By Jamie McGeever
ORLANDO, Florida (Reuters) -Wall Street was mixed on Monday, with bumper corporate dealmaking activity and another mega AI-related tie-up offset by murky signals around the path for U.S. growth and interest rates, while the dollar crept up to a fresh three-month high.
In my column today, I look at whether Big Tech’s big spend on AI will generate the big returns investors are clearly hoping for. No one has a crystal ball, of course, but the huge sums being spent mean the bar for decent returns is very high too.
If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.
Today’s Key Market Moves
Today’s Talking Points
* Tech debt
In September, Oracle tapped the bond market for $18 billion, last week Meta announced its largest ever bond sale of up to $30 billion, and on Monday Google’s owner Alphabet said it is raising debt finance. Media reports put the multi-tranche issue at around $22 billion.
Investors are lining up to lend to these tech giants, of course, but the borrowing does raise questions around how much their collective AI capex splurge is eating into cash flows. If Big Tech borrows big in the months ahead, could that affect demand for U.S. Treasury debt?
* Do you want to make a deal?
Kimberly-Clark is buying Band-Aid maker Kenvue in a deal worth nearly $50 billion, something of a surprise move given the premium paid and some of the controversies and difficulties facing Kenvue.
Dealmaking appetite is strong – Wall Street is booming, the Fed is cutting rates, and financial conditions are the loosest in years. Deals targeting U.S.-based companies totaled $1.7 trillion, according to LSEG, up 36% year-on-year and second highest since LSEG records began in 1970. Justified, or is irrational exuberance creeping in?
* Fed fissures
Uncertainty around the Fed’s next step is rising, and understandably so. The U.S. government shutdown is about to extend to a record-matching 35 days on Tuesday, and online betting market Polymarket is predicting it won’t end until December 2.
No data means very little visibility. Add to that the growing differences between FOMC hawks and doves, and little wonder the probability of a December cut has slumped to 65% from 90% last week. Few would bet against it being closer to a 50-50 call soon.
Big Tech, big spend. But big returns?
The reaction of most “Magnificent Seven” tech giants’ shares to their latest earnings suggests the artificial intelligence boom is far from over. Yet doubts about the future returns from these firms’ astronomical AI expenditures are gnawing deeper.
The third-quarter earnings season has seen these tech behemoths continue to rake in huge profits and offer sunny guidance. Some investors may baulk at the Mag 7’s lofty valuations, but today’s tech leaders – unlike the superstar firms of the 1990s dotcom bubble – appear to have sustainable business models. Federal Reserve Chair Jerome Powell reiterated as much last week, saying that their AI investments are a major source of U.S. economic growth.
Just four “hyperscalers” alone – Microsoft, Amazon, Meta and Alphabet – are expected to spend a combined $350 billion this year, and Goldman Sachs estimates global AI-related infrastructure spending could reach $4 trillion by 2030.
The more these firms splurge on data centers, cloud computing capabilities, and the gamut of AI technologies, the loftier investors’ expectations will get. At some point, they will be impossible to meet.
The financial benefits and cost savings for society resulting from that are one thing; which companies actually profit is another. It is important, therefore, to distinguish between “value creation” and “value capture”.
“The value creation is certainly there,” says Daniel Keum, associate professor of management at Columbia Business School. “But will that value flow back to the companies that are making these AI investments right now? For me, the clear answer is no.”
DO THE MATH
It’s early days in the AI supercycle, but Big Tech’s AI outlays are already eating into hyperscalers’ cash flows.
Torsten Slok, chief economist at Apollo Global Management, estimates that aggregate capex at Amazon, Google, Microsoft, Meta and Oracle as a share of their operating cash flow is now a record 60% – and rising.
Amazon reported strong earnings last week, and its stock surged double digits to hit a new high on Friday. But buried in the report was a slide showing that trailing-12-month free cash flow has fallen almost 70% over the last year.
Ross Hendricks, analyst at independent research firm Porter & Co, estimates that hyperscalers’ free cash flow in the first quarter of next year will be down more than 40% from the same period this year.
“The whole sector faces the same basic problem,” says Bob Elliott, co-founder of Unlimited Funds. “The math is pretty simple, unless there is a surge in revenues from these activities, Big Tech is going to pump nearly all their free cash flow into capex in just a few years.”
This creates several potential problems. It intensifies the pressure to generate high returns on these investments, but until those materialize, non-AI-related activities are also under pressure to produce significant returns. And this leaves hyperscalers vulnerable in the event of a sharp economic or market downturn.
HIGHER BAR
The fate of these megacaps will, of course, have a significant impact on the broader economy, not only because these companies’ capex is helping to drive growth but also because almost everyone with a retirement fund is exposed to them. Nvidia’s share of the total S&P 500 market cap is a stunning 8%, while that of the “Mag 7” is a record 37%.
Investors are well aware of how much these shares have appreciated. The Philadelphia Semiconductor Index has more than doubled from its April low. But expensive markets can always get more expensive.
It will take a brave fund manager to tell clients that they’re reducing exposure to what have effectively become cash-printing machines. Of course, whether these companies can continue printing money as fast as they’re spending it is the big question.
For example, Meta’s announced capex this year is around $70 billion, but Unlimited Funds’ Elliott notes that the company’s income is only $3 billion to $5 billion higher, based on underlying trends, than it was before they started spending all this cash. That’s a pretty “mediocre” return on investment.
Of course, CEO Mark Zuckerberg might argue that this is long-term investment and that not spending now could be more costly down the line if the AI revolution lives up to the hype. But it is unclear how much patience investors will have.
Smaller businesses overall seem to be faring better. A Wharton Business School study published last month found that 74% of businesses say generative AI investment is already producing positive returns, especially smaller enterprises in digital-based sectors like tech and finance.
“Confidence remains strong … but future gains must now be justified by clear performance outcomes,” the authors said.
The bar for Big Tech giants with market caps of trillions of dollars and capex budgets of hundreds of billions is higher though. Much higher.
What could move markets tomorrow?
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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.
(By Jamie McGeever;)
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