With the Iran War In a Stalemate, Software Takes Center Stage

Two days after President Trump extended a ceasefire with Iran, the two countries remained at a stalemate over the Strait of Hormuz.

The U.S. continued to enforce a blockade it announced after the ceasefire agreement, while Iran is also blocking the waterway as the two countries are seemingly battling for control of the Strait. Oil prices rose on the ongoing shutdown as investors seem to be betting that the closure will endure.

Stocks fell, meanwhile, in part due to stalled progress in the conflict, but also due to a collapse in the software sector after ServiceNow (NYSE: NOW) and IBM (NYSE: IBM) both reported earnings last night. While the results were in line with estimates, investors still found reason for concern at a time when fears of AI disruption have swept the software sector this year, causing a massive sell-off.

As a result, the Nasdaq Composite led all three indexes lower, closing down 0.9%, while the S&P 500 fell 0.4%.

Image source: Getty Images.

The software sell-off continues

An ETF that tracks the software sector, the iShares Expanded Tech-Software Sector ETF (NYSEMKT: IGV) fell nearly 6% today, and is now down 22% year-to-date, though it's bounced off lows earlier this month and was up 20% from its bottom before today's plunge.

Though the numbers from ServiceNow and IBM were mostly fine, they didn't overcome broader concerns about AI disruption in the sector. Additionally, investors seemed underwhelmed with both companies' decisions to maintain their guidance for the full year, excluding ServiceNow's acquisition of cybersecurity firm Armis.

IBM cited uncertainty in the global economy stemming from the conflict in the Middle East for holding its guidance even after beating estimates on both the top and bottom lines, while ServiceNow said it rarely raises its full-year guidance after just one quarter.

ServiceNow touted that 50% of its net new business is coming from non-seat-based pricing, including tokens and connectors, showing it's diversifying away from its traditional business model, but that strategy seemed to weigh on its margins as its cost of revenues jumped 44% to $940 million, meaning gross profit rose just 16.1% to $2.83 billion, below the 22% revenue growth it reported. Even after adjustments, subscription gross margin fell from 84.5% to 81.5%, and it lost money on professional services.

If that pattern holds, ServiceNow's margins are likely to shrink further as the company appears to be sacrificing margin in order to maintain its revenue growth. IBM didn't experience the same headwinds as ServiceNow, though it makes less than half of its revenue from software.

What it means for investors

What was notable about today's software sell-off is that the reports from ServiceNow and IBM were enough to drive down the whole sector, even though they make up just a small fraction of the IGV ETF.

For now, it shows that despite the recent recovery in software stocks, investors remain skeptical and continue to buy into the AI disruption narrative, meaning that AI programs like Anthropic's Claude Code will take away business from enterprise software companies.

We'll learn more as earnings season goes on, but the bar will remain high for software stocks as long as that narrative remains.

Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends International Business Machines and ServiceNow. The Motley Fool has a disclosure policy.