Morgan Stanley: AI is a capital expenditure black hole, with risks spreading to the credit market.

Morgan Stanley pointed out that artificial intelligence is transitioning from just being a hot topic in the capital markets to becoming a real variable that is putting structural pressure on the credit market. Vishwanath Tirupattur, the head of North America fixed income research at the bank, believes that there is a significant divergence in the market's perception of AI: on one hand, tech giants continue to invest heavily in infrastructure, while on the other hand, there is a large-scale sell-off in the software sector. This deviation reflects investors' growing awareness that AI represents not only growth opportunities but also poses a threat to existing business models. According to Wind Trade Station, the bank has significantly raised its capital expenditure expectations for large-scale cloud service providers, predicting that related spending will reach $740 billion by 2026. Driven by the demand for AI investments and a resurgence in M&A activity, the bank forecasts that US investment-grade bond issuance will hit a historic high of $22.5 trillion in 2026. In this context, there are two key features worth noting. Firstly, the investment space is still vast. It is projected that by 2028, AI-related investments will accumulate to a 20% increase, but the actual investment to date falls short of this scale by 20%. This means that the majority of investment opportunities are still ahead. Secondly, the financing structure is changing. Unlike the spending phase before 2025, the next phase of development will rely more on diversified credit markets, including secured and unsecured financing, securitization and structured products, and joint venture models. The upcoming capital expenditure scale is too large to be supported solely by equity financing, and credit will play a core role in systemic financing. Currently, the weakness in the stock market is spreading to the credit market. Since the beginning of the year, the S&P Software Index has fallen by 23%. This pressure is particularly evident in the credit field, especially in sectors with large exposures to the software industry such as leveraged loans and business development companies (BDCs). Morgan Stanley warns that sentiment in these sectors may continue to be depressed, and credit investors may need to wait longer or see more significant price corrections before reentering the market. Although default rates are still low at present, with the acceleration of AI applications and ongoing uncertainty, price declines in the credit market may widen and deepen. AI investments are reshaping the financing landscape The latest financial reports from large-scale cloud service providers confirm that AI infrastructure investment commitments are accelerating. Morgan Stanley Internet stock analyst Brian Nowak pointed out that platforms with the richest data resources and the strongest investment capabilities are rapidly expanding their competitive advantages at an unprecedented speed, far exceeding expectations just a few weeks ago. Based on the latest guidance, Morgan Stanley's stock team has significantly raised its forecasts, expecting capital expenditures for large-scale cloud service providers to reach $740 billion by 2026, a significant increase from the initial forecast of $570 billion. The core logic remains solid: the demand for computing power continues to far exceed supply. This financing demand is profoundly impacting the bond market landscape. Morgan Stanley expects that driven by AI-related capital expenditures and a warming M&A activity, the issuance of investment-grade bonds in the US will climb to a record $22.5 trillion in 2026. The increase in supply may lead to a slight widening of investment-grade credit spreads by the end of the year. However, the bank believes that the current market environment is more similar to the scenarios in 1997-98 or 2005, where credit spreads widened in the backdrop of a rising stock market, but this does not signify the end of the cycle. Software sector facing disruptive waves of change Concerns over the disruptive risks of artificial intelligence in the market continue to intensify. This anxiety does not stem from doubts about the technological prospects but from the market's increasingly sober recognition that AI's transformative power is real and that massive capital expenditures are rapidly turning this potential into reality. Recent reports suggest that advanced AI models are nearing the ability to perform most software engineering tasks, sounding the alarm for investors and prompting a reassessment of two core issues: the speed at which the software industry is being disrupted and the breadth of the disruptive effects spreading outward. At the stock market level, the software sector has become a disaster area. The S&P Software Index has fallen by 23% since the beginning of the year, while the S&P 500 Index has remained relatively stable during the same period. This significant divergence clearly outlines the market's pricing logic for the risks of AI disruption. The weakness in the stock market is transmitting to the credit market, with pressure first concentrated in areas with the largest exposures to the software industry. Data shows that leveraged loans in the US software sector have fallen by about 3.4% since the beginning of the year, leading to an overall shift from positive to negative returns, with a 0.4% decline. In contrast, high-yield bonds with smaller software exposures continue to record positive returns, indicating that risks have not fully spread. Credit market under continued pressure Morgan Stanley is cautious about the current market outlook. The bank believes that sentiment in related sectors such as software may continue to be downcast, and it is not yet clear where the next catalyst to reverse the downturn will come from. Credit investors may need to wait longer or see larger price corrections before reentering the market. Although default rates are currently low, with the acceleration of AI applications and ongoing uncertainty. Due to the difficulty in identifying which companies are truly facing survival risks, price declines in the credit market may further widen and deepen. Morgan Stanley warns that when default rates ultimately rise, as many companies have lightweight asset profiles, their default recovery rates may be significantly lower than historical averages. From a more macro perspective, the bank points out that while the surge in supply may drive investment-grade credit spreads to widen, the current market environment is more similar to historical stages of credit and stock market divergence, rather than the end of the cycle. As credit strategists, Morgan Stanley is closely monitoring the pressures building up in the credit market with a sharp perspective, with its core judgment being that the future engine of productivity is catalyzing the current market pains.