"If the bubble bursts, it will all start with debt": How the problems of the neo-claws threaten the S&P 500

Wall Street strategists warn that the decline in shares of cloud providers offering computing power for AI will spread to other segments of the tech sector and could push the U.S. stock market down to its June lows, according to Bloomberg.

On October 26, shares of CoreWeave and other neo-cloud companies fell after Elon Musk predicted a “mass extinction” of cloud providers. However, later—amid general investor optimism regarding AI and tech stocks following the publication of Anthropic’s IPO prospectus—they moved into positive territory along with the major stock indices. At the time of publication, CoreWeave shares were up 4%, Iren’s were up nearly 5%, and Arkady Volozh’s Nebius was up 1%.

Nevertheless, despite Monday’s gains, CoreWeave’s stock has lost more than 35% over the past month, Iren’s nearly 41%, and Nebius’s 32%. Investors are selling off shares of non-cloud companies that provide computing power to AI model developers. They are concerned about how much debt these companies have already accumulated and how much more they will take on after their financial reports are released. Last week, due to these concerns, the credit risk metrics for Meta and SpaceX —the largest tech companies investing in AI—hit record highs.

After the Nasdaq 100 index plummeted nearly 3% on October 22, and the S&P 500 experienced its worst session since late July, analysts expect the sell-off in the tech sector to hit the stock market even harder, according to Bloomberg.

“This is now evolving from a micro-event into a macro-event. In other words, this is affecting not only the neo-claws but also the entire credit market, and subsequently the stock market,” commented Brian Reynolds, chief market strategist at Reynolds Strategy. He expects the sell-off to continue, which could push the S&P 500 back to its June lows—around 7,200 points. That would represent a 4.7% drop compared to the benchmark index’s close on Friday, October 23. But it is precisely at this level that Reynolds is ready to buy: “Over the next few weeks, I want to maintain a defensive position. And I’m very eager to buy right around 7,200,” he said.

Neoclouds rely heavily on bond issuance to finance their expenses. However, with U.S. Treasury yields rising and inflation holding steady, borrowing costs are increasing, according to Bloomberg. If these companies cut back on their capital expenditure plans to reassure investors, it will deal a serious blow to semiconductor manufacturers, warned Osung Kwon, chief equity strategist at Wells Fargo. Their revenue depends directly on data center builders, who spend huge sums on chips. “If they [cloud providers] begin to face financing risks, and the market becomes much more resistant to their capital expenditures compared to the current situation, and if they cut spending next year, it will pose a threat to the semiconductor sector,” Kwon said.

Such concerns have already taken a toll on the Philadelphia Stock Exchange's semiconductor index, which has lost 12% over the past month, according to Bloomberg.

Several Wall Street strategists are now warning that the collapse of Neocloud has become a serious test for the entire market amid concerns about an artificial intelligence bubble.

“If the AI bubble does burst, it will most likely start in the debt market—with defaults by Neocloud and other high-risk borrowers in the AI sector. This will trigger a chain reaction: falling valuations, spending cuts, contracting multiples, and a slowdown in growth,” wrote Tom Essaye, founder of Sevens Report, last week. He added that he continues to monitor signs of stress in the credit markets.

Neoclaud shares are currently showing an “asymmetric” reaction to credit stress, according to Barclays strategists led by Venu Krishna. “The widening of [credit] spreads (an increase in the risk premium on non-bank debt. — Oninvest note) is causing a disproportionately sharp decline [in their shares], while a narrowing [of spreads] brings only limited relief, underscoring skepticism regarding the sustainability of the neo-clouds’ business model,” — analysts say.

Krishna is monitoring “signs of contagion” in the stock market, but so far sees no evidence that the problem has spread beyond tech companies and growth stocks. Investors are shifting from tech stocks, which have risen in price, to defensive sectors. This suggests uncertainty about the AI market rather than a panic sell-off in which everything is hit at once, Bloomberg notes.

This article was AI-translated and verified by a human editor