Enthusiasm for Big Tech and its huge investments in artificial intelligence is powering the stock market to record highs again. With a resilient economy and scorching demand, there’s seemingly only one obstacle that can derail this ride: higher interest rates.
Technology companies are historically sensitive to Treasury yields because their high market valuations are based on growth estimates, with bigger profits anticipated sometime in the future. This is particularly true with AI-related capital expenditures, which aren’t expected to fully pay off for years.
In this forward-looking equation, interest rates help Wall Street determine the value of those future profits in today’s dollars. In essence, the more rates go up in response to rising inflation, the less those earnings are worth, putting selling pressure on the shares.
“Stocks with higher multiples tend to sell off when rates rise,” said Maria Llerena, director of financial research at Domini Impact Investments.
Last week’s relatively subdued readings for consumer and producer prices tamped down expectations that the Federal Reserve will hike rates when it convenes next month. That helped to drive the S&P 500 Index to another all-time high on Thursday and pushed the tech-heavy Nasdaq 100 Index within 2% of its first record since early June.
In the big picture, however, inflation remains well above the Fed’s 2% target. Traders are pricing in at least one interest rate hike by the end of the year. And the yield on 30-year US Treasury bonds is hovering around the highest it’s been since 2007, while Thursday’s long-bond auction drew the highest yield since 2001.
All of which represents a real risk for the major AI spenders, who are increasingly being forced to finance their ambitious capex plans by selling long-term debt.
For example, Google parent Alphabet Inc. has $27 billion of bonds that are due in 2056 or later, Amazon.com Inc. has roughly $32 billion, and Meta Platforms Inc. has about $21 billion. The companies along with Microsoft Inc. are projected to spend $740 billion combined on AI computing infrastructure in 2026 and another $1 trillion in 2027. All are facing questions about when, if ever, those investments will generate proportionate returns.
“Capex has largely been self-funded from cash flows, but now it seems to be tipping over into the companies raising debt,” Llerena said. “That means more question marks around rates and how they will impact valuations.”
Up until recently, fears about that spending had been punishing shares of companies in the AI trade. The Philadelphia Stock Exchange Semiconductor Index, better known as the SOX, plunged 21% in July, its worst month since October 2008. The Nasdaq 100 tumbled more than 11% from its most recent all-time high on June 2 to July 29, meeting the technical definition of a correction. And an index tracking the Magnificent Seven tech giants sank 12% from its record on May 28 through July 29, with Amazon losing 17% and Alphabet sinking 14%.
Since then, AI stocks have reversed direction, with the Mag Seven climbing 9.1% since July 29, led in part by Microsoft’s 27% surge and Amazon’s 16% gain, and the Nasdaq 100 jumping 10%. Meanwhile, the SOX is up 9.8% in August, recovering part of its July drop.
“We still think that AI and tech is the dominant theme of this bull market,” said Keith Lerner, chief investment officer and market strategist at Truist Advisory Services. “Our view is what happened over the last couple of months before this rebound was a healthy reset.”
While rates represent a risk, that’s balanced by the tech giants’ strong earnings and healthy balance sheets with plenty of room to take on debt, Lerner said. But he cautioned that this could change if rates rapidly rise.
In some cases, the spending is so extreme that it’s wiping out the cash generated from the companies’ operations. Alphabet reported negative free cash flow in the second quarter for the first time as a public company, and it’s expected to stay that way through 2028, according to the average of analyst estimates compiled by Bloomberg. Amazon, meanwhile, is projected to have negative free cash flow of $23.5 billion this year and $36.2 billion next year.
That’s forcing the companies to raise debt to make up for the shortfall. Amazon had total debt of $242 billion as of June 30, up from $147.8 million at the end of 2024. Alphabet’s debt totaled $118.7 billion at the end of June, up from $25.7 billion at the close of 2024.
Of course, none of this is eating into the companies’ fundamentals, with second-quarter profits for S&P 500 members on pace to expand 32% from the same period last year, compared with expectations for growth of 23% at the start of earnings season, according to data compiled by Bloomberg Intelligence. The expansion is being led by companies exposed to the AI buildout. The S&P 500 information technology sector, which includes chipmakers such as Nvidia Corp. and Broadcom Inc., is on pace to report 71% profit growth for the second quarter, accounting for about a third of the entire benchmark’s earnings per share.
The second quarter has been “one of the strongest earnings periods I’ve seen in my 20-year career in finance,” said Paul Eitelman, global chief investment strategist at Russell Investments, which has $418 billion in assets. “We’re seeing really strong aggregate earnings growth, and more visibility into the ROI of hyperscaler capex. That positivity is helping propel the sector forward despite the rate volatility we’re seeing at the same time.”
With interest rates an increasingly touchy issue, some companies are selling stock to secure funding. Last week, Intel Corp. raised $20 billion in an upsized share offering, a third more than it was initially targeting. That followed Alphabet’s $85 billion offering in June.
So far, shareholders have been willing to stomach the dilution based on reassurances from management that the investments will result in big payoffs down the road. But there’s a limit to how much they’re willing to accept without bigger payoffs.
Rising interest rates have a long history of wreaking havoc on the stock market. The last Fed hiking cycle started in 2022, with the central bank increasing the fed funds rate from a little over 0% to roughly 4.5% from March to December of that year to calm runaway inflation. The S&P 500 dropped nearly 20% in 2022 as earnings growth also slowed, while the Nasdaq 100 tumbled 33%, its worst year since the 2008 financial crisis. Meta, Nvidia, Netflix Inc. and Tesla Inc. all lost more than half their value.
While few investors are predicting a similar decline now, the interplay between rates and stocks is crucial, with money from AI investments representing a bonanza for companies that make products powering the technology, from semiconductor makers to energy producers.
There’s still plenty of skepticism about how much longer the spending can last. But it isn’t expected to drop off any time soon. And that makes investors confident the rally can continue even if rates push higher.
“We’re still in a place where earnings and the economy are strong enough to offset a higher rate environment,” said Domini’s Llerena. “Having the 10-year at 5% would be a challenge, but so long as the information we get remains positive, it is a challenge we can meet.”
