While Wall Street is focusing on Microsoft's and Alphabet's financial reports this week, the credit derivatives market has already issued warning signals: the credit default swap prices for both tech giants have set new historical records, revealing investors' deep concerns about whether the massive capital expenditures of AI can be translated into actual returns.

According to Bloomberg, the price of the Alphabet five-year credit default swap ( CDS ) hit a record high last Friday, with a monthly increase of 16% in October; Microsoft's five-year CDS also set a new record on the same day, with a nearly 9% increase in October, and is expected to see its fifth consecutive month of growth, which could become the longest consecutive increase on record. This signal indicates that even for the super-large technology companies regarded as safe havens in the market, their credit risk premiums are quietly rising.

Both companies will announce their quarterly results after the close of U.S. markets on Wednesday. Analysts and investors will be focusing on the growth rate of their cloud computing businesses, which is generally regarded as a barometer of demand for AI, as well as whether capital expenditures will generate sufficient cash flow returns. After last week's financial report, Meta's stock price tumbled 7% in a single day due to an increase in future spending plans, sounding an alarm for the market.

Stock price divergence: Microsoft leads the way, Alphabet lags behind

Since the last financial reporting season, the stock price trends of the two companies have clearly diverged, reflecting the market's different assessments of the investment return paths for their respective AI.

Since the release of its financial report on July 29, Microsoft's stock price has risen by 36% in total. At that time, the company announced its fastest growth rate in cloud business in four years, and its stock price soared by 16% in a single day, setting the largest one-day increase since 2008.

Alphabet, on the other hand, moved in the opposite direction. Since the release of its financial report on July 22nd, its stock price has fallen by a cumulative 6.3%. The quarterly financial report showed that due to a significant increase in capital expenditures, the company's free cash flow turned negative, and the market responded tepidly to this.

Judging from their performance since the beginning of the year, both companies have underperformed the market: Microsoft has risen by 9.9%, while Alphabet has only increased by 2.4%. In contrast, the S&P 500 index has risen by 13% during the same period, and the Nasdaq 100 index has even increased by 17%.

Catalyst Dynamic Alpha Fund Portfolio Manager Luke O said: 'In the current market environment, companies that can demonstrate to their shareholders their ability to generate cash have the upper hand over those that cannot. This is precisely why Microsoft has performed better than other large-scale cloud providers in the past few months – it has shown its ability to maintain a balance between spending and returns.'

Free cash flow in distress: AI expenses erode financial space

The scale of capital expenditures of these two companies has begun to exert substantial pressure on their free cash flows, and this is precisely what the credit market is alert to.

According to Bloomberg Consensus forecasts, Alphabet's capital expenditure is expected to more than double this year from $91 billion last year to $202 billion. As a result, the company expects its free cash flow to be negative by $3.6 billion in 2026, and to further deteriorate to negative $30 billion in 2027, before it is expected to turn positive again in 2028. In contrast, in 2025, Alphabet's free cash flow was as high as $73 billion.

Microsoft's situation is relatively controllable, but still not optimistic. Analysts expect that Microsoft's capital expenditures for the fiscal year 2027 will exceed $190 billion, an increase of about 65% from last year's $116 billion. Its free cash flow is expected to decline from $67 billion last year to less than $32 billion in fiscal year 2027, and then gradually recover—about $47 billion in fiscal year 2028 and about $87 billion in fiscal year 2029.

Telos Wealth Advisors, the Director of Portfolio Management, stated that he is not concerned about Alphabet's negative free cash flow: "If it wishes to do so, it can cut expenditures anywhere at any time, and the cash flow will immediately return." He regards such large-cap technology companies as safe-haven assets with sustained growth resilience in the market.

Cloud growth rate becomes key: The market awaits the AI realization signal

Against the backdrop of high capital expenditures, whether the growth rate of cloud services can accelerate has become a key indicator for investors to determine whether investing in AI is worthwhile.

According to Bloomberg Consensus forecasts, Microsoft's cloud business is expected to achieve a 45% growth rate this quarter when calculated using a fixed exchange rate. Analyst Derrick Wood pointed out in a research report on October 14th that third-party data indicates that the cloud business performed "most strongly in history" this quarter, with a possibility of "exceeding expectations above normal levels."

Alphabet's subsidiary, Google Cloud, is expected to generate revenue of approximately $29 billion this quarter, representing a year-on-year increase of 91%, which is a further acceleration from the 81% growth rate of the previous quarter.

Parrish Capital Chief Investment Officer Ted Parrish stated that he holds Microsoft stocks and plans to increase his position: "If we can see a further acceleration in the growth of cloud services, it will greatly enhance investors' confidence in investing in AI."

Sheehan indicates that the realization path of AI is gradually becoming clear: 'We are starting to see marginal returns, although this is not yet sufficient to alleviate their balance sheet pressures.'

It is worth noting that the IPO file submitted this week by Anthropic further confirms AI's high dependence on cloud giants – Anthropic has pledged to spend at least $114 billion with Google and approximately $45 billion with Microsoft over the next few years, regardless of whether the relevant computing power is actually utilized or not.

ROI Doubts dominate the pricing logic

The divergence between CDS prices and stock prices reveals a subtle market reality: while the equity market is still digesting disagreements, the credit market has already begun to price in tail risks.

Luke O ' Neill stated bluntly: "The current market's panic sentiment is clearly in a state of high alert, and the core issue lies in the ratio of expenditures to return on investment." He believes that Microsoft has gained favor in the market because it demonstrates a commitment to capital discipline.

If both companies fail to meet market expectations in terms of cloud growth rates or fail to effectively demonstrate that their expenditures are generating returns, their stock prices will face downward pressure similar to that of Meta. Although Meta reported several positive trends in its financial report last week, it immediately announced an increase in its future expenditure commitments by $125 billion to $825 billion, and the following day, its stock price fell by 7%.

For investors, the core issue of this earnings season is no longer growth itself, but whether that growth can be converted into cash fast enough. As the AI arms race continues to intensify, the answer to this question will determine how the market will reprice these two tech giants.