If you’ve seen the movie “The Big Short” or caught highlights on YouTube, you might recall the term “credit default swap.” It’s the clever tool used by Michael Burry and others to bet against the housing market. Now, this same instrument is gaining traction as a safeguard against the rising AI boom, according to a report from Financial Times.
Since early September, the volume of these insurance policies has surged by a staggering 90%, as revealed by the Depository Trust & Clearing Corporation. Previously, the tech sector’s credit default swap market was stable at around $2 billion per month, but it’s on track to exceed $8 billion by December.
Targeting the Giants: Who’s in the Crosshairs?
Much of this activity is focused on hyperscale tech companies. Meta, for instance, has become a hot topic as it grapples with its AI strategies after its major investment in the metaverse. Meanwhile, Oracle and the newcomer CoreWeave are standing out as primary targets. CoreWeave has been labeled by The Verge as “the AI industry’s ticking time bomb.”
Oracle’s Rollercoaster: A Cautionary Tale
Oracle, in particular, has caught the attention of investors. The company’s stock price seems disconnected from its financial fundamentals. In its recent September earnings report, Oracle failed to meet revenue and earnings expectations, showing flat net income compared to last year. Yet, its stock skyrocketed due to large unfulfilled financial commitments, totaling an eye-popping $455 billion linked mostly to data center contracts with OpenAI. When Oracle announced delays to these projects, it sent waves of concern throughout the AI sector, causing notable sell-offs. This has led to a tripling of Oracle’s CDS trading volume this year as investors start to suspect something might be off.
Understanding Credit Default Swaps: What You Need to Know
So, how do credit default swaps work? Think of them as a form of insurance on an investment. The buyer pays premiums to a seller, who promises to pay out if a borrower defaults on a loan. Recently, fear of defaults has been palpable on Wall Street. Hedge fund Bridgewater Associates has cautioned that there’s a “reasonable probability of an AI investment bubble” looming, leading many to seek profit if it bursts.
Are Credit Default Swaps a Safe Investment Tool?
While they offer a hedge against risks, they can also cloud judgement regarding underlying asset values. If investors start second-guessing major firms, it could heighten overall market volatility.
How Do Hedge Funds Use Credit Default Swaps?
Hedge funds, like Bridgewater, leverage these swaps to insulate themselves from potential losses. They’re essentially saying, “We think there’s trouble ahead, so let’s prepare.” In a landscape filled with uncertainty, what’s their next move?
What Should Investors Watch for in the Tech Sector?
Keep an eye on earnings reports and major announcements from companies like Oracle and Meta. The market’s reactions to these can be telling. Will other tech giants follow suit, or will they stand strong?
Is the AI Boom Sustainable?
While AI is transforming industries, the sustainability of the current tech valuations remains questionable. It’s essential to stay informed and be cautious.
As the landscape shifts, many are asking themselves—are we gearing up for another major market shake-up? The growing interest in credit default swaps indicates that some investors think caution is warranted. What are your thoughts? Do you believe we’re on the brink of an AI bubble? I’d love to hear your perspective in the comments below!