Concerns Over Software Stocks Deepen Amid AI Disruption
Wall Street’s attitude towards software stocks has shifted noticeably. What was once skepticism has spiraled into a more dire outlook, with investors hastily shedding shares across various sectors due to rising anxieties about the disruptions linked to artificial intelligence. This sentiment is sometimes referred to as the “surpocalypse” – a sort of apocalypse for software-as-a-service stocks. As noted by Jeffrey Fabza from Jefferies’ trading desk, the current vibe in trading is decidedly one of urgency, characterized by a “get rid of me” mentality.
On Tuesday, those fears were intensified when AI startup Anthropic introduced new productivity tools aimed at in-house counsel, causing a steep drop in stocks for legal software firms. The selling trend spread throughout the market, with the London Stock Exchange Group’s shares falling 13%, while Thomson Reuters dropped 16%. Other companies like CS Disco Inc. and Legalzoom.com saw declines of 12% and a staggering 20%, respectively.
These worries about the software sector have been simmering for months. The release of the Claude Cowork tool last January raised concerns about human augmentation’s potential disruption. Last week, video game stocks also suffered when Alphabet Inc. began its rollout of Project Genie, a tool allowing users to craft immersive environments using text and images. Continuing this trend, the S&P North American Software Index has seen declines for three consecutive weeks, dropping 15% in January – the largest monthly fall since late 2008.
As Favuzza points out, there seems to be a lack of conviction among clients about where the bottom truly is. Even with widespread selling, there’s a noticeable disinterest in pricing. It’s almost as though people are just anxious to offload their assets, regardless of market value.
Concerns are seeping into the private equity realm as well. Companies like Archmont Asset Management and Hayfin Capital Management are turning to consultants to scrutinize their portfolios for vulnerable investments. Apollo, for instance, has slashed its software exposure in direct lending from around 20% to nearly half by 2025.
Looking at the current earnings reports, only 67% of the software companies in the S&P 500 have exceeded anticipated revenues—a stark contrast to 83% of the broader tech sector. While indeed many software companies are generally beating earnings expectations, the long-term outlook feels clouded by the current atmosphere of uncertainty.
Take Microsoft, for example. It posted solid financial results last week, yet saw its stock fall 10% as investors expressed concerns over sluggish cloud revenue growth, heightening scrutiny of the company’s AI investments. January marked the worst month for Microsoft stock in over a decade. Likewise, earnings reports from ServiceNow Inc. and SAP SE only added to the growing caution regarding software firms’ future growth potential.
As of Tuesday, Microsoft’s stock fell an additional 2.9%, marking its fourth consecutive day of losses. In contrast, Palantir Technologies saw its stock price climb 6.9% following a positive sales forecast and a 70% increase in fourth-quarter sales, which surpassed expectations.
AI-related concerns are also prompting investment firms to become more cautious. Recently, Piper Sandler reduced ratings for companies like Adobe, Freshworks, and Vertex due to worries that the growing use of AI could compress market performance and heighten competition. Analyst Billy Fitzsimmons highlighted that new AI-driven coding methods may impose limits on market multiples.
Interestingly, some investors view the current dip in software stocks as a potential opportunity. The Psychomore Sustainable Tech Fund, having outperformed 99% of its peers over the past three years, opted to purchase Microsoft shares during this downturn, hoping for a rebound as the company adapts to the AI landscape.
This could possibly be seen as a buying opportunity: Microsoft is currently trading at a forward P/E ratio of under 23, marking its lowest level in nearly three years. Furthermore, technical indicators like the 14-day relative strength index suggest stocks may be oversold.
Jonathan Krinsky from BTIG remarked that the software sector appears to be “probably oversold enough to rebound.” Although he acknowledged that recovery may take time, especially considering the accelerated downturn observed in the previous quarter.
Investors face a challenging prospect: identifying which software companies will thrive amid the AI evolution, with some sure to continue growing. The sell-off makes these stocks appear like they are “on sale,” but it remains difficult to pinpoint which ones will emerge as winners.
Fabuzza encapsulated the uncertainty, suggesting that software might become akin to print media or department stores in terms of struggle. The prevailing rapid sell-off indicates there could be appealing investments available, yet the climate feels precarious. A glance at projections for 2026 and 2027 raises concerns; if even giants like Microsoft are facing challenges, more vulnerable firms may find themselves in an even tougher position.
