This week’s summit between Donald Trump and Xi Jinping went pretty well. Except for a few sticky points around Taiwan. The two leaders complemented each other. Trump was soft and conciliatory, while Xi Jinping struck a firmer tone, invoking the “Thucydides Trap” — the idea drawn from the rivalry between ancient Athens and Sparta that war can become inevitable when a rising power challenges a dominant one. Yet, the two countries agreed to ease trade tensions – mostly on non-critical sectors. China even agreed to help with the Iran negotiations.
Markets rallied, ignoring the ongoing Middle East tensions and their impact on prices and inflation figures. Because yes, inflation data released throughout this week confirmed rising price pressures in the Eurozone, and warned that inflation at both the consumer and producer levels was accelerating faster than expected in the US. The latest US PPI data jumped to 6% – the highest in more than three years – as energy prices spiked, while the Japanese PPI print this morning echoed a similar rise: it came in at an eye-watering 5%, the highest since mid-2023.
Rising inflation kept pushing bond yields higher, reflecting continued hawkish pricing across global central bank expectations. The US 2-year yield spiked past 4%, while the Japanese 10-year yield rose nearly 3.80% this morning to around 2.75% – far above the 1.75% level pointed to as the threshold where Japanese institutional investors (life insurers, pension funds, banks) could start seriously preferring domestic bonds over hedged foreign debt, remember.
US crude is pushing higher, above the $102pb level this morning, as traders swing between conflicting announcements from Trump, first saying that the US could live without the Strait of Hormuz, before urging its reopening a few hours later. US oil inventories fell by 4.3 million barrels last week, and by around 12 million barrels over the past three weeks, as US crude exports rose to help fill the Middle East supply gap. Energy prices will likely remain elevated given the little progress made in Middle East talks in the short run.
Many consumer-facing companies have been insisting that US consumers are running out of money. The retail sales data yesterday hinted at resilience in April, but underneath the surface, 13.1% of US credit card balances are now 90+ days delinquent — the highest level since 2011. It means that Americans borrow to spend, and delay their credit repayments. That’s a ticking bomb.
But guess what? The S&P500 and Nasdaq both hit record highs yesterday. No Matter What.
And indeed, Big Tech has done amazingly well since the beginning of the Iran war, somewhat shrugging off rising energy costs and supply disruption risks. It’s not that these companies aren’t paying for energy, but the AI growth outlook – and optimism that it will accelerate revenue generation – is outweighing the geopolitical challenges.
Roundhill’s Mag7 ETF rebounded nearly 30% since the war dip, hitting a fresh ATH yesterday, supported by strong earnings and even stronger guidance. Cerebras Systems, an AI chip company that went public yesterday, surfed on a giant wave, jumping around 70% on its first day as a publicly traded company and giving it a market cap of around $95bn – the biggest IPO of the year so far.
Investors totally brushed aside the circular deal worries, and their frustration with the massive AI spending increasingly financed by debt. No one cares about rising yields, either. And that’s curious.
Yes, tech stocks performed very well during the latest Fed tightening cycle post-2022, aimed at fighting the post-Covid and Ukraine war-led energy crisis. One of the reasons was that Big Tech companies had ample free cash flow and relatively lower debt, which made them less sensitive to interest rate hikes, defying the theory that growth stocks should be hit harder by higher rates as their valuations depend heavily on future revenues that become less valuable when discounted at higher interest rates.
Today, investors treat tech stocks the same way: thinking they could defy the Iran war, rising energy prices, rising inflation expectations and the prospect of tighter-than-otherwise monetary policy.
The problem is this: massive capital expenditure is eating into their free cash flow and obliging them to seek funding through… bond markets. Huh. It makes Big Tech companies more vulnerable to interest rates compared to earlier cycles.
Take Amazon’s 1.5% coupon bond due June 2030. It now yields around 4.40%; it covers US inflation and still offers a certain premium, but the price is falling as inflation expectations push US yields higher. That means the cost of borrowing is rising for these tech companies that are – together – expected to spend up to $1 trillion in AI infrastructure this year.
That’s the cost side.
And what happens if they back down? What happens if they decide to reduce spending?
It could be worse. Because current valuations are fueled by the prospect of future AI-led revenue. But if companies stop investing, they could hit capacity constraints that limit income potential – a scenario that is not favourable for valuations.
Second, the circular nature of these deals suggests that if one company backs down, it could trigger a domino effect across the rest of the companies in the same circle…
Big Tech today stands at an important crossroads. Investors have digested the massive AI spending, the circular deals and the high valuations, yet for the rally to extend further, the macroeconomic backdrop also needs to remain supportive.
And today, looking at global yields, the macro backdrop is not supportive.
The longer the Middle East war drags on, the higher energy prices rise – fuelling inflation expectations and borrowing costs, and increasing the cost of building that extra data centre.
This, I believe, is a red flag that many tech investors have been ignoring, blinded by shiny earnings and even shinier earnings expectations.
But keep in mind that these expectations do not fully reflect the risk of another period of sticky inflation. And this time, Big Tech has less cash in hand to weather the stormy seas.
Alas, there is one more possibility — the one being priced in today — that the war will end, inflation and yields will come down, and markets will further rally on relief.
