The AI boom stumbles

0:00Rob Armstrong: There's some bad juju in the markets right now, and no one is quite sure why. Tech stocks have taken a big hit. Investors are rushing to protect themselves from tech debt blow-ups. And you know things are really pretty bad because people are finally buying the classic supposed safe stuff, US government bonds. This last bit is especially weird, given that the economic data says sell. So markets have got the heebie-jeebies on tech. What is going on? Nothing really new, honestly, but the vibes have turned. So today on the show, it is finally time to ask, is this the big one? Is the AI bubble popping?

0:42Rob Armstrong: Tin hats on, boys and girls. This is Unhedged, the markets and finance podcast from the Financial Times. I'm Katie Martin, a markets columnist, hiding in the bunker of FT Towers just in case. Joining me through the magic of the internet in New York City is that guy, Rob Armstrong. my partner in crime on the Unhedged newsletter. Rob, I have a bad feeling in my bones. Do you have a bad feeling in your bones?

1:09Katie Martin: I long ago learned that my bones are a bunch of liars. So whatever they tell me, I try to ignore.

1:18Rob Armstrong: I see. I see. Let's go from the start of the global trading day onwards. So South Korean stocks, we all know the South Korean stock market It basically is semiconductors. And specifically memory chips.

1:34Katie Martin: It's not even that broad as semiconductors. It's memory.

1:38Rob Armstrong: It closed down 8 % today. Today is Thursday. That's bad. The biggest companies in that index, which include, again, like chippy things. So SK Hynix closed down 11%. Samsung Electronics down 9.5%. Bad. These are all bad things. In Japan, SoftBank, which has got a big stake in OpenAI, that thing closed down 9%. So Asian tech stocks took a pretty sizable hit today. Treasuries, U.S. government bonds. Now, tell us a little bit about the inflation data that came out yesterday, Rob, because that should tell you that those bonds should be going down.

2:18Katie Martin: Yeah, it was not only a hot CPI inflation report, it was a broadly hot inflation report. So we saw goods inflation and services inflation, and a lot of hot numbers down in the details. So like the last report before this one, the report for August, there was just a couple of categories like wireless services that went completely bananas and dragged the whole number up. This report looked like very pervasive inflation. And the market didn't go bananas in response to that. But at first, it did respond like markets respond to a high inflation report.

3:03Rob Armstrong: In other words, bonds fell and the stock market didn't like it that much either. But that quickly reversed through the course of the day as the AI news came rolling in. Yeah, because bonds in general, government bonds in particular, they really don't like high inflation. This is like kryptonite for bonds. And so you would normally expect when you've got a high inflation environment that bonds are going down, but they're not. Bonds are going up, so the yields are coming down. That is a sign that investors are generally quite nervous.

3:34Katie Martin: Dollar got stronger too, I noticed. That could have been a safety trade as well.

3:38Rob Armstrong: Well, it's got weaker today. That's the thing, though. And I think that is happening because overseas investors are getting out of a lot of dollar-denominated techie investments. So another thing that makes me, again, I don't like this, is that techie bonds have fallen. So, you know, all these lovely data center bonds that we've been talking about quite a bit recently. Yes. They are weakening quite a lot, particularly stuff issued by CoreWeave. Now, I am only a girl. I don't understand what CoreWeave does. It's like.

4:19Katie Martin: Basically, they build data center capacity, which they then plan to lease to someone else. Data center infrastructure for a lease. I think that's a broadly fair way.

4:29Rob Armstrong: Okay. That sounds reasonable. But so we have a quote in one of the stories that we've got on our site today about what's going on in markets today from Ludovic Subran, who is at Allianz, a big German investment firm. And he says, data center bonds are having their Darwin moment where the weakest credits struggle to survive.

4:50Katie Martin: That sounds serious. That's not good, is it? Darwin talk. Yes. This is not good.

4:56Rob Armstrong: And so like one of the funny, like funny peculiar rather than funny ha ha, one of the funny things that's going on here is that investors are saying, well, you know, these tech companies have been borrowing loads of money and the cost of borrowing is going up. And there's lots of speculation in the AI trade. And you're like, all of these things were true a week ago. Like, why are you suddenly worried about them now?

5:21Katie Martin: But it is a sort of market classic that everyone knows the tree can't grow to the sky, but no one knows when it's going to stop. And so it's kind of like you have a market that's looking for an excuse and we'll find one one way or the other. I mean, I think this is the way that it usually goes.

5:40Rob Armstrong: Well, speaking of that, enter stage right. Brannan McBee, a co-founder of CoreWeave, who is like the money guy. So he figures out what debt they're going to issue and this and that. He gave an interview to the FT in which he said that he really wants Corweave's bonds to get what we call an investment grade rating, which is kind of a stamp of approval from the rating agencies that says, yes, these are nice, safe bonds. Because if you've got that stamp of approval that says, yes, these bonds are nice and safe, then you can sell them into really big investors like insurers. and he said in this interview that we ran that he wants to sell them into insurers because their capital quote is unlimited like that's all the money in the world sitting around in insurance and go ahead go ahead I'm gonna say that was not a wise thing to say that like we want to tap all the money in the world.

6:40Katie Martin: And it's whose money you're talking about. Classically, the kind of money that comes from an insurance company and goes to an investment, like say a data center, would be premiums from annuities. And who buys an annuity? Grandma and grandpa.

7:01Rob Armstrong: Right.

7:02Katie Martin: They want steady income in retirement. So they go to Mutual Life of Cincinnati, a name I just made up, and they buy an annuity, which pays. They give a lump sum. They get a stream of income in response. The company takes that lump of money and goes to invest it somewhere. So what the guy in the highly speculative tech business said is, I need your grandmother's money.

7:30Rob Armstrong: Yes. I want these very, very sensible, conservative pots of money to start trickling in my direction. And it just, I don't know, there was just something about the way he said it, like, that's all the money in the world. Yeah. It just, the tone was like.

7:50Katie Martin: It did not sound correct. Off. That's not it, my friend. And that stock on the 13th was$77. Now it is$59. And it could have been other stuff. You know, there was other AI news, flotsam and jetsam floating around on the surface. You know, this company has this problem or there's this blog post about the growth of revenues or whatever. So it could be just very bad timing on the part of what is the guy's name again?

8:24Rob Armstrong: Brannon McBee. I'm not making that up.

8:27Katie Martin: I'll take your word for it that you're not. And as we just said, it's very important to remember at these kind of febrile moments in markets.

8:36Rob Armstrong: Yeah.

8:37Katie Martin: The action of the market and the explanation often have a quite loosey goosey relationship.

8:42Rob Armstrong: Yeah. And like vibes matter. But also, I believe our colleague and friend, Sajid Indap, was commenting on this online the other day because this idea that slightly kind of Yahoo-ish tech companies want to hook themselves into the central nervous system of like massive pots of money. This is like a thing that we've all thought maybe they want to do. But anyway, tell us what Sajid said.

9:09Katie Martin: Here's Sujit on X, the artist formerly known as Twitter the other day. He writes, like every finance reporter is trying to prove a cabal between private capital, data centers, life insurers, and rating agencies. And this guy, whose marginal cost of capital is 20%, just says on the record in the FT that it's all true and that it's his business model.

9:32Rob Armstrong: Yes.

9:33Katie Martin: Which is a nice summary, which is a very nice summary of just what just happened.

9:36Rob Armstrong: It's a very nice summary, and it goes a long way to explaining why markets nerds are invoking the three most terrifying letters in finance. Rob Armstrong, do you know what those letters are?

9:52Katie Martin: CDS.

9:54Rob Armstrong: No, not CDS. So let me just pause very briefly to say, so CoreWeave CDS is trading at 1 ,100 basis points. Now, if you know anything at all about CDS, which is credit default swaps, you know that is really bad. If you don't know anything at all about credit default swaps, then congratulations, you are a normal person. But the only thing you need to know about that is that 1 ,100 basis points is a lot and it's not good. And it means that investors are willing to pay up quite a lot of money to protect themselves in the event that Corweave defaults on its bonds.

10:37Katie Martin: Now, we should mention here, and this was a notorious subplot of the great financial crisis, that CDS are nominally kind of like insurance against default. I know there is a lecture here to be had about why they're not really insurance.

10:54Rob Armstrong: Please don't email us, CDS nerds. We know, we know.

10:56Katie Martin: However, people do speculate in these instruments directly. In other words, they will take out fire insurance on someone else's house and trade it around. So that could be happening here too. Punters are having a go betting that core weave is not a going concern. And I feel obligated, as this shows token optimist, to say the following. If the AI industry at large turns out to make loads and loads of money by selling either access to these models or by selling services that are built on top of them or whatever else, if the industry goes on to make a lot of money, none of this debt stuff is going to matter.

11:46Katie Martin: You got to keep your eyes on the final question. Is AI a very profitable business? If the answer is yes, we won't be talking about CDS. We won't be talking about circular financing. We won't be talking about CoreWeave. Won't be an issue. If the answer is no, also the finance won't kind of matter because the whole thing's going to be a smoldering pile of rubble. And what's the difference?

12:12Rob Armstrong: But I was sitting in a room full of credit fund managers just earlier today. And we're all going around the room saying, I don't know, does AI make money? Does anyone know the answer to this question? Like it's a genuinely live question for people who manage credit funds, who invest in corporate bonds for a living. So CoreWeave CDS has gone up a lot, but there's also been a big pickup in CDS across all of these different tech bonds. And that is kind of the market's way of saying, hang on, they've borrowed a shed load of money. can they make a corresponding shed load of money to pay back that debt in time for when they have to pay it back or not?

12:54Rob Armstrong: So this is the kind of live question that's in markets today. The other thing that seems to have spooked markets somewhat is that company whose name you can't pronounce, Anthropic.

13:05Katie Martin: Ah, yes, that one.

13:09Rob Armstrong: We had a story yesterday. Yesterday, they told investors that third quarter revenue had risen nearly 50 % to$16.8 billion. That's a lot, but it's slower than the pace they set at the beginning of the year. And it's below some investors' expectations. So you add all of these tiny little nuggets together. So, you know, Mr. Brannon McBee says something a little bit iffy about tapping into insurers.

13:34Katie Martin: Still don't think that's a real name.

13:36Rob Armstrong: I'm led to understand it. is. Anthropic puts out some slightly squidgy numbers and you have higher borrowing costs because of what's been going on for months and months in the government bond market. And now all of a sudden the vibe has shifted from woo woo AI trade go go go to oh lads I just wonder if we've slightly overdone it here and whether we need a bit of a pullback.

14:02Katie Martin: Let me just say, by way of calm vibes, that the daddy of all tech indexes, the NASDAQ, is exactly where it was on the 13th of May. The sideways pattern we've been rattling on about on this show and elsewhere still holds. This has been a bad couple of days. These things happen. And I would say it is not tin hats time. I would say that we have a very speculative market that is based on expectations of the future rather than what is happening right now. And people are jumpy and they should be jumpy. But the bottom is not falling out as of yet. Might it be good to prepare for the bottom to fall out potentially?

14:54Katie Martin: Yes, it would be good to prepare for that. But that's a different thing.

14:57Rob Armstrong: I'm at the stage of just going and getting my tin hat out of the attic and dusting it down and having it ready. I'm not putting it on yet. But that does lead us to an interesting question, which we have been asking people about through our newsletter, which people email us about all the time, which is if the AI trade does go belly up, because as discussed on lots of previous podcasts that we've made, this is like the dominant theme in global markets. If it goes belly up, what can you do about it to protect yourself? And actually, what we're seeing in markets today, and again, it's Thursday as we record this, is just do the simple thing.

15:39Rob Armstrong: Just buy government bonds. Like, you know, good, safe government bonds that are definitely going to pay you back. They are yielding very generous numbers at the moment because you're buying them really nice and cheaply. And so they're picking up pretty handily. So maybe it's that simple. Just buy the bloody bonds.

15:56Katie Martin: I would add to that that there is not only good yields on high quality government bonds, but there's good yields on relatively short maturity government bonds, right? So you don't have to buy the 30-year, which has an incredible amount of interest rate risk plugged into it. You can get a nice yield. I mean, you can get an okay yield on cash right now, by the way.

16:19Rob Armstrong: Right.

16:20Katie Martin: But you can get a very nice one on a five-year bond, right? And that's a little safer from the point of view of your inflation risks.

16:27Rob Armstrong: This is not investment advice, people. But just like...

16:30Katie Martin: But I know it's an option. I will say, I will continue to not give investment advice by saying, if the other side of this is stagflationary, meaning we have low growth and our little inflation problem continues, we've just taken the growth out because the AI bubble has popped, bonds aren't going to do that great.

16:52Rob Armstrong: Okay. So it's not a perfect.

16:55Katie Martin: The theme of any discussion we have of this is going to be there are no perfect solutions.

17:00Rob Armstrong: Well, do you know what is kind of not necessarily perfect but looking pretty good? So one way that investors say they are protecting themselves for the event that the AI trade goes belly up is to buy into parts of the global stock market that have just not got very much tech in them. So you need a really, really boring stock market. And you know what fits the bill, Rob Armstrong? I do.

17:25Katie Martin: I'll let you say it, though.

17:27Rob Armstrong: It's the UK. So one of the only national indices in the world that's up today is the FTSE 100. It brings a tear to the eye. I'm so proud. Now is finally the time for extremely boring stock markets.

17:43Katie Martin: and finally yeah the united pork pie company is really doing well today listen don't knock it man it's doing pretty well maybe it's going to be

17:55Rob Armstrong: a port in the storm yeah i mean let me say this and i feel like in some weird way our roles have

18:03Katie Martin: reversed where you are now sounding optimistic and i am sounding pessimistic but a lot of those markets, not just the UK, but you might look at global markets like Brazil or people have mentioned certain Eastern European markets, whatever. A lot of these non-AI markets, they have a lot of commodity exposure and a lot of bank exposure. And again, for those kinds of companies to work for you, you need the economy to be growing. And so the question is, if the AI bubble turns out to be a bubble and pops, is that going to kneecap global growth? And so the markets that are insulated from direct exposure get this indirect problem that we are at or near recessionary conditions.

18:53Rob Armstrong: That's the thing. If the brown stuff really hits the fan, if this really is the big one, then everything will take a hit. The question is about how big of a hit that you take. And it's about losing as little money as possible. But just really quickly, Rob, what do you reckon? Is this the big one? Is this a flutter? What are you saying?

19:11Katie Martin: I'm going with flutter. I'm the resident optimist. I mean, I think this is a good time to be having the kind of conversations you and I just had. I think the risks are high. But I think because there is a lot of money kind of locked in right now to the AI build out, that will support things for the time being.

19:35Rob Armstrong: All you need is one more tech bro to say something really stupid, and we're off to the race.

19:42Katie Martin: But the real answer to your question, Katie, is you want to stay out of the business of trying to make that guess. 100%.

19:51Rob Armstrong: 100%. So just tread carefully and try not to do something overly stupid. Speaking of which... You sound like my wife. Speaking of which, we'll be back in one second with long shorts.

20:10Rob Armstrong: All righty, it is time for long, short, that part of the show where we go long, a thing we love or short, a thing we hate. Rob, what are you saying?

20:19Katie Martin: I am coming out against the letter K, Katie.

20:24Rob Armstrong: Are you?

20:24Katie Martin: Yeah, I wrote my column out this week about the K-shaped economy, which is this very popular idea that especially in the last six years since the pandemic, the U.S. economy has grown massively more unequal and is made up of a small number of people who are partying hard and the rest of us chumps who are just slogging away, possibly going backwards. This is a very intriguing theory that I think the best evidence shows is not true. And you can read my column if you want the evidence. But my conclusion is America is wildly unequal, and that's a shame. But it doesn't seem to be getting that much more unequal.

21:04Rob Armstrong: I mean, yeah, it doesn't seem that new to me. Okay, fine, fine, fine.

21:08Katie Martin: In any case, everybody loves the K-shaped economy idea. Every single comment under the column tells me I'm an idiot who doesn't know how the real world works. And luckily, I'm very used to being told this, so it's not that big a deal.

21:22Rob Armstrong: Water off a duck's back. speaking of water i am short salmon specifically i am short the news in the ft today that salmon farms in norway are feeding chicken to their fish oh this is very bad i feel like the whole protein maxing thing's gone too far and also like this is where problems start

21:48Katie Martin: right like you give animal protein to animals and weird things happen i just feel like this has a slight first scene of a horror movie.

21:56Rob Armstrong: I feel like it just gives me the ick, but I don't know why. Because like if fish eat other fish, then I don't mind eating the fish. But if fish eat chicken, I think ick. So our story says there's a professor of aquaculture nutrition at Norwegian University of Life Sciences. So I'm going to guess this person knows what she's talking about. She says, this is a very sensitive issue. Consumers have historically been very sceptical, but the market seems to be more ready now. I am not ready, Professor of Aquaculture Nutrition. No, no, I do. No, I get the ick from this.

22:30Katie Martin: Does the salmon taste like chicken after it eats chicken? I just don't know.

22:34Rob Armstrong: But I don't know why it's worse than if they're eating other fish.

22:38Katie Martin: Yeah.

22:38Rob Armstrong: It just, I think it's an offense to things that are holy. Speaking of things that are offensive to all that is holy, we'll be back on Tuesday, so listen up then.

22:53you