Why This AI Bubble Won’t Pop Just Yet
- There is an important and meaningful difference between the current AI capex boom and the Tech bubble from 25 years ago. That being that the current AI spending boom is largely funded by internal cash flows as opposed to external (debt) financing.
- However, we do know that commitments to AI capex are increasing. As these commitments increase, it will be harder for today’s generation of tech firms to continue to finance them from their current operating cash flows – meaning more debt financed spending.
- For now, we’re going to continue to lean into the AI capex cycle. We’re still expecting another quarter or two of strong growth here while favourable tax treatments (courtesy of theOne Big Beautiful Bill Act) should continue to provide a strong tailwind.
Funds in focus
- BMO MSCI USA High Quality Index ETF (Ticker: ZUQ)
- BMO Covered Call Technology ETF (Ticker: ZWT)
- BMO SPDR Technology Select Sector Index ETF (Ticker: ZXLK)
There are a lot of parallels being drawn between the current AI boom and the Tech bubble at the turn of the century. The concern appears to be with the degree by which both the markets and the U.S. economy are reliant on AI-related capital expenditures. Indeed, if the outcome for this AI boom is the same as the Tech bubble, then conventional wisdom would be that we are likely to see a pronounced shock when the AI“bubble” finally does burst.
However, there is an important and meaningful difference between the current AI capex boom and the Tech bubble from 25 years ago.
For the latter, the top tech firms were investing heavily in infrastructure (mostly fibre-optic networks, servers, software and IT systems), but most of that capital expenditure was speculative in nature. A lot of the firms didn’t have the earnings to support the large-scale spending – which meant relying heavily on equity (IPOs) and debt financing to fuel capex. What this meant was that when the Tech bubble did burst, overcapacity in infrastructure led to massive write-downs of assets. But you can’t write down debt on the liability side of the balance sheet, which meant that creditors were left holding the bag and the path to systemic risks was wide open.
Fast forward to today, and it does feel like the current generation of tech firms have understood the lessons from the past. For example, the Mag 7 and Oracle are estimated to have spent over US$180bln on AI-related capex in H1 of this year – with total spending expected to reach over $300bln in 2025. Despite that, the free cash flow for the big spenders (which is cash flow from operations minus capex) was positive – suggesting that much of the spending has been funded by internal operations instead of external financing. This is good news (see Chart 1).
Chart 1 – Free cash flow for the Mag 7 + Oracle, H1 2025
However, we do know that commitments to AI capex are increasing. And as these commitments increase, it will be harder for today’s generation of tech firms to continue to finance them from their current operating cash flows. An easy way to see this is from the capex/EBITDA ratio, which gives us a sense of just how much of a company’s earnings (before interest, taxes, depreciation, and amortization) are reinvested back into capital assets – including AI. The higher the ratio, the more likely it is that firms will run into cash flow pressures, which implies that they’ll need to look at external financing (debt) to maintain the same pace of capital expenditures. From Chart 2, we can see that this ratio has been rising for the Mag 7 (plus Oracle) over time.
Chart 2 – Capex/EBITDA ratio is rising
Naturally, an increase in debt financing will bring some complications, including additional scrutiny on capex rates of return. If those rates don’t clear important hurdle rates, then the risk is firms will dial back on AI spending – which is something that (as we’ve covered in prior reports) the markets are not pricing in just yet.
However, for now, we’re going to continue to lean into the AI capex cycle. We’re still expecting another quarter or two of strong growth while favourable tax treatments (courtesy of the‘One Big Beautiful Bill Act’) should continue to provide a strong tailwind.
We’ll continue to play this theme via ZUQ (which contains a fair bit of tech exposure) for now. Within our tactical portfolio, we continue to see value in holding ZWT. Investors seeking a pure-play exposure to the U.S. Technology sector can also consider ZXLK.
Performance (%)
Year-to-date |
1-month |
3-month |
6- month |
1-year |
3-year |
5-year |
10-year |
Since inception |
|
7.69 |
4.70 |
8.36 |
10.91 |
13.61 |
26.95 |
15.83 |
16.21 |
16.52 |
|
15.44 |
6.84 |
11.82 |
29.23 |
31.41 |
42.87 |
- |
- |
20.91 |
|
Returns are not available as there is less than one year’s performance data. |
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Bloomberg, BMO Global Asset Management, as of September 30, 2025. Inception date for ZUQ = November 5, 2014, ZWT = January 20, 2021, ZXLK = February 4, 2025.
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