Credit Markets Bracing for Potential AI-Driven Asset Bubble: DoubleLine's Cohen Warns of Rising Risk

Artificial Intelligence Debt on the Rise: Experts Warn of Potential Bubble

The market for artificial intelligence (AI) debt is experiencing rapid growth, with more than $370 billion in US sales of high-grade notes, junk bonds, loans, and other types of AI debt issued since the start of last year, according to data compiled by Bloomberg News. This surge in demand for AI debt is expected to continue, with Bloomberg Intelligence estimating that capital expenditure for AI will approach $5 trillion over the next five years, with a significant portion coming from debt markets.

At the Bloomberg Global Credit Forum in New York, DoubleLine portfolio manager Robert Cohen warned that the odds of an AI bubble are high, citing the history of periods of heavy investment in areas like railroads and the internet. Cohen emphasized the importance of focusing on companies with strong balance sheets and investments with strong protections, as fund managers buying debt assuming companies will grow into being able to meet their obligations is a key indicator of overly exuberant credit markets.

Despite the warning signs, the market for AI debt remains strong, with investors and bankers on the panel stressing that demand is still high. The backing of big, profitable tech companies known as hyperscalers, including Alphabet Inc., the parent of Google, and Meta Platforms Inc., the parent of Facebook, has helped reduce risk for many AI debt deals. Additionally, bonds that pay down principal over time can provide further protection for investors.

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The rapid growth of the AI debt market has led to a significant increase in issuance, with Morgan Stanley estimating that more than 10% to 15% of all debt issuance across credit markets could be tied to AI this year. This is a shocking amount, given that AI debt barely existed just two years ago. Morgan Stanley expects a record $2.25 trillion of US high-grade corporate bond sales this year, up from about $1.81 trillion last year.

The influx of AI debt has also led to a shift in the junk bond market, with some investors and bankers predicting that issuance in this market could help boost its size over time. However, spreads on the debt are expected to remain around their current levels, according to investors and bankers speaking at the event.

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With so much debt coming across markets, some companies have been looking to borrow now rather than later, according to Morgan Stanley's Anish Shah. Despite the warning signs, DoubleLine's Cohen said that his firm has shied away from buying much AI-linked debt, citing tight spreads and bubble risk. However, he added that for the right price, his firm would be willing to buy more AI-linked debt.