The Bank for International Settlements (BIS) has issued a stark warning about the sustainability of the AI-driven global stock market rally, according to reports from Reuters. The global umbrella body for central banks highlighted that investors are growing more cautious about the profitability of future AI investments, marking a shift from the momentum that has supported equity markets over the past two years. The BIS identified rising leverage among major U.S. technology companies and growing debt used to finance AI spending as key risks that could challenge the rally's durability. Latest developments show AI-connected stocks took a sharp downturn after leading AI companies urged a slowdown in technological development over the weekend, citing potential threats to humanity, as reported by Reuters. BIS head of economic analysis Frank Smets told reporters that "the AI momentum, which had propelled equity markets and contributed to the resilience of the global economy of the last year, has begun to show growing signs of vulnerability."
The BIS report revealed a dramatic increase in technology sector borrowing, with aggregate borrowing by technology companies rising from about $22 billion in 2010 to more than $1 trillion projected by 2025, representing 44% of total private credit compared to 22% previously, as reported by Reuters. Total outstanding loans to technology firms across different forms of financing stood at nearly $2.5 trillion. The rapid increase in borrowing by AI companies has issued hundreds of billions of dollars in debt, potentially adding pressure on government bond markets and contributing to higher borrowing costs. The BIS identified the complexity and limited transparency surrounding some AI financing arrangements as additional concerns, with Smets noting that "many of these financing deals are quite opaque. They're often off balance sheet. They have sort of circularity in them."
AI-linked stocks came under pressure on Monday after several leading AI executives called for a slower pace of development, citing concerns over the potential risks posed by increasingly advanced technology, according to Reuters. The BIS noted that AI-linked stocks came under pressure on Monday following these executive concerns. Despite these challenges, the BIS reported that investors' risk appetite has remained remarkably resilient in recent months, with Smets adding that "there were no signs of stress overall." However, he warned that this resilience could be tested if upward pressure on bond yields continues, stating that "it's related to the fiscal fragility that comes also with higher uncertainty in the world economy." The latest market data shows that price/earnings ratios of the broad IT sector dropped by between nearly 15% for hyperscalers and 40% for semiconductor manufacturers after corrections, with hyperscalers' valuations appearing more moderate at least by historical standards.
Despite AI-related jitters and rising volatility, overall equity volatility remained broadly compressed even as markets absorbed significant challenges. Some investors reacted to AI woes by reallocating their portfolios towards other sectors and countries, leading to more dispersed equity returns. Korean markets plunged due to greater exposure to AI-linked firms and turmoil in leveraged investment vehicles, while euro area equities rose steadily, outpacing a choppier US market and benefiting from strong bank performance. EME equities generally performed better than advanced economies, supported by capital inflows and investors seeking greater diversification. Small caps and the rest of the S&P 500 outperformed hyperscalers and semiconductor manufacturers, with more traditional sectors extending positive performance. Credit markets weathered the rise in yields and bouts of turbulence, with spreads remaining compressed near historical ranges, though investors became more selective demanding greater risk compensation amid hyperscalers' booming debt issuance.
