Rising Corporate Debt Costs May Slow AI Expansion, Impacting Investor Growth Prospects

Imagine if your friends all borrowed money from each other to build the coolest treehouses in the neighborhood. If one friend gets in trouble paying back their loan, everyone could feel the pain. That’s what’s happening with big tech companies building out artificial intelligence (AI) and cloud computing right now.

Why This Matters for Investors

When companies borrow more money, it can affect their stock prices and even whole market sectors. If these companies struggle to pay back their debts, investors could lose money. That’s why it’s important to watch what’s happening with tech company credit spreads—the extra money investors demand to lend to riskier companies compared to safer ones, like the U.S. government.

The Upside: Why Some Investors Are Still Bullish

• Big tech companies like Google, Amazon, and Microsoft still have much lower debt compared to smaller “neocloud” companies, making them safer bets.
• The need for more AI and cloud services means these companies may keep growing, and their investments could pay off in the long run.
• Some companies, like Nvidia, are getting creative with financing, helping smaller tech firms get the money they need to keep building.
• AI and cloud are expected to be massive growth areas, which could lead to strong profits in the future if companies manage their debt wisely.

The Downside: Why Some Investors Are Worried

• Credit spreads are growing wider, which means investors see more risk and want higher returns for lending money—this can make borrowing more expensive for tech companies.
• Some smaller tech companies, like CoreWeave and Applied Digital, have taken on huge amounts of debt relative to what they own, which is risky.
• Even big companies are seeing their credit risk rise—Oracle’s credit default swap (a kind of insurance against default) is as high as it was during the 2008 financial crisis.
• Experts warn that “circular financing”—where tech companies all invest in each other—could create a domino effect if one company runs into trouble.
• According to the Bank for International Settlements, overinvestment and too much debt could lead to a bust, where problems at one company spread to others (source).

Historical Perspective

This isn’t the first time investors have seen warning signs. In 2008, risky debt played a big role in the financial crisis. Now, the tech sector’s credit default swaps are moving up again, showing that investors are getting nervous about the risk of defaults.

According to S&P Global, the average U.S. corporate bond spread was about 1.2% in early 2024, but tech sector spreads have started to rise faster than the overall market (source).

What Could Happen Next?

Experts at UBS and Goldman Sachs expect credit spreads to widen even more through 2027. This means it could get harder and more expensive for tech companies to borrow money, especially if the economy slows down or if investors decide the risk isn’t worth it.

Some companies are already struggling to get good terms when they issue new bonds—Nvidia and SpaceX recently saw their new bonds lose value right after being sold, and Amazon had to pay higher rates than usual.

Investor Takeaway

• Check debt levels: Before investing in tech stocks, look at how much debt the company has compared to its assets. Safer companies usually keep debt in check.
• Watch credit spreads: Rising spreads can signal more risk in the sector. If spreads keep climbing, expect more volatility in tech stocks.
• Diversify: Don’t put all your eggs in one basket. Mix tech shares with other sectors to protect your portfolio if trouble hits.
• Focus on quality: Companies with strong balance sheets and steady cash flow are more likely to weather tough times.
• Stay updated: Keep an eye on news about tech company financing and bond markets, since things can change quickly in this sector.

For the full original report, see CNBC