Former Fed President Bill Dudley Talks AI Bubble, Bond Yields

**SPEAKER_1** (0:02)
Bloomberg Audio Studios, Podcasts, Radio, News.

**Romaine Bostick** (0:07)
Former New York Fed President Bill Dudley, also a Bloomberg Opinion columnist, is out with a new column, and he's warning that the US equity market is in bubble territory. Dudley writes in this column, the tilt toward even higher yields and the diminishing impact of AI spending on the economy could mean that the bubble, as he sees it, may be set to pop in 2027 Pleased to say that Bill Dudley joins us right now to talk a little bit more about that.
Bill, I want to start off first with this idea of the bubble itself and sort of what the metrics you're using to, I guess, make that judgment call that this is indeed a bubble or bubble territory.

**Bill Dudley** (0:45)
Well, the first thing you see is just the equity market valuations are really stretched. If you look at the Schiller-K ratio, it's at 41, the all-time high was 44 in December 1999
The average over the last 25-30 years has been about 17
You look at the real equity risk premium, the excess return you get for holding equities compared to Treasury inflation protected securities, 1.1 percent, excess expected return, less than half the average we've seen since 2010 Look at the Buffett indicator, which is just the US market cap to GDP ratio, it's currently around 240 percent. Buffett said that the stock market was at a risky point when it was above 100 So we're at 240 percent. So the first thing is just to look at valuations. And then you think about what's actually happening in the cycle. There's a huge investment boom going on in artificial intelligence. And this year we're getting tremendous impetus to the economy from that. But the impetus in 2027 is almost certainly going to lessen because it's not the level of investment, it's the change in investment that matters. And the change in investment also matters for earnings growth of the suppliers to the AI hyperscalers. So I think that that's another thing that's going to start to win the market is that you're going to start to see slow down in the boom itself. And when the boom slows, that means profit growth expectations are going to come down.
And there's going to be downward pressure on profit margins. So just like you had a really great story on the way up, expanding profit margins, higher volume. On the way down, you'll have slowing volume growth and more constrained profit margins. And the last problem you have for the AI is just the fact that are the AI hyperscalers going to be able to generate the $2 trillion of revenue they need to justify their investment.

**Romaine Bostick** (2:30)
Yeah, well, absolutely. And we're going to get there in a second. But I do want to go back to the financing thing because, and we know obviously these levels can't sustain themselves, but then you talk to the CEOs of these companies or the analysts who cover them. And they all seem to think at least for the next two or three years, that we're going to continue to kind of see this type of spending. And there was a story that just crossed the wire before you came on on Broadcom helping to arrange a financing deal for 60, 70 billion dollars. It seems, I know it's not never ending, but when I hear, okay, 2027, that's around the corner. You don't think that some of these tens of billions, hundreds of billions of dollars that have already been announced and the idea that they keep raising their CapEx numbers, you don't think that that is going to continue much longer?

**Bill Dudley** (3:13)
Well, I think CapEx in 27 will be higher than 26, but the increase in CapEx in 27 will be smaller than the increase in 26
Also, if you look at the financing, it's much less by the hyperscalers doing it out of their own cash flows on their own balance sheets. So it's getting pretty incestuous as the suppliers are lending to hyperscalers and private equities, obviously, private credits doing their own piece. So you're also getting greater opacity in terms of how this is actually being funded.
The way it comes to an end, I think it's pretty simple. Profit margins, the whole thing starts to slow, profit margins start to be compressed, and then expectations of future profits get diminished. And the stock markets, the discounted present value of future earnings, and you start pushing down earnings expectations, that flows back to the stock price at present. Another issue that doesn't get a lot of attention is also the supply of equities is going to increase. We've had some really big IPOs this year, and the lockups on those IPOs are going to end. And so you're also going to have a greater floating supply of equities that has to be absorbed by the marketplace.