Why did US technology stocks suddenly crash?

Tech stocks, which have been unstoppable until recently, suddenly collapsed.

In overnight trading, the Nasdaq index fell below the 21-day moving average for the first time since early May, with the 50-day moving average support near 18,200 points, showing signs of technical fatigue. The market's fear-driven buying of AI abruptly stopped, with the semiconductor industry ETF SOXX falling more than 3% intraday.

So, what exactly happened to cause such a sudden and drastic reversal in market sentiment?

Peter Callahan, a TMT industry expert at Goldman Sachs, shared his views on the tech stock crash overnight, highlighting two key words - profit margins and software.

Callahan mentioned that although tech giants like NVIDIA have seen rapid revenue growth, the massive cost of investing in AI has raised concerns in the market about the profitability and valuation rationality of tech stocks.

The weakness in software stocks this year may also reflect investors' concerns about AI. The software industry is facing its worst earnings season ever, with former stars like Salesforce facing severe challenges of slowing growth. Goldman Sachs believes that the software industry is still far from recovery.

Who Will Foot the Bill for NVIDIA's High Gross Margin?

Callahan stated that after last week's earnings release, there is increasing evidence that companies are shifting their focus from cost savings in 2023 to investments in 2024.

The main driver of this shift is NVIDIA's expectation of achieving $150-200 billion in revenue in the coming years, with gross margins as high as 75-80%.

The question is, who will foot the bill for NVIDIA's high gross margins?

Goldman Sachs points out that while most investors see increased AI investment as a positive, the market may demand higher returns on these investments, hoping to see clearer prospects for profitability in the AI field.

However, recent earnings reports have released many signals unfavorable to profitability:

Snowflake lowered its full-year free cash flow and operating margin guidance, citing increased GPU costs and rising R&D and personnel costs.

Microsoft expects its operating margin for the 2025 fiscal year to decline by about 1 percentage point year-on-year, mainly due to investments in cloud computing and AI, as well as the impact of the acquisition of Activision Blizzard

Super Micro Computer expects a quarter-on-quarter decrease in gross margin in the second quarter, as the company focuses on driving strategic market share growth.

Dell has lowered its full-year gross margin guidance by 1.5 percentage points due to "inflation cost pressures, competitive environment, and a higher proportion of AI-optimized servers."

Chip manufacturer Marvell's guidance also indicates soft gross margins in the second half of the year, with the company stating that custom chip project orders (which typically have lower gross margins) have seen significant growth.

The significant cost investment in AI has raised concerns in the market about the profitability and valuation rationality of tech stocks.

What Does the Collapse of Software Stocks Across the Board Mean?

Returning to Thursday, the collapse of US software stocks: the US software sector saw its largest single-day decline in nearly 2 years, Salesforce stock had its worst performance in over 20 years, and Goldman Sachs' growth software basket has entered the "oversold" territory.

Callahan believes that investor sentiment towards software stocks has collapsed, leading to a "better safe than sorry" attitude towards related stocks, such as cloud computing service management software company ServiceNow and cloud security software company CrowdStrike, which experienced significant declines despite strong financial performance.

Weak financial reports from Salesforce and enterprise automation software company UiPath have exacerbated concerns about further slowdown in software spending in the first half of the year.

Callahan states that this may delay the recovery of the software industry, making it more difficult to achieve a recovery in the second half of 2023.

It is worth noting that the weakness in the software sector this year contrasts sharply with the strength in other tech sectors (such as public cloud), prompting three considerations about the underlying reasons:

First, the software industry is in the late stage of the economic cycle, so a slowdown during peak employment is normal.

Second, the weakness in the software sector remains a post-COVID-19 norm, especially considering the customer base of software companies.

Of particular note is the last point, where some believe that this weakness reflects the uncertainty in the AI field, leading to a shift of funds from software investments to other areas.

Goldman Sachs believes that in the current economic slowdown environment, investing in a long-term growth industry like software has become very challenging.

The economic slowdown, the complexity and uncertainty of AI, subtle differences in enterprise valuations, and high interest rate pressures have led many investors to temporarily reduce their exposure to the software industry and plan to refocus on this sector later in the year when the industry outlook becomes clearer.