The AI Boom Just Sent a Warning Sign That Has Nothing to Do With Stock Prices

The biggest warning for artificial intelligence (AI) stocks right now might not come from valuations, high earnings expectations, or the demand for semiconductor chips.

It might come from the bond market.

In the past two weeks or so, CoreWeave's (NASDAQ: CRWV) share price dropped more than 30%. The company's bonds also suffered a sharp sell-off. Bonds issued earlier this year with a yield of 9.675% are now yielding around 15%.

In other words, the market is now pricing in much more risk for one of the AI trade's biggest names.

The big question now is whether this marks the beginning of a broad risk repricing driven by concerns that AI companies won't generate sufficient return on investment (ROI) from the build-out.

The bond market has questions about the economics of AI

CoreWeave operates data centers that provide computing power to all of the big AI developers. Building all that infrastructure obviously can be enormously costly. Its potential revenue generation is substantial, but it could be a while before these companies break even on their investments.

A year ago, investors were comfortable with the risk because they were focused only on the long-term potential of how big AI could get. Over the past few months, however, investors are looking for results. Stocks aren't just popping based on how much they're spending. They're starting to move based on revenue and earnings growth.

CoreWeave's current financial condition suggests some of these companies may have gotten out over their skis.

Consider the potential financial impact if the company needs to issue more debt. A hypothetical $1 billion loan at original terms would cost nearly $97 million in annual interest expense. If CoreWeave needs to do another raise at the current implied rate of 15%, it would add roughly $53 million in expenses. If the market is already concerned about ROI, it will be even more challenging to generate the cash flow needed to break even.

There's another potential complication. As we've seen in other tech booms, both hardware and software can become outdated quickly and much cheaper over time. Not only could a lot of that spend result in obsolete architecture, but the margin of less expensive future tech also makes it more difficult to become profitable.

History suggests investors pay attention to the credit markets

The economy went through a similar tech build-out around 30 years ago, during the advent of the internet. Telecom companies spent huge amounts to build out the fiber-optic networks to support an anticipated surge in internet traffic.

The internet boom happened, and much of the tech and infrastructure proved to be necessary to its success. However, many companies had revenue expectations that proved overly optimistic. They borrowed billions of dollars based on those forecasts and ended up in dire financial straits. Many companies became highly indebted or eventually went bankrupt.

It's unclear whether CoreWeave or any of the companies in this space are headed down the same path. But the bond market's reaction to its financial condition isn't encouraging. It does suggest that investors might want to be more discerning here.

Credit spreads overall have jumped by about 50 basis points over the past month, suggesting that the bond market is getting a little more nervous. They're not yet at the level that would indicate real stress in the system, but it's an early warning that investors shouldn't ignore.

Here's what I'd do with VOO and QQQ

I wouldn't sell tech stocks or the S&P 500 (SNPINDEX: ^GSPC) just because CoreWeave's borrowing costs are rising. That means maintaining a buy-and-hold perspective on both the Vanguard S&P 500 ETF (NYSEMKT: VOO) and the Invesco QQQ ETF (NASDAQ: QQQ).

I do think it's time to distinguish between heavily indebted companies and those that have been able to finance AI expansion more heavily through generated cash flow. That's the quality tilt that can make a difference if the AI trade begins to weaken.

The S&P 500 is still only 1% off its highs. But the bond market may be the real warning sign here.

David Dierking has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.