The dot-com bubble burst in March of 2000 when historically high stock market valuations (Price to Earnings ratios) combined with declining earnings growth for companies that comprise the U.S. stock market.
This week’s chart examines the relationship between stock market valuations (12-month forward Price to Earnings ratio in blue) and earnings growth for the S&P 500 (500 largest U.S. publicly traded companies in red). Notice in the year 2000, the 12-month forward Price to Earnings (PE) ratio for the S&P 500 peaked at approximately 40 times, while the 3-year annualized earnings growth for companies which comprise the S&P 500 were declining and approaching zero.
If we compare the current U.S. stock market (S&P 500), you will notice that valuations (blue line) are elevated; however, lower than the peak in 2000 while three-year annualized earnings growth (red line) are reaccelerating above 10% after a recent trough in the high single digits. While valuations have an impact on expected stock market performance, they haven’t historically been a great tool for timing the market.
In other words, valuations can move higher from relatively high levels and move lower from relatively low levels, depending on whether earnings are growing or shrinking. As we enter 2026, stock market valuations (PE ratios) are relatively high globally, led by higher-than-average valuations in the U.S., yet earnings growth is accelerating due to several factors including productivity growth from the adoption of artificial intelligence as well as tax cuts and other incentives for companies to invest in the U.S.
If we dig slightly deeper into the dot-com analogy, one of the drivers of declining earnings for S&P 500 companies leading up to the new millennium was over-investment in capital projects to enable the adoption of the internet.
Companies spent a lot of their earnings and borrowed significant capital to invest with the belief that earnings growth would follow. Many companies followed the famous line from Field of Dreams which happens to be one of my favourite movies, “If you build it, they will come.”
This rush to invest in new technology led to over-investment and a subsequent decline in earnings. Roughly a quarter century later, the market is again concerned that U.S. publicly traded companies (specifically the Hyperscalers: Amazon, Microsoft, Google, Meta & Oracle) are over-investing in artificial intelligence.
If there is another over-investment in technology, it will have a negative impact on earnings. However, what we’re seeing is earnings growth reaccelerating as we enter 2026. In other words, investment in artificial intelligence is translating into earnings growth.
One of the key drivers of stock market performance next year will be whether earnings growth continues to accelerate or if earnings peak and roll over.
We will be watching closely but leading indicators (interest rates, value of U.S. dollar, global GDP growth, etc.) continue to paint a positive picture.
Thank you for your readership and comments in 2025. Wishing you and your families Happy Holidays and a prosperous 2026!
Eric Van Enk is a wealth adviser & associate portfolio manager with National Bank Financial in Medicine Hat. He is a graduate of the University of Calgary, as well as a CFA charter holder with 20 years of financial markets experience in New York, Toronto and Calgary. He can be reached at eric.vanenk@nbc.ca
