Is the equity bubble bursting?
Equity market valuations are precarious. Until recently, they have continued to rise despite rising bond yields. Bullish momentum appears to be declining.
ALASDAIR MACLEOD
There are now concerns expressed about some of the financing practices over AI data centres and associated activities.
Consequently, tech-heavy equity indices from NASDAQ to the Nikkei to Korea’s Kospi have taken a tumble.
This is the Kospi:
Its bear market has been in place since June.
The downturn in Japan and NASDAQ is a relatively new shock.
It’s not just a question of trouble with data centres, but will a funding crisis in this vital area of the economy spread to other stocks?
There’s evidence of this risk to the wider market from two sources.
One is the valuation extreme of equities relative to bonds, and the other is record levels of bullish leverage.
It was a further rise in bond yields which was expected to finally undermine equity valuations, hence the importance of the chart above.
It shows the valuation disparity between rising bond yields (inverted) and the S&P.
Normally, there’s a tight negative correlation between the two, but the relative overvaluation of the S&P (arrowed) is at record levels by a country mile, three times greater than during the dotcom bubble.
But it appears that equities are losing upside momentum without further increases in bond yields.
Furthermore, speculators’ borrowings are also at records.
Brokers’ loans, which have increased sharply in recent months are next:
Hedge funds are equally leveraged:
That’s $3.5 trillion between the two waiting to be foreclosed upon when the bubble pops.
In the tech industry itself, there are mounting financial concerns about AI, data centres, and related debt.
On Friday, Elon Musk said that Softbank is defaulting on its turbine orders, its share price slid 11% on Friday having lost 58% since June, and its credit default swap rate has soared.
It’s not just Musk’s opinion hitting Softbank, though it wouldn’t have helped.
The funding situation for AI, data centres, and related suppliers seems to be going through a period of indigestion.
It has grown too rapidly.
Furthermore, funding is worryingly opaque, with off-balance sheet special purpose vehicles, reliance on private credit, circular financing by suppliers, funding secured on rapidly depreciating equipment, and financing on the ephemeral promise of tenancies.
It is all a mess at a time of high vulnerability for the equity market as a whole.
There is a significant risk that starting with AI there’s going to be a wider debt crisis, pulling in the entire banking system, triggering a cascade of margin foreclosures in the coming weeks.
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