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Interview

Why Investors Are Reducing AI Exposure

Goldman SachsRich Privorotsky, Chris Hussey
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Market Dynamics and Concentration Risks

  • The "long AI, short everything else" consensus trade is currently unwinding as third-quarter earnings season begins.
  • Market concentration in AI, semiconductors, and hyperscalers has become excessive, leading to painful adjustments in recent weeks.
  • Three primary issues are driving current market volatility:
    • Cost of Capital Spillover: Rising sovereign and triple-C credit spreads are affecting leveraged segments of the AI trade, particularly "neo clouds."
    • Supply Constraints: Concerns exist regarding the ability to deliver 20–50 gigawatts of power next year, potentially rendering forward-ordered chips unusable without energy.
    • De-risking Behavior: Investors are lowering growth expectations for the AI sector, causing bonds to rally unexpectedly.

Third-Quarter Earnings Focus

  • Market attention is shifting to hyperscaler earnings to validate capital expenditure (CapEx) sustainability.
  • The market expects next-year AI CapEx to remain near $1 trillion.
  • Success requires demonstrating that massive spending translates into meaningful cloud revenue growth and backlog monetization.
  • The timeline to free cash flow breakeven is a critical metric that could acutely impact credit markets if it deviates from expectations.
  • Despite high costs, spot compute prices are making new daily highs, indicating insatiable underlying demand.

Energy, Macroeconomics, and the "Spending Glut"

  • The "as goes oil, so goes everything" mantra remains relevant; energy risks are compounding broader market issues.
  • While the S&P 500 has compartmentalized energy risk, the median equity has fallen over 10%.
  • High energy prices have driven Financial Conditions Index (FCI) tightening and led to a repricing of the Fed's hiking cycle.
  • The macroeconomic backdrop has shifted from a "savings glut" to a "spending glut" driven by a $1+ trillion AI CapEx cycle and global fiscal deficits.
  • This structural shift is pushing out lower-quality borrowers, evidenced by widening triple-C spreads and French sovereign bond concerns.

Investment Strategy and Outlook

  • The market is currently paralyzed by contradictory fears: that AI providers will either fail to deliver compute or over-invest and fail to monetize.
  • Long-term allocation should remain in nominal assets unless a disinflationary bust occurs, though a "barbell" portfolio approach is now suggested for the medium term.
  • Specific attractive sectors identified include:
    • Electrification: Derated assets with significant visibility and margin of safety for 2027.
    • Aerospace: Civil aviation assets offering attractive valuations.
    • Transportation: Specific parts of the sector.
  • If an energy resolution occurs, these sectors offer significant convexity due to recent deep selling.
  • Investor sentiment is cautious; Goldman Sachs noted the largest tech selling week in their prime book last week.

Immediate Forward-Looking Triggers

  • Next week's focus will center on hyperscaler earnings figures, specifically CapEx guidance and monetization data.
  • Outcomes from these reports will shape market sentiment regarding underlying demand and credit risk.
  • Further data points from AI labs and hardware providers will be scrutinized for confirmation of demand sustainability.