Enthusiasm for Big Tech and its huge investments in artificial intelligence is powering the stock market to record highs again. With a resilient economy and scorching demand, there\u2019s seemingly only one obstacle that can derail this ride: higher interest rates.<\/p>\n
Technology companies are historically sensitive to Treasury yields because their high market valuations are based on growth estimates, with bigger profits anticipated sometime in the future. This is particularly true with AI-related capital expenditures, which aren\u2019t expected to fully pay off for years.<\/p>\n
In this forward-looking equation, interest rates help Wall Street determine the value of those future profits in today\u2019s dollars. In essence, the more rates go up in response to rising inflation, the less those earnings are worth, putting selling pressure on the shares.<\/p>\n
\u201cStocks with higher multiples tend to sell off when rates rise,\u201d said Maria Llerena, director of financial research at Domini Impact Investments.<\/p>\n
Last week\u2019s relatively subdued readings for consumer and producer prices tamped down expectations that the Federal Reserve will hike rates when it convenes next month. That helped to drive the S&P 500 Index to another all-time high on Thursday and pushed the tech-heavy Nasdaq 100 Index within 2% of its first record since early June.<\/p>\n
In the big picture, however, inflation remains well above the Fed\u2019s 2% target. Traders are pricing in at least one interest rate hike by the end of the year. And the yield on 30-year US Treasury bonds is hovering around the highest it\u2019s been since 2007, while Thursday\u2019s long-bond auction drew the highest yield since 2001.<\/p>\n
All of which represents a real risk for the major AI spenders, who are increasingly being forced to finance their ambitious capex plans by selling long-term debt.<\/p>\n
For example, Google parent Alphabet Inc. has $27 billion of bonds that are due in 2056 or later, Amazon.com Inc. has roughly $32 billion, and Meta Platforms Inc. has about $21 billion. The companies along with Microsoft Inc. are projected to spend $740 billion combined on AI computing infrastructure in 2026 and another $1 trillion in 2027. All are facing questions about when, if ever, those investments will generate proportionate returns.<\/p>\n
\u201cCapex has largely been self-funded from cash flows, but now it seems to be tipping over into the companies raising debt,\u201d Llerena said. \u201cThat means more question marks around rates and how they will impact valuations.\u201d<\/p>\n
Up until recently, fears about that spending had been punishing shares of companies in the AI trade. The Philadelphia Stock Exchange Semiconductor Index, better known as the SOX, plunged 21% in July, its worst month since October 2008. The Nasdaq 100 tumbled more than 11% from its most recent all-time high on June 2 to July 29, meeting the technical definition of a correction. And an index tracking the Magnificent Seven tech giants sank 12% from its record on May 28 through July 29, with Amazon losing 17% and Alphabet sinking 14%.<\/p>\n
Since then, AI stocks have reversed direction, with the Mag Seven climbing 9.1% since July 29, led in part by Microsoft\u2019s 27% surge and Amazon\u2019s 16% gain, and the Nasdaq 100 jumping 10%. Meanwhile, the SOX is up 9.8% in August, recovering part of its July drop.<\/p>\n
\u201cWe still think that AI and tech is the dominant theme of this bull market,\u201d said Keith Lerner, chief investment officer and market strategist at Truist Advisory Services. \u201cOur view is what happened over the last couple of months before this rebound was a healthy reset.\u201d<\/p>\n
While rates represent a risk, that\u2019s balanced by the tech giants\u2019 strong earnings and healthy balance sheets with plenty of room to take on debt, Lerner said. But he cautioned that this could change if rates rapidly rise.<\/p>\n
In some cases, the spending is so extreme that it\u2019s wiping out the cash generated from the companies\u2019 operations. Alphabet reported negative free cash flow in the second quarter for the first time as a public company, and it\u2019s expected to stay that way through 2028, according to the average of analyst estimates compiled by Bloomberg. Amazon, meanwhile, is projected to have negative free cash flow of $23.5 billion this year and $36.2 billion next year.<\/p>\n
That\u2019s forcing the companies to raise debt to make up for the shortfall. Amazon had total debt of $242 billion as of June 30, up from $147.8 million at the end of 2024. Alphabet\u2019s debt totaled $118.7 billion at the end of June, up from $25.7 billion at the close of 2024.<\/p>\n