on the eve of the tech bubble bursting in early 2000. In his book, Professor Shiller referenced a Barron’s Magazine poll of professional money managers in April 1999 which asked, “Is the stock market in a speculative bubble?” An astounding 72% of respondents said, “yes.” The Barron’s poll from 1999 is a perfect lead-in to our second point. As Emerson once said, “your actions speak so loudly I cannot hear what you say.” As evidenced by the 1999 Barron’s poll, what an investor says and what an investor does are often two different things. While a large majority of the professional managers polled said they believed the market was in a bubble, it is likely that most of them were heavily invested in those very same stocks. The same is true for today. You would be hard pressed to find any Large Cap Growth or Blend Fund, index or passive, that does not have enormous exposure to large technology stocks. Therefore, it is not what people say that counts, but it is what they do. We appreciate the effort to be contrarian of those who say it can’t be a bubble because everyone is talking about it, but the fact that most investors are so heavily concentrated in the same stocks tells us that it probably is.
The second argument that we hear, and we believe one that is held by a good number of professional investors, is that “the market valuations may be a little high, but we’ve got a year or two to go before we could see a significant pull back in stocks, and therefore we must remain invested.” It is the old Chuck Prince, “dance while the music is playing” argument. The talking heads that we see on TV ascribing to this rationale as a reason to stay invested, typically add that, “valuations are still not as high as they were in the late 1990s tech bubble.” As with many things, valuations are in the eye of the beholder. Price-to-Earnings (PE) is the main valuation metric that is often referenced. Using forward projections (guesses) for earnings, the statement that the market is not as expensive as it was in early 2000 is true. However, if we look at price-to-sales or market cap to GDP, the stock market today is dramatically more expensive than 2000 or any time in history for that matter. From our perspective, we believe management teams have become more adept over the years at manufacturing earnings-per-share (EPS), but it is much more difficult to fake sales or GDP. The best example that we can show to state our case is a modified version of the Buffett Indicator (see below).
This chart shows the market capitalization of the three largest stocks in the S&P 500 (Microsoft, Nvidia, and Apple). The combined total market cap of the three is $12.52 trillion as of November 10, 2025. That compares to the size of the US economy as measured by GDP at $30.49 trillion. Stated another way, the big three tech stocks account for over 40% of GDP. During the peak of the tech bubble in 1999 / 2000, the three biggest market cap stocks (Microsoft, Cisco and GE) had a combined market cap equal to 14% of GDP. Today’s value at over 40% tells us that, not only are these stocks grossly overvalued, but there is also significant risk in the degree of concentration.
Could these stocks continue to rise in value over the next 6, 12 or 24 months? Sure. While we are confident that the music will eventually stop, we have no idea when. Investors in these stocks have become accustomed to returns of 40% or more per year. Could Nvidia, the largest of all, a company that is already valued greater than Germany’s entire economy, go up another 50% to 100% in the coming years? We would say that is unlikely, but anything is possible.
The prospect of continued outperformance from the tech behemoths is enough to keep many investors in the game. For all of those who believe there is more room to run and want to ride the wave, we’d offer a bit of caution from John Kenneth Galbraith’s book titled, “A Short History of Financial Euphoria.” When considering that what goes up must come down, Galbraith stated, “and thus the rule, supported by the experience of centuries: the speculative episode always ends not with a whimper but with a bang.” When the market decides that the game is up, there will be a mass rush for the exit. Case in point, here is the precipitous drop of the Nasdaq 100 in the early 2000s.
As you can see from the chart above, the Nasdaq-100 index peaked on March 21, 2000, at a level of 4,704.73. From there, it tumbled over the next two years until finally bottoming on October 7, 2002, at 804.64. From peak to trough the decline clocked in at just under 83%, a devasting loss of equity capital.
An important question to ask today is, if you believe there is a bubble in AI stocks, and history (chart above) may ultimately repeat itself, is it worth staying invested for the hope to ride the wave for a few months longer? This hypothetical would exclude the group of investors who truly believe that the AI tree will grow to the sky. Our sense is that those investors are in the minority, and that most AI investors believe that the current buildout is over done to one degree or another. One way to think about the risk/reward tradeoff that has helped steer us to largely avoid the tech darlings of recent years is represented in the chart below. It assumes that stocks ultimately suffer a loss of 80%, like what we saw in the early 2000s and applies that negative performance to a portfolio value today vs a future value that has gained an additional 25%, 50%, 75% or 100%.
The first column states the obvious that if you lose 80% of your portfolio today, you’re left with 20% of the starting value. We believe the more compelling argument for managing risk exposure before it is too late comes from the last column which assumes that the investment portfolio doubles from the original value today before suffering an 80% loss. The hypothetical investor in that column, after seeing his financial net worth double, is ultimately left with only 40% of his STARTING value. Yes, he’s better off than the investor who lost 80% immediately, but still not in an envious position.
Some will counter by saying that volatility is normal and point out that NVDA was down over 60% in 2022 at the October lows only to bounce back and hit all-time highs by the 1st quarter of 2023. The resiliency of the “market” has encouraged investors to buy every dip in sight. The confirmation that investors have received from the buy-the-dip strategy continuing to work for the last 17 years has led to a dangerous level of complacency. We’d argue that we haven’t seen an actual down cycle since the Great Financial Crisis in 2008, and the reason for that has nothing to do with exciting new technology, but rather it’s due to the old tricks of fiscal and monetary stimulus that governments have used in one shape or another for thousands of years. The bottom line is that sometimes stocks, specifically stocks caught up in a speculative bubble, go down and stay down. The chart below is an example of the famous case of Cisco Systems (CSCO), which some have referred to as the Nvidia of the late 1990s.
As you can see above, a $100,000 investment in CSCO stock in March of 2000 lost almost 90% of its value over the next 2 ½ years. For those diamond hand investors who stuck it out and held their shares from March 2000 until today (11/11/25), they’re still sitting on a loss of about $11k, representing an annualized return of -0.44% for 25 years. Yes, it is true that if you add dividends paid the return would be slightly positive over this period, but it is still not a ride that most investors would knowingly sign up for.
Renowned hedge fund investor, Howard Marks, once said, “we may not know where we’re going, but we better have a good idea of where we are.” So, where are we? We believe the S&P 500 is the most overvalued it has ever been, not only in our careers, but in the last 100 years. We may be wrong. Stocks may continue going up in a straight line and we all live happily ever after. However, if we’re right, and gravity ultimately reasserts itself, the timing doesn’t matter.
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