Investors trim growth bets over fears of US economy’s AI exposure

Investors are curbing their expectations for US growth, buying up government bonds in response to mounting fears about the AI trade.

In spite of hotter than expected growth the US reported this week, investors have drawn mixed conclusions about the durability of the AI rally from third-quarter corporate earnings. While some of this shift into bonds has been a temporary move for traders waiting out the volatility in stocks, others argue there is a more fundamental change happening.

Market measures of growth expectations, which had driven the multi-month Treasury market sell-off, have changed course over the past two weeks. A 10-year government bond yield stripped of the effects of inflation — a Treasury inflation-protected security — has dropped to 2.58 per cent this week, its lowest point since early September. Moves in the five-year and the 30-year bonds have been similarly large — both at their lowest points since September as well, erasing much of the sell-off.

Bond yields drop with growth expectations as investors buy up the debt, betting it will perform better than shares. The rush out of stocks this week is smaller than the one this summer, but the entry into bonds is enough to suggest investors are seeking ways to protect themselves from their significant exposure to AI.

Bill Campbell, portfolio manager at DoubleLine, said: “The market had been underwriting strong growth — underpinned by AI and the expectation that there would be some relief in the Middle East — and now we’re re-evaluating some of the growth expectations.”

Bad news out of Meta, Alphabet, Amazon and Intel this week have all contributed to the 2 per cent drop in the Nasdaq 100, adding to previous weeks’ losses and putting the index in correction territory. A huge chunk of that was from Alphabet, whose shares fell 13 per cent on Thursday after it reported that its free cash flow had fallen into negative territory for only the second quarter since going public in 2004. Capital spending rose dramatically at the other three and revenue had in some areas begun to slow.

This came as the Bureau of Economic Analysis on Thursday reported the US economy had grown 3.4 per cent in the third quarter, higher than the 3.2 per cent forecast by economists polled by Bloomberg.

Priya Misra, portfolio manager at JPMorgan Asset Management, said: “You can’t find the growth slowdown in any of the economic data. But markets are forward-looking. A reassessment of AI means a reassessment of growth expectations.”

Economists have long warned the US economy has become too reliant on the AI boom.

“The composition of growth is worrisome,” said Vincent Reinhart, chief economist at BNY Investments. “It is so heavily dependent on spending on technology. And it is not just a US phenomenon, it’s a global phenomenon.”

Reinhart added: “You don’t have to be a tech pessimist to be worried.”

Robert Sockin, chief US economist at PGIM, said the AI boom was also triggering concerns that the US economy was at risk of overheating.

“We’ve been calling this environment the story of the fatter tails,” Sockin said. “Often you get an overheating economy and that leads to a recession.”

He added that, while PGIM had raised the probability of strong growth over the coming year, the risk of a recession also had increased from 10 per cent earlier this year to 20 per cent a month ago. “Given the developments in the last few weeks … maybe it’s 25 per cent,” Sockin said.

Federal Reserve chair Kevin Warsh this week tried to eschew those concerns, saying the sources of US economic strength were not “only in narrow pockets”.

“That’s a much harder story to tell now than it would have been several quarters ago,” Warsh said on Wednesday after the Fed opted to keep borrowing costs on hold.

Some investors also suggested the problem with growth and the AI boom was more relative.

“With growth we often measure the rate of change year over year,” said Jason Granet, chief investment officer and head of credit services at BNY. “Because AI companies grew so much last year, it will be harder to beat those numbers. Growth may be decelerating, but it doesn’t necessarily signal weakness in the economy.”