The software and services industry's recent plunge has ignited fears that the artificial intelligence boom may be reshaping markets in unexpected ways, raising questions about whether a rotation out of technology stocks signals trouble ahead for the AI trade.
Financial markets, juiced for months with investor enthusiasm about the artificial intelligence trade, got a rude awakening last week as software stocks around the globe sank on worries that fast-advancing AI tools could upend the industry.
While a rebound in the broader market helped soothe nerves on Friday, the outlook for U.S. software stocks, at the epicenter of the selloff, remained murky. Despite a 2% rebound on Friday, options market participants remained on high alert for further pain.
The selloff, which crossed continents knocking stocks from Europe to Asia, was triggered by a new legal tool from Anthropic's Claude large language model that raised existential questions about traditional software business models.
Investors are questioning whether the earnings-compounding nature of software companies would get disrupted, with strategists noting a broader rotation into value and cyclical-oriented sectors such as consumer staples, energy and industrials.
Software and services stocks' underperformance against the S&P 500 has reached near-record proportions, with the sector lagging the benchmark by nearly 24 percentage points over the past three months, nearly the worst such gap in data going back three decades.
The downturn marks a stark reversal for the industry group that overall put up outsized gains for much of the post-pandemic era, when investors bet on digital transformation and cloud computing.
The current selloff rivals only a handful of periods since 1995, including the dot-com crash of 2000-2001, when the spread plunged below negative 25.
To be sure, historically, such extreme readings have sometimes preceded either capitulation selling or marked attractive entry points for contrarian investors, though the 2000-2001 period showed underperformance could persist for extended stretches
For now, the selloff has left many U.S. software stocks smarting from eye-watering losses since the S&P technology sector peaked in late October. Oracle (ORCL.N), opens new tab is the loss leader, having shed nearly 50%, from October 29 to February 5, while ServiceNow (NOW.N), opens new tab and AppLovin (APP.O), opens new tab each tumbled more than 40%.
Gartner (IT.N), opens new tab, Palantir (PLTR.O), opens new tab, Intuit (INTU.O), opens new tab, Datadog (DDOG.O), opens new tab, and Workday (WDAY.O), opens new tab were also swept away in the selloff.
The swoon in software stocks comes amid a broader market shift away from technology. The heavyweight tech sector (.SPLRCT), opens new tab has stumbled since its late-October peak, sinking some 10% over that time as of Friday morning trading. Other areas of the market have thrived over that period.
The energy (.SPNY), opens new tab, materials (.SPLRCM), opens new tab, consumer staples (.SPLRCS), opens new tab and industrials (.SPLRCI), opens new tab sectors all have climbed at least 10% over that time, during which eight of the 11 S&P 500 sectors have posted gains.
