Warning signs are flashing on the AI trade. Here's where to spot them
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The adults have entered the AI chat — bond investors this week looked up from their massive buying binge and asked themselves, "Hey, are we sure these investments are going to pay out?"
Why it matters: The AI boom is looking a little wobbly these days, at least when it comes to all the borrowed money that's fueling it.
- "Credit markets are where some of the AI boom's weaknesses can show up first," Robert Schiffman, a senior credit analyst at Bloomberg Intelligence, tells Axios.
- If you look back at the history of many big investing booms that later went bust — from railroads to housing — the first warning signs were with the bonds.
The big picture: Bond investors — the adults in the room — can often spot trouble brewing in a market.
- Why's that? Stock investors place a much higher value on growth. Their basic question is: How high will this go?
- But bond investors are all about risk. They just want to know: Will I get paid back?
Follow the money: A few factors have converged to cause bond investors to have a rethink about AI debt.
- At the macro level, the Iran war that began earlier this year led to a surge in energy prices that drove up inflation.
- And that has helped drive interest rates higher, creating a potential problem for weaker borrowers that need to raise fresh money or refinance existing loans.
Zoom in: That's especially true for the so-called neoclouds, "the newest layer of the AI economy," as Mark Malek, chief investment officer at Muriel Siebert, calls them.
- These are companies racing, alongside Big Tech, to build and rent out AI compute. You've likely not heard of them — Crusoe, Nebius, Nscale, Lambda and, most prominently, CoreWeave.
- Unlike the hyperscalers — Microsoft, Alphabet, Amazon — the neoclouds are smaller and are more dependent on borrowing to build data centers and buy the chips to fill them up.
- "This is the subprime tranche of the AI trade," Gil Luria, head of technology research at D.A. Davidson, tells Axios.
Catch up quick: Investors have been selling off CoreWeave's bonds for weeks, worried that the revenues from AI may not be enough to sustain its growing debt burden.
- The prices for its bonds have now tumbled, pushing its yields (or interest rates on the bonds) into distressed territory.
- The accelerated deterioration shook the broader AI trade.
- Bonds issued to fund several different data centers have also tumbled in recent weeks, as the Financial Times noted — one investor called it a "Darwin moment," where only the strongest would survive.
By the numbers: On Thursday, five-year credit default swaps on CoreWeave — a kind of insurance that investors can buy to protect them against a company defaulting on its debt — jumped to nearly 1,100 basis points (or 11 percentage points) for every $100,000 of CoreWeave debt to be insured.
- That means it costs about $1.1 million a year to insure $10 million of CoreWeave bonds against default.
Between the lines: Luria, perhaps inadvertently, helped push the sell-off this week. He went on the "Prof. G Markets" podcast Wednesday, and warned that CoreWeave's stock price could go to zero if the AI investment cycle turns.
- Attention on the company started building the previous day when venture capitalist Chamath Palihapitiya posted a chart showing CoreWeave's record-high bond yield. To cap it off, Elon Musk replied, "Yikes."
- "All this stuff was coming together," Luria says. As for his quotes? "I don't know that they were the reason or the problem, but it probably didn't help."
Reality check: Investors and analysts still believe AI demand is strong enough to keep the cycle turning.
- But the recent weakness in CoreWeave and others shows where a break in the excitement is likely to start.
- It's unclear if there would be contagion from there.
