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Why Equity Valuations Need to Adjust, Not Collapse

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When the Internet bubble burst, valuations had to adjust 47%

The Internet bubble started in the mid-1990s, but prices collapsed in 2000. The S&P 500 Index (SPXL) (VFINX) shed about 761 points, falling 50% from its high of 1,500 in January 2000. During this time, earnings fell about 9%. The crisis was triggered by the overvaluation of Internet stocks. Near its peak, the S&P 500 Index was trading at a valuation of 25.89x as the chart below shows. As the market crashed, the S&P 500’s valuation fell by 47% to a low of 13.73x.

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What was the dot-com bubble?

The dot-com bubble was a historic speculative bubble. The financial markets in industrialized nations saw their equity value rise speedily from growth in the Internet sector, which helped to rapidly increase the stock prices. The collapse of this bubble took place between 1999 and 2001. The information technology sector (XLK) of the United States (QQQ) (IWM) saw a massive sell-off. At that point, Internet businesses grew on the back of exponential growth in the number of networks generated. However, they ignored their ability to generate cash from the existing network. The Internet industry after that grew more rapidly. The graph above shows the performance of the S&P 500 Index (SPY) (IVV) (VOO) during the Internet bubble.

In the next part of this series, we will analyze the performance of the S&P 500 during the 2003–2007 bull run phase and discuss whether valuations have topped out at the 2,138 level for the S&P.

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