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“A pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learns some very old lessons.”
— Warren Buffett
Markets were down this week, possibly because GPUs are starting to go dark.
In Oregon, for example, three of Amazon’s new data centers are sitting idle because the local utility company refuses to connect them to the power grid.
That leaves thousands of cutting-edge GPUs, likely costing hundreds of millions, sitting idle as well — aging in place without making any return on the giant investment they represent.
Microsoft is having the same problem.
Satya Nadella says the “biggest issue” that Microsoft is now facing in AI is “a bunch of chips sitting in inventory that I can’t plug in.”
“It’s not a supply issue of chips,” he adds. “It’s actually the fact that I don’t have warm shells to plug into.”
The “shells” Nadella’s referring to are data centers and they’re not warm because they’re not connected to a source of power.
There are many such cases.
“The infrastructure has now been outpaced by the construction of facilities,” Kristin Hammond of CBRE explains. “There’s no use to having the facility if you don’t have the power poles to service it.”
But we’re still constructing the facilities.
Spending on data centers is on pace to double this year vs. last, and the pipeline of proposed projects is growing even faster than that.
This might be starting to sound familiar.
For stock market investors, data centers going unused for want of power should evoke memories of 1999, when an estimated 97% of fiber optic cables that investors were frantically funding remained “dark,” or unused.
The analogy is not exact: It was a demand problem then, and it’s a supply problem now. But the end effect might rhyme to the effect of many billions of dollars of stranded infrastructure.
For credit investors, the current infrastructure frenzy is evoking memories of 2008.
Data centers are increasingly being funded with debt, often in special purpose vehicles that keep the debt off-balance sheets, and sometimes by selling asset-backed securities in various risk tranches to investors indifferent to the underlying assets.
Does that sound familiar? Here’s a refresher on credit markets from Margot Robbie, if not.
For one veteran investor, the data center boom is evoking 1999 and 2008 — and all the other ones, too.
“For the first time,” Paul Kedrosky says, “we’ve combined all the major ingredients of every historical bubble into a single bubble.”
Fun!
Kedrosky sees these ingredients as a compelling technology story, a speculative real estate boom, increasingly loose credit and a form of government backstop.
He sees this as a toxic brew for both markets and the economy: “The notion we can land this thing safely is nonsense.”
In short, the risk is that the current power shortage causing GPUs to go dark will cause data centers to build their own power plants — with borrowed money — in the out-of-the-way places where AI data centers are built, but hardly anyone lives.
These new power plants will become “stranded assets,” Kedrosky warns, when efficiency gains in AI training radically reduce the number of chips required: “We’re completely mis-forecasting arc of demand for compute.”
It’s the classic pattern: “The system is running at full throttle on forward expectations,” Kedrosky writes, “perceived shortage-now/glut-later is exactly how bubbles form.”
On the other hand, there’s no telling how long this process might take.
Kedrosky says it may be “four or five years” until the credit instruments underwriting the data center boom run into trouble.
Five years of booming markets in return for a bust?
I’d take that trade, for sure.
In the meantime, let’s check the charts.
We have big plans:
The number of announced plans to build data centers has exploded. But they’re increasingly hard and ever-more expensive to build. Perhaps more worryingly, the number of stalled projects is growing. What this chart will look like next year is probably the key to nearly all asset markets.
The plan for revenue:
If the data centers do get built, will we use them all? JPMorgan projects that “AI products would have to create an additional $650 billion a year, indefinitely, to give investors a reasonable 10% annual return” on their AI investments. The Raymond James forecasts above suggest we might fall well short of that.
Electricity prices:
People worry that data centers will raise the cost of electricity, but, per the above, that has not been the case so far — electricity prices have risen slower than inflation for years. There’s also evidence that data center demand might even lower electricity prices — likely because higher demand allows fixed costs to be spread over more customers.
It’s mostly a US story, for now:
The US continues to lead the world in data centers, with 4,189 vs. just 381 in China. Tellingly, in announcing its data center plans this week, Anthropic was careful to say it’s investing in “American AI infrastructure.”
Chinese exporters seem to be thriving without the US:
Torsten Slok notes that while China has exported $75 billion less to the US so far this year, it’s exported $150 billion more to Asia.
Worst US sentiment ever:
The University of Michigan’s November survey of consumer sentiment returned its lowest reading on record, going all the way back to 1960. And the bubble hasn’t even popped yet!
Bearish sentiment, bullish returns:
The best returns happen when people are most bearish.
You don’t have to be bullish on AI:
David Hay notes that stocks dropped from the S&P 500 (the black line above) outperformed the index by 5% a year in the 32 years from 1990 to 2022 — a cumulative excess return of 400%.
Do call it a comeback:
CSCO stock — left for dead in 2000 and long forgotten — is now 50% above its dotcom peak in total return (dividends reinvested).
A reminder that, if this bubble is soon over, there will be others to look forward to.
Have a great weekend, everything readers.
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