How Far Can AI Stocks Rebound? Key Factors: Financing and Profitability

TL;DR · AI concept stocks have driven a rebound in the U.S. stock market, but trading desks indicate that institutional funds have not fully replenished their risk exposure. · Meta's stock issuance received enthusiastic subscriptions, and Broadcom's $63 billion computing power financing has alleviated market concerns about tightening financing channels. · Broadcom provides residual value support for the transaction, indicating that large-scale AI financing demands higher requirements for risk-sharing mechanisms. · The focus of major companies' earnings reports is shifting towards capital expenditures, utilization rates, depreciation, and cash flow, as demand growth alone is insufficient to explain valuations. · The expectation that the Federal Reserve will remain on hold this time is strong, and Waller's statements on future rate hikes may still change the valuation environment for tech stocks. · The author believes that caution should be exercised regarding whether the rotation in the AI sector is accompanied by broader credit tightening; this is a risk scenario, not a fact that has already occurred.

AI financing has seen continuous progress, leading to a rebound in the U.S. stock market. However, the willingness of capital to pay for expansion and whether that expansion can ultimately yield sufficient returns remain two separate issues that need to be verified. In this market commentary, Stephen Innes points out that AI investments are entering a phase that places greater emphasis on financing conditions, execution capabilities, and capital returns.

Financing Eases Anxiety

After last week's sell-off, AI trading has warmed up again. On Tuesday, the Nasdaq 100 index rose by 1.3%, and the Philadelphia Semiconductor Index increased by 3.6%. The drop in oil prices also supported risk appetite, with major stock indices recovering some of the technical positions they had previously lost.

One important factor driving the recovery in sentiment is the market's renewed belief that financing for AI infrastructure expansion is still attainable.

Meta's $25 billion common stock issuance reportedly received about five times the subscriptions. Broadcom's participation in the $63 billion financing arrangement, along with Anthropic's listing application, has also helped alleviate investors' concerns about the massive funding needs of the AI industry.

These developments indicate that the capital markets are still willing to provide funding for AI expansion. However, the demand for financing remains, and how much risk fund providers are willing to take and what conditions they require are gradually becoming important variables affecting this round of market performance.

The structure of the Broadcom transaction is particularly noteworthy. According to the company's announcement, Bank of America, Blackstone, Citigroup, and Morgan Stanley have committed to providing financing for a newly established special purpose vehicle (SPV), which will purchase Broadcom's AI accelerators and networking equipment and lease them to Anthropic. Broadcom will provide residual value support equivalent to the first-priority financing amount. This means that the financing arrangement includes a risk-sharing mechanism for the future value of the equipment.

Therefore, this transaction should not simply be understood as Broadcom borrowing $63 billion, nor should the financing's realization be directly equated with the project's returns being validated.

Innes believes that Meta's financing from the stock market and the introduction of large structured financing for computing power reflect changes in the AI investment cycle: the scale of construction continues to expand, and companies need to more actively mobilize external capital. Thus, financing capability has become part of industry competition.

Earnings Reports Must Address Return Issues

The rebound in stock prices does not mean that institutional funds have fully turned optimistic.

From a technical perspective, the Nasdaq 100-related ETF QQQ has regained the 100-day moving average, and the S&P 500 index has also returned above the 50-day moving average. However, price recovery does not imply that institutional funds have fully turned optimistic.

Innes cites observations from Goldman Sachs' trading desk, stating that overall trading activity that day remained relatively subdued, with fund flows still leaning towards selling. Accounts that only take long positions continue to net sell in the communication services sector and macro products; although hedge funds have slightly net bought, the trading amounts are limited. The risk exposure of fundamental long-short strategies is still close to recent lows.

These observations correspond to the funds covered by the trading desk and cannot directly represent the entire market. However, they highlight a noteworthy divergence: prices are recovering, but positions still appear cautious.

After a concentrated reduction in positions, short covering and buying on dips can drive a rebound. However, for the market to continue rising, stronger fundamental evidence is needed. Upcoming earnings reports and guidance from major cloud service providers like Alphabet, Microsoft, and Amazon will bear this verification task.

The questions the market is concerned about are also changing. While whether AI demand is growing remains important, investors also need to know whether this growth can generate returns sufficient to cover massive expenditures.

Capital expenditures (Capex), which involve investments in building data centers, purchasing chips, and other long-term assets, will first consume cash; once the equipment is in use, depreciation will continue to be accounted for as a cost. Utilization rates, service pricing, and customer demand will determine how much revenue and profit these assets can contribute. Several factors combined create a complete picture of investment returns.

Therefore, even if giants continue to increase AI spending, it may not be enough to drive stock prices. Investors must also assess how long new investments will take to generate revenue, whether cash flow can keep up, and whether companies will need to continue financing in the future.

Innes's core judgment is that understanding the trend of AI adoption and determining who can derive sufficient profits from it are increasingly requiring separate discussions.

In the early AI market, the focus was more on technological breakthroughs and scarce resources; now, financing, execution of construction, and capital returns are gaining higher weight. The industry's prospects remain attractive, but financial constraints are becoming difficult to bypass.

Federal Reserve's Impact on Funding Costs

Whether AI companies can continue to finance also depends on the overall market's cost of capital.

At the time of publication, the market widely expects the Federal Reserve to maintain interest rates at the October 28 meeting, but still sees the possibility of a rate hike in December. Therefore, the focus of this meeting is more on the press conference of Federal Reserve Chairman Kevin Waller.

Innes believes that the resilience of economic data and the persistent inflationary pressures make it difficult for the Federal Reserve to clearly shift towards easing; however, in a situation where the market has fully anticipated a pause in rate hikes, immediate action could cause unexpected shocks.

Policy language is therefore particularly important. If Waller's statements lead investors to lower their expectations for future rate hikes, tech stock valuations may receive support; if he emphasizes the necessity of further tightening, short-term U.S. Treasuries may face selling pressure, pushing yields higher.

Bond prices and yields typically move inversely. For tech companies, rising interest rates can increase financing costs and also reduce the present value of future profits. Companies whose valuations rely more on future growth are usually more sensitive to this.

The drop in oil prices has temporarily eased some inflation concerns. On Tuesday, Brent crude closed below $114 per barrel, with market expectations for progress in Middle Eastern diplomacy providing some support. However, Innes warns that tight physical supply and unresolved regional issues mean that this drop may not be sufficient to establish a sustained downward trend.

He also noted that gold has risen above $4,050 per ounce, and Bitcoin has found support around $80,000. During the previous widespread de-risking process, different assets were sold off together; the stabilization of these assets at least provides some signs of reduced pressure from forced selling. However, a rebound in just a few asset classes is still insufficient to conclude that the market has entered a new operational phase.

Next Steps: Watch Credit

The risks of this rebound may not first manifest as a significant drop in major stock indices.

One downside scenario proposed by Innes is that funds first flow from the crowded AI sector to defensive industries and lower-volatility stocks, allowing major indices to maintain temporarily; if financing conditions subsequently tighten across broader industries, the credit market may issue early warnings, and corporate earnings expectations may be adjusted downward. Following that, if multiple asset classes begin to decline simultaneously, systematic strategy reductions and portfolio risk reductions may further amplify pressure on indices.

This is a risk transmission path that needs to be observed, not a result that the author deems inevitable.

For Tuesday, the market did show improvement: concerns over AI financing have eased, credit spreads have narrowed, oil prices have fallen, and tech stocks have regained some ground. A narrowing of credit spreads means that investors require less additional yield for holding corporate bonds compared to government bonds, which usually reflects a decrease in their concerns about credit risk.

However, these changes still require verification from earnings reports and subsequent financing conditions. If major cloud service providers can demonstrate that spending growth is supported by corresponding revenue and cash flow, and if the Federal Reserve's statements do not significantly raise interest rate expectations, the rebound may continue.

Conversely, if earnings reports reveal a larger funding gap and the cost of borrowing for companies rises again, the current sentiment recovery may still face challenges.

For the upcoming market, the variables worth tracking have become very specific: whether the returns on new investments are clearer, whether financing conditions remain stable, and whether credit pressures extend beyond the AI sector.