Wall Street's Software Stock Slump: AI Boom Shifts Investor Sentiment
Global Wall Street has dramatically cooled on software stocks, marking a significant shift in investment priorities. Once beloved by investors, software shares are now facing steep declines as artificial intelligence companies capture market attention and capital.
Steep Declines for Software Giants
Software heavyweights including Salesforce, Adobe, and ServiceNow have all fallen at least 30% since the beginning of last year. An S&P index tracking small and midsize software stocks has also dropped more than 20% during the same period, with losses accelerating recently following the introduction of Anthropic's Claude Code. This AI tool reportedly can dramatically reduce the time required to build complex software, raising concerns about the future of traditional software development.
The declines demonstrate how quickly market sentiment can change as money flows toward the next hot investment opportunity. At a time when many investors question whether the AI investment boom might itself be a bubble, software's struggles serve as a stark reminder of how rapidly fortunes can shift on Wall Street.
From Software Frenzy to AI Focus
Just a few years ago, software stood at the center of an investing frenzy, seemingly fulfilling Marc Andreessen's prediction that software would "eat the world." The sector's rise was fueled by high-speed internet expansion and cloud computing growth, where companies could rent storage from providers like Amazon rather than maintaining their own data centers.
Software startups proliferated to serve every imaginable niche, from helping yoga studios manage scheduling to securing businesses against cyberattacks. Wall Street came to view software as remarkably stable, believing businesses would be reluctant to switch products once integrated into their workflows. The emergence of multiyear subscription contracts providing steady revenue further attracted investors.
Software stocks soared, and the sector became central to a credit boom, with debt investors eagerly funding private-equity buyouts. The pandemic supercharged this dynamic through remote work adoption and lower interest rates that facilitated borrowing.
Changing Dynamics and Rising Defaults
Enthusiasm began waning with 2022's interest rate increases and the return to office work. For debt investors, software companies started appearing less invincible as competitive pressures and highly leveraged balance sheets pushed more businesses toward distress.
Before this decade, software defaults were practically unheard of, partly because lending to software companies remained relatively new. However, according to PitchBook LCD, thirteen software companies have defaulted on broadly syndicated loans over the past two years, including both traditional defaults like bankruptcies and out-of-court restructurings known as liability management exercises.
One such company was Quest, maker of OneLogin software for employee authentication. Purchased by Clearlake Capital in early 2022 with $3.6 billion in investor loans, the company benefited from remote work trends but struggled under debt weight and competition from larger publicly traded rivals like Okta, eventually restructuring its debt last June.
AI's Disruptive Threat
The emerging threat from artificial intelligence has intensified investor caution. The practice of "vibe coding"—using AI tools to rapidly produce apps and websites—has particularly rocked the software sector. Major risks include increased competition from new AI-powered entrants and businesses developing more software internally rather than paying specialists.
"The narrative has really shifted," observed Rishi Jaluria, a software analyst at RBC Capital Markets. Investors have moved from initially believing software companies could benefit from AI to questioning whether "AI is just the death of software."
Few analysts believe software companies will become obsolete in the foreseeable future. However, the more pressing risk involves difficulty increasing revenue as customers experiment with alternatives rather than paying for traditional updates and add-ons. Jaluria suggests AI could damage "fat, lazy incumbents" while helping innovative companies that effectively integrate AI into their products.
Investor Scrutiny Intensifies
Uncertainty about software's future is compounded by unanswered basic questions about the emerging AI industry's structure. While AI excitement has propelled stocks to recent records, with investors particularly eager to buy shares of AI hyperscalers like Alphabet and Microsoft, they've grown more discerning in recent months about which stocks to purchase even within this group.
Default rates for software loans remain lower than for buyout loans generally, and investors haven't abandoned the sector entirely. However, according to PitchBook LCD, the extra yield investors demand to hold software loans over benchmark short-term interest rates has increased over the past fifteen months, even as overall loan spreads edged lower.
"The investor base is definitely scrutinizing these software names much more closely," confirmed Vince Flanagan, a portfolio manager and senior leveraged-finance research analyst at Seix Investment Advisors.
Cautious Approach to AI Infrastructure
As companies borrow heavily to fund AI infrastructure development, debt investors have adopted a more cautious approach than they previously did with software companies. This has forced big-spending firms like Meta and Oracle to pay high interest rates on new bonds relative to their credit ratings.
"Investor sensitivity is high," noted Rich Gross, a senior fixed-income analyst at Columbia Threadneedle Investments. Investors are asking fundamental questions: "Are these investments sustainable? Are they going to be profitable? Are there going to be cash flows, or will there not be?"
Investors will gain valuable insight into the technology sector's overall state in the coming week, with Apple, Meta Platforms, and Microsoft scheduled to report earnings. The Federal Reserve will also meet, though it isn't expected to change interest rates.
The software sector's dramatic reversal illustrates Wall Street's fickle nature, where today's darling can quickly become tomorrow's laggard as new technologies emerge and investment priorities shift. As artificial intelligence continues its rapid ascent, software companies face the dual challenge of adapting to technological disruption while convincing increasingly skeptical investors of their continued relevance in an AI-dominated future.
