Key takeaways

  • Software stocks sold off dramatically after months of underperformance.
  • The losses stemmed from fresh fears that AI models could upend the industry.
  • Analysts say that while AI does pose a competitive threat to some software businesses, there are still opportunities in the sector.

A dramatic selloff in software stocks deepened on Wednesday, with some popular names seeing double-digit declines for the week. Losses were sparked in part by the Tuesday release of a new tool from artificial intelligence startup Anthropic designed to automate legal work. More broadly, the selloff was fueled by fears about the threat AI poses to software, which was once the darling of the tech sector.

Shares of legal and information services stocks like services provider Thompson Reuters TRI and analytics software RELX RELX fell sharply after Anthropic’s announcement, but so did other heavy hitters. Microsoft MSFT slumped 3.7%, Salesforce CRM fell 6.0%, and Adobe ADBE lost 4.6% over the week.

Even shares of asset managers that invest heavily in software were caught up in the action, with Blue Owl Capital’s OWL stock down more than 12% and shares of Ares Management ARES down more than 8% over the past three days. The Morningstar US Market Index was down 0.72% over the same period.

“There’s clearly a ‘Get me out’ element,” says Steve Sosnick, chief strategist at Interactive Brokers, who explains that this week’s action was likely driven by a combination of institutional selling and momentum-chasing retail investors. “Rather than looking strictly at the rewards that AI can offer, people are starting to look under the hood … and if you’re expecting this to be a disruptive technology, who’s getting disrupted?”

This week, that meant software was in the spotlight. “The entire industry is under pressure,” adds Dave Harrison Smith, chief investment officer and head of technology investing at Bailard.

Why are software stocks selling off?

Over the past few months, software has struggled, thanks to a persistent fear among investors that AI will upend the industry entirely, either by reducing licensing revenue and traditional business models or by rendering traditional applications totally obsolete.

That threat is present even if the capabilities of AI applications are still somewhat limited, says Bailard’s Smith. “You just look at the incredible pace of improvement from artificial intelligence, and it makes the competitive set in the future highly uncertain,” he explains. “Investors hate uncertainty.”

Zooming out even further, many on Wall Street have spent the last few months wondering whether the massive investments in AI by mega-cap technology firms and chipmakers will translate into profits and share price growth. Shares of those firms were caught up in the selloff too, with Nvidia NVDA down 9%, Broadcom AVGO down 7%, and Advanced Micro Devices AMD down an eyewatering 15% since the start of the week, even after earnings results that came in ahead of guidance.

Are there opportunities in software stocks?

Overall, however, the magnitude of the market’s moves this week leaves little room for nuance, according to Bailard’s Smith. “There is a clearly a sell-first reaction happening,” he says.

He points out that some software offerings remain core to operations across a wide swath of businesses, adding that he “doesn’t expect that to be challenged in the near- to intermediate term.” That could present an opportunity for investors, since some software companies with strong competitive advantages, sticky products, and attractive valuations now look like buying opportunities.

“Our opinion is that there are babies being thrown out with the bathwater,” Smith says, though he cautions that investors looking to time the bottom of the selloff may not be successful. “It’s hard to catch a falling knife,” he says.

Sosnick of Interactive Brokers adds that big secular market moves “often overshoot in both directions.” Investors may have been overly optimistic about the benefits of AI for certain firms, but they may also be overly pessimistic about its detriments.

Morningstar senior equity analyst Dan Romanoff says that software’s fundamentals still look good. “We acknowledge the risks, but we believe the fears are overblown,” he says.\

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