Wall Street Analyst: Sharp Drop Overdone, US Tech Stocks Fall into "Golden Pit"

Market professionals are increasingly believing that the software stocks have been hit too hard in the past few weeks, and in the midst of excessive selling pressure, stocks that have seen steep drops in prices present new opportunities for buying at low prices. Strategists at JPMorgan Chase wrote in a report to clients on Tuesday that based on "overly pessimistic expectations for disruptive changes in artificial intelligence and solid fundamentals," there is potential for a rebound in the software market. Meanwhile, Goldman Sachs Group, Inc. CEO David Solomon said on Tuesday that he believes this sell-off is "too broad in scope." Janney Montgomery Scott's Chief Investment Strategist Mark Luschini said, "It seems people now think software prices will plummet in a straight line to zero. Such one-sided trading is so evident that a rebound could actually occur." These stocks are currently at historic lows. The S&P North American Software Index's forward price-to-earnings ratio fell below 20 times for the first time last week. The index is currently around 23 times, seeing some rebound in stocks but still far below its long-term average price-to-earnings ratio of 34 times. Jefferies Financial Group Inc. researched the 64 software stocks it covers and found that "42% of stocks are at or near their historic undervalued levels," according to an analyst report to clients led by Brent Thill on Sunday. Michael Toomey of Jefferies Financial Group Inc.'s equity trading department said, "I think software stocks are poised for a strong rebound." BTIG's technical traders also expressed a similar view in a report last week, writing that software stocks are "on the brink of collapse and should hit a tactical low here." The rebound appears to have begun. A widely watched ETF tracking the software industry fell 15% over eight consecutive trading days from January 26 to February 4, but has since rebounded by 7.2%. Vanda Research reported that retail investors in this ETF set a record for buying dips, describing it as "one of the most aggressive cases of retail buying the dips in tech stocks, especially software stocks, that we observed in our dataset." While uncertainty looms over the industry, the sell-off has been so severe that many companies that were expected to be long-term winners have also not been spared. The most commonly mentioned companies by market experts include: Microsoft Corporation (MSFT.US), Snowflake (SNOW.US), ServiceNow (NOW.US), Salesforce, Inc. (CRM.US), and Palantir Technologies (PLTR.US). Data analysis software company Snowflake saw its stock price drop 27% in just six trading days from January 29 to February 5. However, the company holds a favorable position in the AI ecosystem. Last week, Snowflake signed a multi-year partnership agreement worth $200 million with OpenAI and reached a similar agreement with Anthropic PBC in December last year. Thill wrote in a report to clients on February 5 that Snowflake is "one of the most obvious AI beneficiaries in all of public software." Institutions such as UBS Group AG, Loop Capital, Wedbush, Bank of America Corp, and DA Davidson have also highly praised Snowflake. Michael Mullaney, Global Market Research Director at Boston Partners, noted the weak performance of Salesforce, Inc., ServiceNow, and Workday Inc. If he were focusing on growth stocks rather than value stocks, he would buy these stocks on the dip. Datadog (DDOG.US) was also mentioned, with the company's stock surging 14% on Tuesday, marking its largest increase since November, after reporting strong performance and providing better-than-expected revenue outlook. The core reason for the low sentiment in the software market is the advent of artificial intelligence coding (i.e., using AI to write software code). If AI services provided by companies like Anthropic or OpenAI can replace existing software packages, it will exert enormous pressure on the revenue, profit margins, and pricing power of the companies being replaced. Recent sharp declines in the stock market were largely triggered by the release of a legal work automation tool by Anthropic, following which the company introduced a tool focused on financial research. Prior to this, an AI tool by Alphabet Inc. had also led to sharp declines in video game and mobile advertising stocks. So far, this disruptive change has been largely foreseeable, but its impact is yet to be quantified. Industry research forecasts that the earnings growth rate for the software and services subsector is expected to reach 14.1% by 2026. Although this growth rate is lower than the overall technology industry's expected growth rate of 31.7% (benefitting from the booming semiconductor industry), it is higher than the expected growth rate of 13.7% for the S&P 500 index. Software sales also show a similar trend. Luschini of Janney said, "There are many speculations about what could happen, but nothing has happened yet. The market is trying to reflect future risks in prices, but for now, these speculations seem more like speculation than reality." However, there are indeed some signs of concern among software skeptics. Monday.com (MNDY.US) saw its stock price drop by 21% earlier this week due to disappointing revenue expectations. S&P Global, Inc. (SPGI.US) also fell by 9.7% on Tuesday after issuing similarly disappointing performance outlook. But these cases are mostly isolated incidents. Data shows that, so far this earnings season, 10 software companies in the S&P 500 index that have reported earnings have exceeded expectations, with 8 of them exceeding revenue expectations. This ratio is higher than the overall level of the S&P 500 index, with an earnings beat rate of 81% and a revenue beat rate of 66%. Mullaney said that such performance proves that the current trend is not severe enough to make investors completely abandon the software industry. He said, "A slowdown in earnings alone cannot explain the magnitude of the stock price declines. However, I think concerns about AI disruption are a reasonable reason for profit-taking."