Are Software Stocks About to Become the Latest Victim of Wall Street’s AI Boom?

It’s no secret that AI has inspired excitement and fear at the sight of its whirlwind emergence on Wall Street. The high potential of automation technology has prompted many onlookers to question whether job security should be a leading concern in the US as more companies seek to adopt artificial intelligence. 

But it appears that AI is also set to retire the software sector, if recent market movements are to be believed. 

The beginning of February has seen many major stocks with software exposure suffer sharp losses, with the likes of analytics firm RELX (NYSE: RELX), Thompson Reuters (NASDAQ: TRI), and Blue Owl Capital (NYSE: OWL) posting double-digit declines, while Microsoft (NASDAQ: MSFT), Adobe (NASDAQ: ADBE), Salesforce (NYSE: CRM), and Ares Management (NYSE: ARES) also experienced strong losses. 

The losses were caused by the launch of a new tool from AI startup Anthropic, which was designed to automate legal work. This strong adverse reaction was prompted by a turnaround in perceptions of artificial intelligence as an innovation that poses a threat to software, where it was once identified as a tool that could coexist with the industry’s stocks. 

Fear surrounding the impact of AI on the software industry spread beyond pure-play stocks and towards asset managers like Blue Owl Capital and Ares Management, which are heavy investors in software. By Tuesday, February 10, the year-to-date returns for OWL and ARES were -16.2% and -18.5%, respectively. 

Are Software Stocks in Danger?

So, what do recent developments in AI mean for the future of software stocks? Is there really an existential threat to the industry as we know it? 

The emergence of Anthropic’s Cowork plug-ins, as well as Palantir’s SAP migrations, highlights that artificial intelligence could certainly impact application service revenues for IT firms. 

Jefferies analysts Akshat Agarwal and Ayush Bansal suggest that artificial intelligence could place more growth pressures on IT firms in a way that consensus growth estimates have failed to account for, meaning that there’s an increased level of downside risk for valuations. 

The analysts point to Claude Cowork as an example of a general-purpose work assistant that has the ability to organize tasks and files on an autonomous basis, forecasting that AI will be a drag on revenue growth for IT firms over the next one to two years. 

With data suggesting that 68% of US companies are already either currently using AI in some form or considering using it, there is certainly a danger that software firms are set to face new challenges in a market that’s increasingly swayed by artificial intelligence innovations. 

Shaking Off AI Concerns

Not all analysts share the same sense of alarm over the downturn in software stocks. Invesco chief global market strategist Brian Levitt labeled the sell-off as ‘overdone’ in an interview with Yahoo Finance. 

Levitt claimed that some of the industry’s biggest names have been caught up in the downturn, owing to concerns about the wider impact of AI programs and their ramifications for the sector. 

“Investors are right to be wary of short-term volatility among software stocks that are exposed to AI innovations,” said Vsevolod Smirnov, Head of Marketing at Just2Trade. “However, what we’re seeing is larger-cap software firms showing resilience in the face of disruption to underline their ability to adapt to disruption.” 

“Market leaders like Alphabet and Meta are all heavily exposed to the software market, both in terms of infrastructure and productivity software, and have already shown a high degree of adaptability this year in the face of challenges to the software industry by posting slight growth.”

It’s also important to recognize the role that AI could play in supporting growth within the software landscape, with sell-offs representing a knee-jerk reaction that fails to acknowledge how the technology can support more sophisticated tools, rather than destroy them. 

In a recent interview with CNBC, Box CEO Aaron Levie suggested that the widespread sell-offs fail to take into account how businesses would prefer to pay for products and services from a vendor specializing in back office software or customer relationship management (CRM) systems, rather than going it alone and taking on all the liabilities themselves. 

Time to Buy the Dip?

With Snowflake (NYSE: SNOW) falling 40% to recent lows of $168 as sentiment cools on software stocks, the stock’s price-to-sales ratio tumbled to an all-time low of 10. This suggests a degree of overselling. 

Although the scale of the AI boom is having an unpredictable impact on smaller-cap, pure-play software stocks, it’s certainly worth tracking the recovery of the companies affected by the recent sell-offs by adopting a more long-term mindset. 

Artificial intelligence may be the most disruptive innovation to hit Wall Street in decades; short-term fear could present fresh opportunities to investors with a higher risk appetite.