Software Stocks Plunge, Yet Wall Street Dismisses Fears and Continues to Buy the Dip

The panic over AI disruption has dealt a heavy blow to the software sector, but some Wall Street investors believe that market panic has surpassed actual fundamental changes, and the sharp valuation correction is creating buying opportunities.

The S&P North America Expanded Tech Software Index currently trades at a forward P/E of 21 times, down from 40 times in July last year and below its 10-year average of 34 times; valuations for Salesforce and Adobe are nearing historic lows; yet earnings expectations for software companies are being revised upward.

Software stocks staged a strong two-day rebound this week, with popular ETFs tracking the industry gaining a cumulative 6.4% over the two days. Emily Roland, Co-Chief Investment Strategist at Manulife John Hancock Investments, stated, "The view that AI will destroy all software companies is hard to accept; it is at least premature."

However, the path to buying the dip remains controversial. While some investors see this rebound as an ideal setup, others remain cautious about structural risks in the software sector. According to a previous Wallstreetcn article, Goldman Sachs believes that the strong rebound in U.S. software stocks was merely a short-covering rally triggered by oversold conditions, not an improvement in fundamentals.

Technical Rebound After Sharp Decline

This rebound occurred against a backdrop of continued weakness in software stocks. The iShares Expanded Tech-Software Sector ETF (Ticker: IGV), which tracks the software industry, closed on Friday at a new low since November 2023, with a year-to-date decline still reaching 24%.

Market technicals also showed certain support signals. Adam Turnquist, Chief Technical Strategist at LPL Financial, pointed out that the S&P North America Tech Software Index found support near the 1600 level; if it breaks above 1908 points, it would open the technical pattern space for a double-bottom breakout.

He simultaneously warned, "The software sector remains in a downtrend, and technical repair is not yet complete, but improvements in momentum and trading volume suggest selling pressure may be waning."

Notably, earlier Tuesday afternoon, the gain in software stocks narrowed significantly. The trigger was a report by The Information stating that Anthropic is preparing to launch an AI tool for website and presentation design. This news quickly touched upon the market's sensitive nerves regarding AI replacing software, reflecting the fragility of investor sentiment.

Valuation Compression Amid Improved Fundamental Outlook

The logic supporting buying the dip rests not only on technicals but also on a dramatic revaluation at the valuation level. The S&P North America Expanded Tech Software Index currently trades at a forward P/E of approximately 21 times, a significant contraction from nearly 40 times in July last year and well below its 10-year average of 34 times.

Valuations for some leading software stocks have reached historically low levels. Salesforce currently trades at a forward P/E of less than 13 times, compared to a 10-year average of 45 times; Adobe trades at a forward P/E below 10 times, down more than 60% from its 10-year average of 30 times, with both approaching historic lows.

At the same time, Wall Street analysts are revising up earnings expectations for the sector—according to Bloomberg Industry Research data, profit growth expectations for software and services companies for 2027 have risen from 15.7% at the end of February to 16.5%, while revenue expectations show a similar improving trend.

Jonathan Dane, Chief Investment Officer of Defiant Capital Group, which manages over $1 billion in family wealth, stated, "The fundamentals of the software sector are not without merit, but every individual stock has been tagged with the same disruptive narrative."

Persistent Divergence: How Deep Is the AI Threat?

The fundamental divergence between bulls and bears lies in the depth and speed of AI disruption.

Bulls argue that current market panic has surpassed actual fundamental changes, with sentiment driving pricing; bears worry that each iteration of AI capabilities could bring new shocks, making it difficult to assess the moats of software companies.

Brad Conger, Chief Investment Officer at Hirtle Callaghan & Co., stated plainly, "We prefer undervalued assets, and software stocks usually interest us. But the deeper we dig, the greater the uncertainty becomes; I am not interested in trying to find the bottom."

Brian Kersmanc, Portfolio Manager at GQG Partners, which manages approximately $162.5 billion in assets, described the current situation in the software industry as a "forest fire," saying, "Everyone must go through pain to reach the other side. There may now be some 'zombie software companies' in the market. This fire will clear away the brush, and only then will we see which trees are the strongest."

In his view, under the evolution of the AI bull cycle, winners and losers will eventually emerge—the question is simply one of time.