If there is a bubble in AI investment, and that bubble bursts, the fallout would spread far beyond the tech sector, to financials and the broader economy, says Moody’s Ratings.
In a report released Thursday that examines the possible consequences of a sharp drop in market valuations for AI companies, the rating agency said that while it’s difficult to determine when a bubble exists, there are warning signs in the current environment.
“These include the strong enthusiasm behind the technology, rapid valuation increases — even among companies recording significant losses — and a degree of FOMO or ‘fear of missing out’ influencing investor behaviour,” it said.
The report also explores the possible impact of a bubble bursting — specifically, a theoretical 40% drop in valuations, similar to the bursting of the “dot-com” bubble in the early 2000s.
“In the event of a bubble burst, the equity valuation collapse would ripple across the tech ecosystem, hitting loss-making AI labs, well-established tech firms and ultimately the entire supply chain,” it said.
For the tech sector, the rating agency said that while the demand for AI services and computing power would continue to grow, investment funding would dry up, likely slowing the development of new models by private firms, such as OpenAI and Anthropic.
Diversified tech giants, such as Microsoft and Alphabet, would face more limited credit effects — and, they would be well positioned to acquire struggling AI startups on the cheap, it said.
For data centre owners and suppliers, long-term contracts with the tech giants and steady demand for AI “would soften the impact” of an investment bubble popping, it said. Semiconductor firms would also see earnings come under pressure.
Additionally, the fallout would spread well beyond the tech sector, most directly to the financial industry that has funded the investment bubble.
“Venture capital funds that had invested heavily in the AI industry and participated in funding rounds at increasingly elevated valuations, would be hit hard,” Moody’s said.
Another key source of AI funding — private credit “would also come under pressure” it said — with ripple effects that could spread to other segments of the financial industry, including pension funds, insurers and banks.
In recent years, pension funds have shifted toward passive investing, which has increased their exposure to the tech sector, the report noted. At the same time, many funds have increased their allocations to private markets in a search for higher returns — potentially increasing their exposure to dropping valuations in private markets too.
Banks would also be at risk through their massive lending to private credit lenders and funds, it said.
“An AI-driven downturn would also hurt investment banking and wealth management revenues. These are increasingly tied to the AI ecosystem through IPO underwriting, M&A advisory fees and wealth management fees associated with heightened equity valuations,” the report said, adding that they could be affected through their commercial real estate lending.
The utilities sector, which is investing heavily to support data centre construction, and commercial real estate would suffer from a bursting AI bubble as well, the report said.
More broadly, the effects would spread to other support services, such as law firms and consultants, and could reduce ad spending, hitting the media sector.
An equity downturn would also “dent household wealth, thereby reducing consumer spending,” Moody’s said. “Reduced consumption from high net-worth investors would weigh on sales of luxury goods, high-end real estate and discretionary travel, lowering the credit quality of firms in these sectors.”
Local governments would be affected too.
“Falling office valuations would shrink cities’ tax bases, and tech-exposed cities would experience a decline in credit quality, leading to higher borrowing costs,” it said.
While the report doesn’t aim to establish whether a bubble currently exists or not — if there is one, it said that various factors could trigger a drop in AI valuations.
“New evidence that companies are failing to translate AI adoption into meaningful productivity gains would likely raise concerns,” it said. “An earnings miss by an AI bellwether, tighter financial conditions, or a broader slowdown could also weigh on valuations, as bubbles often deflate when overall economic conditions deteriorate.”
Growing concerns about AI companies’ ability to generate cash flow could also trigger a downturn, it said. “Market participants are already concerned by the potential circularity of deals within the AI industry,” it noted.