For years, the AI boom has run on the assumption that capital would always be readily available, whether through cheap debt, bottomless private credit or an IPO window to cash out and raise billions more.

However, as the realities of the AI race grow clearer, that assumption is being stress-tested across all funding sources.

As the AI companies’ off-balance sheet hidden debt surpasses the net exposure in the credit-default-swap market prior to 2008, investors must ask: At what point does “smart” money stop throwing capital at a cash-burning endeavor?

If the answer is anytime in the foreseeable future, investors must prepare for the consequences of no fresh capital to continue the AI spend.

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The Downside Risk: A 20% Hit To The S&P 500

If AI liquidity dries up — and there are clear signs it is — I see large, 20% downside risk in the S&P 500, with most of that concentrated in the valuation of AI-related stocks.

How do I quantify the risk?

I start with the $1.4 trillion of hidden earnings expectations (detailed in The New Constructs Most Wanted List: Worst AI Earnings Manipulators). I assume AI companies meet 50% of that expectation, or $700 billion. I multiply that by the S&P 500’s forward P/E of 21x to get $14.7 trillion, or the value of those lost hidden earnings expectations. That’s roughly 21% of the S&P 500’s aggregate market cap and about 45% of the market cap of the 15 largest AI companies. If economic returns on AI spending end up higher, the downside is lower — and vice versa.

Why Washington Won’t Bail Out AI

Unlike the Great Financial Crisis and the COVID crisis, a government bailout is not a solution. The U.S. government has largely maxed out what it can spend, as evidenced by the recent Treasury selloff. Even if the government were in good standing with bond investors, I don’t think it would have the means to fill a $700 billion to $1.4 trillion hole in unfulfilled AI earnings.

Mounting Warning Signs That Liquidity Is Retreating

In hindsight, it’s easy to pinpoint the moment a major liquidity squeeze begins. Predicting that moment in real-time is much more difficult. I’m not here to predict exactly when the market pulls the plug, but I am seeing enough small liquidity squeezes emerging across the market to believe the liquidity tide has turned and is starting to go out. It will not be long before, as Warren Buffet says, we see who’s wearing a bathing suit. In the meantime, I think the risk over reward of the AI trade has shifted, and investors might take profits now.

Warning Sign 1: IPOs Are Stalling Out

The clearest sign of tightening liquidity is also the most public facing. AI and AI related companies are delaying their IPOs due to investors balking at lofty valuations. Private market AI investors are........

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