Why did CoreWeave get crushed this week? Look to this corner of the debt market
Mounting fears that CoreWeave’s debt stress may signal a broader problem with the insatiable borrowing-driven artificial intelligence infrastructure build-out slammed tech stocks this week. The Nasdaq logged a weekly loss of 4.5%. CoreWeave stock plunged nearly 12% on Friday. Shares of the neocloud declined every day except Thursday, losing a quarter of their value since last Friday’s close. Perhaps even more concerning than the stock rout has been the jump in CoreWeave corporate bond yields and spike in credit default swaps, a kind of insurance policy on debt. Corporate credit quality is getting a lot of attention these days, as funding costs increase due to above-target inflation that just won’t quit and investor worries about the level of financial commitment being made by companies that don’t want to be left behind in the AI race. We’re obviously stock-focused investors around here, but in this wobbly moment for the AI trade, we cannot ignore what’s happening in the corporate bond market. Credit default swaps help us get a more complete understanding. If they sound familiar, it may be because you’ve seen the movie “The Big Short,” which focuses on the 2008 financial crisis. Hedge-fund manager Michael Burry, portrayed by Christian Bale, used credit default swaps as part of his bet against the U.S. housing industry. This week, the yield on a CoreWeave 2031 bond almost reached 16%. Friday, the yield stood around 14.5%. The instrument was issued in April at a 9.75% yield. At the same time, five-year CoreWeave CDS exceeded 1,000 basis points, up nearly 19% this week and 178% higher than they were 12 months ago. The CDS trading action puts the implied odds of a CoreWeave default within the next five years at around 60%, according to Bloomberg. The holder of debt can buy credit default swaps to protect against any losses resulting from issuer default. Like insurance, the amount paid is tied to the value and quality of the insured asset. To be sure, yields on a debt instrument are tied to the risk of default — when the risk goes up, so does the interest rate. Other factors also matter when it comes to the yield investors demand, such as inflation expectations, liquidity premiums, and the risk-free rate — usually measured by the 10-year Treasury yield , currently nearly 5.1%. A credit default swap, however, only reflects credit risk and none of those other aforementioned sentiment factors. As a result, a CDS can provide a more transparent picture of how investors actually feel about the debt issuer itself. For example, if an investor owns $1 million in debt issued by XYZ Corporation and wants to insure it, they could purchase a CDS. If the quote is 100 basis points, they would pay a premium of $10,000 (on an annual basis) to protect against default. An investor does not need to own the debt to buy a CDS — credit default swaps can also be bought and sold as ways to speculate on improvement or deterioration of a given company’s credit quality. Apply that to CoreWeave CDS over at 1,000 basis points, and the cost to insure $1 million of CoreWeave debt goes above $100,000. So, why, as stock investors, do we care about insurance rates tied to the bond market? If we think of the things in our everyday lives that require insurance, it starts to make more sense. When you look to insure a home, or car, or anything for that matter, the premium you pay is based on two key factors: (1) the value of the item to be insured, which dictates the max payout in the event of a total loss; and (2) how risky it is to insure, factoring in the odds of the policy ever being triggered and the expected payout (as any residual value can offset the amount the insurer is ultimately on the hook for). It’s that second point that we as stock investors care about. If the perceived risk of default increases, then that pushes up the quoted price for the CDS. The quoted price therefore acts as an easy-to-watch, real-time, quantifiable proxy for that risk. Obviously, the risk of default is something that should concern all stakeholders because equity value will generally be demolished long before any default actually happens. Those worries about debt risk are what’s driving the CoreWeave situation. The stock is getting obliterated even though an actual default might never happen. And, according to Nvidia CEO Jensen Huang on Thursday, CoreWeave’s financial position is stable and “improving every day.” Huang’s comments, which were made to Bloomberg at an event in Stockholm, were credited with reversing Thursday’s earlier losses in CoreWeave and leading the stock to a higher close. Club name Nvidia is a big CoreWeave shareholder, and CoreWeave uses Nvidia chips to provide its clients with AI compute. Huang said Nvidia does not need to backstop CoreWeave because “their cost of capital is actually decreasing.” Remember, risk and reward are tied at the hip. CDS rates, or more importantly, the move in the rate, can provide stock investors with a quick way to see what bond investors think. It’s not an official credit quality rating, like those issued by S & P Global, Moody’s, or Fitch. But what they lack in prominence, they make up for in pricing frequency, which can be far more useful to stock investors like us trying to better understand the market overall, as well as the price action of individual securities. Going back to the housing example, say you’re considering a home on the beach but are concerned about the risk that a natural disaster can come in and damage or destroy the home. You could look to the listing price (think of this like the stock price) and try to figure out risk based on the pricing dynamics (is the house selling for more or less than it last sold, has it been sitting on the market a long time, have the sellers lowered the price to try and increase demand), or you can look into what has happened to the insurance rate on the property. The seller wants to get as much as they can. The insurer, on the other hand, is concerned with the risks posed to the property going forward, something the seller does not care about once it’s out of their name. Bottom line So, as the AI trade plays out, be sure to watch trading in credit default swaps. It can get complicated, but from the perspective of stock investors, don’t let that scare you and don’t overthink it too much. Just remember that, just like insurance premiums, the movement in the CDS market can indicate whether perceived default risk is rising or falling, whether it is increasing or decreasing. While we don’t think the rates on our names are anywhere near concerning at the moment, even as they are higher due to funding initiatives, where they go from here likely will determine the price action on the equity side. (See here for a full list of the stocks in Jim Cramer’s Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. 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