What also followed those previous capital-expenditure booms was a bust, a new report from BCA Research reminds us. A key component of the peak and turn of those cycles was the increasing reliance on debt to finance those massive expenditures, the respected research firm points out.
The hundreds of billions being spent to build and equip data centers have become a key focus of both the equity and credit markets in recent weeks, as I wrote here a fortnight ago. It’s not only the enormous funds being spent today but the uncertainty of future payoffs that concern investors.
That’s especially acute for fixed-income securities, much more than for tech stocks. “Kissing a few frogs won’t matter provided you find a prince or two,” observes Macro Intelligence 2 Partners. “But is that also true for credit, where your upside is limited to your coupon and your downside is your entire investment?” the United Kingdom research outfit rhetorically asked in a client note this past week.
Nobody is more familiar with this risk/reward calculus in credit than Dan Fuss, vice chairman of Loomis Sayles but better known to Barron’s readers as the “Buffett of bonds.” He’s only 92, however, three years junior to Warren Buffett. While Fuss no longer manages portfolios, he still leads morning meetings at Loomis, after which I caught up with him this past week.
“We are good at taking credit risk,” Dan said, cheerfully admitting to having the scars to show for it. That is, he added, if they know the credit. But that’s become less clear with the recent spate of mind-bendingly complex megadeals, with myriad entities funding multibillion-dollar data centers, as our colleagues at The Wall Street Journal described them this past week.
Fuss thinks current data-center deals are too speculative. The risk is too great and future revenue too uncertain. And yields aren’t enough to compensate, he concluded.
Increased wariness about monster hyperscaler borrowings has sent the cost of insuring their debt against default soaring. Credit default swaps more than doubled for Oracle since September, after it issued $18 billion in public bonds and took out a $38 billion private loan. CoreWeave’s CDS gapped higher this past week, mirroring the slide of the data-center company’s stock, per colleague Nate Wolf.
All of this contains echoes of past capex booms. In addition to increased dependence on debt to finance previous capex booms, BCA writes, investors failed to appreciate the “S-shaped nature of technological adoption.” That is, an initial spurt tends to be followed by a more moderate pace before widespread adoption. BCA also says revenue forecasts underestimated how much technology prices would fall.
In later stages, asset prices for new tech peaked before capex declined. So prices of railroad securities in the 1800s, utility stocks and bonds in the 1920s, and dot-com stocks in 2000 topped out ahead of spending, BCA points out. The oil patch has also gone through repeated boom-and-bust cycles in the past half-century, BCA adds.
Capex busts weigh on the economy, which further hits asset prices, the firm says. Following the dot-com bust, a housing bubble grew, which burst in the 2008-09 financial crisis. “It is far from certain that a new bubble will emerge this time around, in which case the resulting recession could be more severe than the one in 2001,” BCA notes.
There is redemption if you wait long enough. Cisco Systems, perhaps the most prominent Icarus among the dot-com highfliers, this past week finally equaled its 2000 peak of $78 a share. Those of us who were around then remember vividly how Barron’s was flamed for its cover story which had the temerity to question its valuation at a mere 130 times estimated earnings. The stock would end up bottoming in single digits in October 2002.
Adding to the angst this past week was a parade of Federal Reserve officials casting doubt about another rate cut at the Dec. 9-10 policy meeting. Odds of a quarter-percentage-point trim from the 3.75%-to-4% target range for federal funds were down to 45.8% Friday from over 90% before the previous confab that ended Oct. 29, when Fed Chair Jerome Powell said a December trim was not a foregone conclusion.
Reopening of the federal government this past week should allow the resumption of some official data releases to help guide monetary policymakers. The Bureau of Labor Statistics said it would release September payroll numbers on Nov. 20. National Economic Council director Kevin Hassett said that the household data, from which the unemployment rate is derived, won’t be available.
Interest rates, always a major factor for stock and bond markets, may be even more important during the AI borrowing boom. J.P. Morgan credit strategists project investment-grade corporate-bond borrowing to rise to a record $1.81 trillion in 2026, topping the previous peak of $1.76 trillion in 2020, Bloomberg reported. Tech companies are seen boosting borrowings to $252 billion, 61% over what they’ve raised so far this year.
The word credit is derived from the Latin to believe. There is little room for doubt in the AI boom.
Write to Randall W. Forsyth at randall.forsyth@barrons.com