The biggest sign of an AI bubble is starting to appear
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Debt is the canary in the coal mine for market bubbles. Housing debt fueled the global financial crisis. Corporate debt led to dotcom bust. Now, the tech companies driving today's bull market are quietly levering up, sometimes through private lenders that make their debt less visible to shareholders.
Why it matters: That debt — and how it is getting structured — is "almost an acknowledgement that this is getting out of hand," Dario Perkins, managing director of global macro at TS Lombard, tells Axios.
What they're saying: Regarding returns on AI expenditures, the Big Tech firms "say they don't care whether the investment has any return, because they're in a race…Surely that in itself is a red flag," Perkins says.
- He sees two major issues: increased leverage to fund costly AI infrastructure and few opportunities to make money once that infrastructure is built and paid for with debt.
Zoom out: Big Tech is turning to private debt markets and special purpose vehicles. The catch? That kind of borrowing doesn't have to be reflected on balance sheets.
- "SPVs mean companies like Meta do not need to show the debt as their debt," Perkins writes in a note. He likens today's financing tactics to the subprime era when firms shifted risk off the books to reassure investors.
- Meta seeks $29 billion via private capital for its AI data center buildout.
- Other tech giants are tapping the public market for debt. Oracle recently issued $18 billion in debt to fund its AI and infrastructure expansion.
Yes, but: Plenty of strategists have reminded Axios of the old Keynesian adage of "the market can stay irrational longer than you can stay solvent."
- In other words, this tech-driven bull market could still have legs to create more wealth before the bubble bursts. Perkins, however, isn't convinced.
- "I wouldn't touch this stuff now," Perkins says, adding that comparing this market with the dotcom bubble, "we're much closer to 2000 than 1995."
Between the lines: Why are tech companies spending this much to win the AI race if the bubble risk is so prescient?
- Because the market is rewarding them even if it "makes no economic sense to spend at this level because there's no way they can recoup the value of the capital spending," investor and author Paul Kedrosky notes on the Plain English podcast.
- He is also watching how companies are moving financing off the balance sheet: "That for me is a reflection of not wanting the credit rating agencies to look at what they're spending."
What we're watching: Hidden debt, recycling of investment, and insider selling are examples of the warning signs of a late cycle, Perkins says.
- Perkins doesn't see the economy as tied up in AI like some other macro strategists have argued. That means investors who are well diversified across the U.S. economy and globally could still benefit even if the AI bubble bursts.
The bottom line: If hugely profitable tech companies need to mask their borrowing to fund AI spending, it signals they're not confident that they'll soon get the returns needed to justify such investments. That suggests the very spending powering today's earnings boom can't last forever.
