Software stocks lose steam as AI shifts investor bets

Software’s long streak as a Wall Street favorite is wobbling as artificial intelligence resets expectations.

Salesforce Inc., Adobe Inc., and ServiceNow Inc. are among the S&P 500’s weakest names this year, each down at least 16%, wiping out roughly $160 billion in combined market value. Investors pulled money from the software and services group for two consecutive months through June after just one monthly drawdown in the prior 18.

“Tech obsolescence can come out of nowhere,” said Robert Ruggirello, chief investment officer at Brave Eagle Wealth Management. “There’s good reason people are growing cautious.”

Not all software stocks are suffering 

Microsoft Corp., Oracle Corp., and Palantir Technologies Inc., all software makers, are among the year’s top performers in the S&P 500. What separates them, in many investors’ eyes, is that they are playing offense with AI rather than just defending existing franchises, as the largest tech companies spend tens of billions of dollars to roll out products and add capacity for AI computing. 

Meta Platforms Inc. is seeing accelerating revenue growth as its AI efforts improve ad targeting and user engagement. Palantir’s AI products are expected to help fuel sales growth of 45% this year. Cybersecurity names such as CrowdStrike Holdings Inc. have also thrived, backed by the view that AI cannot easily replace their core offerings.

The strain is not limited to the U.S. 

SAP SE, Europe’s biggest company by market value, fell alongside smaller peers such as Sage Group Plc and Dassault Systèmes SE after Monday.com’s warning. 

With OpenAI’s ChatGPT now boasting roughly 700 million weekly users, Ruggirello likens software vendors to “an energy company waking up and realizing there’s now a company the size of Exxon it’s competing with.”

That worry shows up in valuations. The Morgan Stanley software basket traded this month at 23 times projected earnings, half the average of the past decade and the lowest level in Bloomberg data back to 2014. By comparison, the Nasdaq 100 changes hands at just under 27 times forecast earnings.

Some on Wall Street see opportunity in the selloff. Strategists at UBS said earlier this month that the selloff in parts of software could open doors, recommending that investors look at internet and software firms that have lagged the AI craze. 

“While AI revenue growth has yet to match the industry’s aggressive spending, rising monetization and AI adoption trends have been encouraging,” strategists led by Ulrike Hoffmann-Burchardi, chief investment officer Americas and global head of equities, wrote in a note.

Even so, wariness is hard to miss. In the two decades before the 2021 market peak, no S&P 500 industry group lifted its weight as much as software and services, climbing from less than 6% to nearly 14.5%, even after Google, Facebook, and Amazon.com were moved to other sectors in 2018. 

The group’s share now sits around 12% and has been eclipsed by semiconductor companies benefiting from surging demand for computing hardware. If not for the outperformance of Microsoft, Oracle, and Palantir, the sector’s weight would be lower. 

“The perception is that risk has gotten much higher, and we’re not going to get clarity anytime soon,” Ruggirello said. “All we can really say right now is that a few companies like Meta and Microsoft seem to be winning, and they keep winning. It certainly isn’t everyone.”

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