Last Sunday evening, Elon Musk admitted the Grok Bot business model isn’t working when he posted on X: “The cost of serving Grok Bot was unsustainably high relative to revenue.”
The world’s richest man just admitted what investors already know: AI is an incredibly expensive technology to provide. SpaceX, Google, OpenAI, and Anthropic are burning hundreds of billions of investors’ money running the closed-source models xAI, GPT, Claude, and Gemini.
Investors know the AI revolution is real—they’re worried about the massive debt and leverage that the leading companies hold on (and off) their balance sheets.
The laundry list of risks facing the leading AI firms has become overwhelmingly obvious to the markets, but the AI trade had been unwinding very slowly, until last week.
Tuesday’s midterm election sent stocks on a wild ride. After a strong rally on Wednesday, the reckoning came on Thursday, when the Invesco QQQ ETF, which mirrors the tech-heavy Nasdaq, fell 6.5%. The index lost $2.5 trillion in market value as Wall Street’s “fear gauge," the CBOE Volatility Index, jumped to its highest level since March.
The AI Gamble
It’s been four years since ChatGPT launched and still, no pure-play LLM provider has been able to make more than it spends—and they continue to take on new massive debts, leveraging investors’ bets that the largest-ever industrial build-out the world has ever seen will eventually pay-off.
Anthropic's recently released IPO filing offers a window into the scale of the AI gamble investors are taking in the AI trade.
At first look, investors noted that Anthropic’s revenue grew 1,200% to $33 billion through the first 9 months of the year, and operating losses sank by about 75%. But a deeper look into the numbers suggests a much different future.
Anthropic is about to spend more money than we can comprehend as it plans to hemorrhage cash for years. At low interest rates, investors can be patient, but interest rates are rising throughout the economy, and even more so for unprofitable tech companies.
Anthropic’s purchase commitments are massive. It has made contractual commitments to spend $895 billion in the coming years—about $100 billion per year starting next year. Compare that to the $19 billion it has spent this year and it becomes clear that the company’s business is going to look much different going forward—and not in a good way. Investors thinking about buying the stock after the IPO should be scratching their heads—and current investors should be pulling their hair out.
The idea that this company will become profitable anytime soon is pure fantasy—and Anthropic admitted it in its pre-IPO filing: "Our increasing efforts to build out our compute and infrastructure require substantial capital expenditures that are changing the cash flow of our business." In other words: Investors, prepare for massive losses.
Bulls will tell you that the company has cash reserves of more than $130 billion, but its costs will dwarf that—and that’s why Anthropic is going public. It needs your money, and if it doesn’t get it, it won't be able to pay its bills.
In its IPO, Anthropic will float about $100 billion worth of stock, a massive capital raise. Other AI firms are raising investor capital too. Over the past 10 months, the hyperscalers—Microsoft, Meta, Amazon, Google, and Oracle—have depleted their cash reserves and, at the same time, have raised more than $300 billion in debt and equity to build data centers—and they need a lot more. Morgan Stanley estimates that hyperscaler debt issuance could exceed $1 trillion by 2028.
The trajectory of the broader stock market is now inextricably linked to the AI sector. For investors holding broad index funds like the S&P 500, portfolio performance is increasingly dependent on the highly leveraged AI trade. And with warning signs emerging, the trade is losing momentum.
If your investment strategy is to buy-and-hold broad stock market index funds, last week was shot across the bow. At Alpha Rock, we take an active, risk-managed approach that currently holds a large allocation to cash-like securities such as short-term Treasury Bills, gold, natural resources and other investments with lower-correlation to high-risk technology companies and the broader stocks market, which is increasingly dependent on the AI gamble.
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Some interesting things I came across this week…
The Bull Case for the AI Trade (Gene Munster)
U.S. economy added 165,000 jobs in October, way more than expected (CNBC)
What Makes a Moat? (Apollo)
Chris Whalen: Warsh’s Credibility Is Eroding (Julia La Roche Show)
IRS Raises 2027 Tax Deductions, Estate/Gift Exemptions & Adjusts Income Tax Brackets (Financial Advisor)
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Off the beaten path...
The Iran War Nuclear Option (Cappy Army)
Elizabeth Warren, new chair of the Senate Banking Committee to hold investigations into Trump, Wall Street and Big Tech (Yahoo! Finance)
Understanding the Learjet Crash in Palm Beach (Captain Steeeve)
Jordan Peterson on 12 Rules for Life (How to Academy)
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