For those of you who would prefer to listen:
The S&P 500 hit another fresh new high this week. That is the 27th for the year. We are smack dab in the middle of another historic Tech boom. It’s an AI revolution. It took off at the end of 2022. This is the Digital Age. The advancement has been palpable. The money spent is unprecedented. The hype and expectations are out of this world, literally. Space is the next frontier for Tech. But gravity still applies on Planet Earth. It’s a law that’s as powerful as any.
There was an announcement made this week that the Stock Market embraced but gave us some serious pause. Nvidia is partnering with a group of Wall Street firms on a $500 Billion plan with the stated goal of standardizing the cost of buying chips. They are essentially creating asset-backed pools of capital for AI companies. There is talk of securitizing a new class of digital assets. It sounds similar to the securitization of loans tied to cars, planes, credit cards and mortgages, which were rolled out on the 1980s and ‘90s.
The goal here is not to help the Tech Titans like Amazon, Google and Microsoft. They are well capitalized with strong balance sheets and significant operating leverage. This arrangement is designed for smaller organizations that have the demand for Nvidia chips but face higher borrowing costs. It will help expand the use of AI well beyond the Tech Titans so smaller businesses can participate and benefit too. Throughout this run, demand has consistently outstripped supply. It appears it still is. That’s the Bull case. The skeptics here say this is a fabricated way to extend the AI spending boom at its current torrid pace. An important consideration is the fact that innovation keeps moving at such a rapid rate. The chips that will be used as collateral could be considered obsolete within a couple of years. That’s a risk for investors buying the debt. That’s the Bear case.
Many have drawn comparisons to this AI boom and the Dot-com days. They both can be characterized as periods of speculative enthusiasm for game-changing technological advancement. They both saw a massive buildout of infrastructure. But they have been fundamentally different in corporate profitability, structure, and the mechanics of its funding. The Dot-com revolution was in many ways a speculative frenzy of cash-burning startups that raced to go public. The technology was real and survivors have thrived, changing the way we live our lives. The bubble was in the excessive spending and Stock Market surge represented by new companies that had no plans to be profitable. This AI revolution is being driven by a concentrated build-out led by the highly profitable Tech Titans. And private companies have stayed private much longer.
The Dot-com bubble burst when the internet start-ups ran out of cash and venture capital stopped funding. Remember Pets.com spending $1.2 Million on that Super Bowl ad? The company failed within 10 months. Also contributing to the bubble burst was the hangover from the aggressive Y2K spend and the excessive rollout of fiber optic cables. New advancements allowed vast data to be squeezed through fewer pipes, rendering the excess capacity unnecessary. Telecom companies like Lucent, Nortel and JDS Uniphase sunk. What’s more, the Fed started raising interest rates in attempts to cool the euphoria. The Fed Funds went from 4.75% to 6.5%, peaking in May of 2000. The party had already ended in March. But so significant, the innovative companies like Amazon, Apple and Google saw opportunity amidst the rubble. They re-positioned and reinvented themselves time and again. These small startups became Tech Titans.
The late 1990s were defined by startups chasing growth with limited revenue and easy access to capital. Today’s AI expansion looks very different. The world’s largest Tech companies have been aggressively reinvesting their substantial free cash flow into physical infrastructure because they view AI as essential to their long-term competitiveness. What has the Market a bit uneasy is the size and unknown length of the spending. This year has seen an acceleration of that spend, leaving some companies cash flow negative for the first time and borrowing what they don’t earn in order to capitalize on this generational technology boom. Nearly $350 Billion in debt has been issued by Silicon Valley companies already this year, with another $100 Billion expected by year’s end. That would amount to roughly 3X the amount borrowed last year to spend on the AI boom. The good news is those bonds have been slurped up quickly with strong demand for high-quality debt. But everything has a price. Yields keep rising. The cost to borrow is more expensive. The Bond Market is eyeing this like a Hawk.
Here’s another consideration: The onslaught of investment grade corporate bond issuance is competing for investment Dollars typically geared for Treasuries. At a time when America’s Federal debt has reached $40 Trillion and an annual deficit of $2 Trillion, it’s getting more expensive just to maintain. It costs $1.3 Trillion in interest payments just to service America’s debt. This week’s 30-Year Treasury auction came at the highest cost in two and a half decades. Uncle Sam has had a spending problem for years now, with no evidence of intent to pay it down. Foreign buyers have also cut their Treasury purchases of late, with many opting to build Gold reserves instead. Demand for American Dollars and Treasuries around the world has shifted quite a bit. Fitch just reiterated America’s AA+ credit. Remember, it lost its AAA status. It’s still extremely high-quality. However, the credit rating agency warned the country is “vulnerable to economic shocks due to its high fiscal deficits”. The United States Federal debt is more than double the median of similar nations.
Building infrastructure has been a quintessential American investment theme. Long before the advancement of the internet was the expansion of the railroad. The Railroad boom during the Industrial Revolution in the 19th century brought massive investment to connect the country from coast-to-coast. It opened up Markets for commerce as well as travel and communications. It kickstarted America’s modern Economy. It forever changed the American way of life. But it also triggered feverish speculation. Despite all its benefits of advancement, the Railroad boom eventually went bust due to heavy debt financing, overbuilding of duplicate tracks in anticipation of demand, and a sudden credit crunch
In the late 1800s, companies relied on bonds rather than equity for financing. Less than 1% of Americans owned stocks back then. Institutions weren’t large investors either, the way they are today. The banks were the primary lenders. The heavy reliance on debt meant that even minor revenue declines forced widespread corporate bankruptcies. The spending was massive and disorganized. Money was recklessly chasing opportunity. Companies laid thousands of miles of unneeded track through sparsely populated regions. Revenues didn’t follow. Railroad companies didn’t generate enough freight or passenger ticket sales to cover their costs.
Rising interest rates and tighter credit Markets pricked that speculative bubble. There were nearly 2,000 railroad companies in America. Roughly one-quarter of them defaulted and crashed into bankruptcy. It was quite a train wreck. Pun intended. Railway insolvencies dragged down regional banks and thousands of other businesses. It was widely felt throughout the economic system. But that was opportunity too. The surviving, deep-pocketed financiers bought up bankrupt, discounted railroad companies for pennies on the Dollar. They merged the fragmented tracks into unified regional systems. It was called “Morganization”. A guy named J.P. Morgan led that charge. The result was a more organized and efficient transcontinental system, which was the backbone of our nation’s Economy. But it also drove out competition. Trust ownerships were established. Monopolistic tendencies emerged. That’s a subject for another day.
These 3 revolutions (Railroad, Internet and AI) are similar in speculative euphoria and massive upfront capital requirements. Money chased opportunity. But they certainly have their differences. That’s history’s rhyme versus repeat.
The early railroad tycoons laid duplicate parallel tracks across the open plains before traffic existed. Today’s Tech leaders are aggressively building massive data centers before the anticipated robust revenue materializes. Historically, the greatest success stories came for those that supplied the raw physical infrastructure. Think steel, land, and trains; Picks and shovels during the Gold Rush. Those that used the system to capitalize on consumer demand benefited too. Levi Strauss and Sears Roebuck are examples here. It wasn’t the transportation companies that made it big at first.
The early winners of this AI Revolution have been the companies that are building the foundational hardware, like semiconductors, data centers, and power providers. When the rail bubble burst, the underlying tracks still remained in place. That connected the country and served as the backbone for decades of sustained economic growth. The probabilities are high that even when a major AI correction occurs, it will leave behind a highly advanced grid of data centers, power infrastructure, and digital networks that will fuel the next generation of computing. The Digital Age will reset and go on.
This AI rally definitely fits the description of a bubble. But history has proven bubbles can last for a while. Remember, it was in December of 1996 that then Fed Chair Alan Greenspan delivered his irrational exuberance speech. That was three and a half years before the Dot-com bubble burst in the Spring of 2000. The S&P doubled in price during that time before the Bear Market took over.
There is a pattern here. As one of my favorite Americans Sam Clemens once said: History doesn’t repeat itself. But it often rhymes. Raising debt to pay for growth has been the fuel for many of our nation’s advancements. It’s also been the culprit for boom-and-bust cycles. The July sell-off went a long way to correct the excesses in this Bull Market led by Tech. That was healthy. It created a reset. But it could prove to be a sneak preview into what ultimately lies ahead. We don’t think it’s a 2026 event. We’re not even sure if a bigger correction occurs in 2027 either. What we are sure of is excessive borrowing at high costs does have limits. It’s like gravity for stocks.
The Bond Market has our attention. We get paid to anticipate. We embrace and take comfort in the fact that the Stock Market has repeatedly hit fresh, all-time highs, including another one Thursday. It’s been great to see all the green on the screen. Equally important, we have our eyes fixated on what tomorrow brings. Earnings growth has been nothing short of stellar so far. This ignited the rally further. The big question is how long this lasts. It’s seldom a smooth and straight line for investors. Gravity is powerful. When the facts change, so do we. Whatever the case, we are ready for whatever comes our way.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
