Emerging credit risk: What could take out the AI trade
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Artificial intelligence stocks may not be the sure-fire bet they once were as credit risks mount. "Until recently, investors didn't need to worry about leverage or credit in the AI buildout because hyperscalers were investing out of their cashflow. Things have changed, and debt is now the marginal source of funding," wrote Dario Perkins, economist at TS Lombard. Indeed, U.S. equity markets took a hit last week as investors feared CoreWeave may be taking on too much debt in order to finance its AI build-out. The stock plunged 25% last week and is down another 2% this week. Stocks fell again on Thursday after Nvidia CEO Jensen Huang told CNBC that capital for AI is scarce and holding back growth. .SPX 5D mountain SPX 5-day chart "If you look at the fundamentals, the demand for the neo clouds is off the charts," Huang told CNBC's Arjun Kharpal . "What is missing in the middle is the working capital to fuel that growth … because there's just so much demand across so many sectors of AI, there's a scarcity of capital." AI companies are increasingly turning to debt to fund expansion, and Perkins at TS Lombard warns that borrowing may be rising too quickly. "In 2027 alone, AI companies are expected to issue around $700 billion in new bonds, split between the hyperscalers ($400 billion) and the rest of the AI ecosystem. As a comparison, that is more than the total issuance of all euro-area governments combined (you know, the ones facing a 'debt crisis')," he said. This is important because, "if credit markets are now the marginal source of funding, it is possible that someone outside the AI ecosystem will turn off the credit taps – even if tech insiders are happy to keep investing on such a gigantic scale," Perkins said. On top of that, credit costs are likely to rise. The Federal Reserve is expected to keep its overnight benchmark rate unchanged in a 3.75%-4% range when it meets next week, after lifting rates a quarter percentage point in September. But there's a 75% chance that the central bank hikes rates by another quarter point at its December meeting, according to the CME Group's FedWatch tool. If oil prices stay elevated and drive up consumer goods prices, it could force the Fed to tighten policy further. More positively, business fundamentals for many AI companies look solid. Meta Platforms reported 26% revenue growth in the September quarter versus the year-earlier period . FactSet analyst John Butters said in a note last week that earnings for the " Magnificent Seven " group of companies are expected to have grown 33% on a year-over-year basis in the latest quarter. The question for investors now is: Can AI companies justify their rapidly growing mountain of debt?