Neocloud Shakeout Sets Tone for Pivotal Week
With the Fed, Microsoft, Alphabet and Amazon on deck, the AI-related spending debate comes to a head.
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We have some small bounce action early Monday as oil eases. The Federal Reserve announces its rate decision on Wednesday, and Microsoft (MSFT) and Alphabet (GOOGL) report that evening, followed by Amazon.com (AMZN) on Thursday. The big issue hanging over the market is still AI spending and profitability, and over the weekend Elon Musk weighed in on who is going to be left without the money to keep building.
Musk on the Neoclouds
On X, Musk wrote that over the past few weeks, “debt markets have almost entirely shut off access to money for any company that doesn’t have substantial revenue independent of AI data centers.” He said SpaceX (SPCX) closed $40 billion in debt for graphics processing units because it is investment-grade and has Starlink and launch revenue. His conclusion: “That means the 200+ neoclouds are going to see guppy-level death and consolidation. Some will make it through, but not many.”
Neoclouds are the specialized cloud providers that buy huge numbers of Nvidia (NVDA) chips, install them in data centers and rent out the computing power to AI companies. CoreWeave (CRWV) is the largest publicly traded one, and Nebius Group (NBIS) and IREN (IREN) are in the group as well.
Neoclouds are different from the major hyperscalers such as Amazon (AMZN), Microsoft (MSFT) and Alphabet (GOOGL), which offer hundreds of different cloud services. The neoclouds do one thing: They are graphics processing unit rental shops, and many of them are funded with borrowed money.
This is the marginal borrower issue I have been writing about. When rates were lower and investors were eager to fund anything tied to AI, the neoclouds could borrow freely. Now the debt markets are getting selective, and the companies without other revenue to fall back on are the ones being cut off.
Demand Isn’t the Problem, Money Is
Nvidia CEO Jensen Huang told CNBC that demand for the neoclouds is “off the charts,” but he acknowledged that what’s missing is the capital to fund the growth. “The demand of the capital is much greater than the availability of the capital,” he said. “That’s going to get solved.”
Nvidia has a lot riding on that. According to The Wall Street Journal, it owns roughly 10% of both CoreWeave and Nebius and has backed or partnered with several other neoclouds. When the chipmaker is also a major investor in its own customers, it is fair to ask how much of the demand it is paying for itself. Some of the biggest AI bears are convinced that this “circular financing” will lead to disaster.
Two Companies Are Carrying the Earnings Boom
The Wall Street Journal also had a piece this weekend on how narrow the earnings boom has been. Analysts expect S&P 500 earnings to jump about 30% from a year ago in the third quarter. But according to a Dow Jones Market Data analysis, just two companies, Nvidia and Micron Technology (MU), account for 34% of that growth. Micron’s quarterly profit rose more than tenfold from a year ago.
Only 10 companies account for about two-thirds of the profit growth. Most are tied to AI, and several of the others are oil companies that benefited from the jump in energy prices caused by the conflict with Iran. So the two biggest drivers of earnings growth are AI spending that depends on the money staying available and oil prices that depend on a war. Neither is something you would want to embrace for the long term.
The more encouraging number is what is happening in the rest of the market. Even without those Top 10 names, the rest of the S&P 500 is expected to grow earnings about 10%. Share prices have risen far less than earnings estimates this year, so much of the market is cheaper than it was in January. That is the strong case for the rotation. There are plenty of companies growing their profits at a respectable pace whose stocks have been ignored because they aren’t part of the AI story.
The Week Ahead
The Fed decision comes Wednesday afternoon. The market isn’t expecting a hike this week, so the focus will be on what the Fed signals about December, especially with oil this high. We also get the first estimate of third-quarter gross domestic product and the September personal consumption expenditure inflation numbers on Thursday.
Then the megacaps take over. Microsoft and Alphabet report after the close on Wednesday, and Amazon reports Thursday. After the reaction to Meta Platforms (META) and Tesla (TSLA) last week, the bar is high. These companies can fund their spending out of their own cash flow, which puts them on the right side of the split Musk is describing, but investors still want to see the returns. They are spending so much on AI that they throw off far less free cash than they used to, and that leaves much less room for big purchases of their own stock.
Game Plan
I’m not going to bet on how the market reacts to these reports. I’m going to trade the reaction. Last week showed that good numbers don’t guarantee a good response, and the moves after the reports were bigger than the moves leading into them. I’ll let the price action tell me whether the selling in the AI names has run its course, and I’ll keep focusing on the groups that are benefiting from the rotation.
Long AMZN, SPCX
