AI Fear Grips Wall Street as a New Stock Market Reality Sets In

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The developments added to angst fueled by a set of disappointing earnings reports from software makers late last month. The biggest was Microsoft Corp., which lost $357 billion of market value in a single day after slowing revenue growth in its cloud-computing business fanned anxieties about heavy spending on AI. ServiceNow Inc. sank 10% and SAP SE tumbled 15% following similarly lackluster results. 

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“It was the stalwarts that failed us,” said Jackson Ader, a software analyst at KeyBanc. “If your results and your guidance aren’t up to snuff, it’s kind of like: What confidence should we have for the rest of the sector?”

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While plenty of new names were bruised last week, few have been punished to the extent of traditional software makers, which have been under pressure since last year. Salesforce, which owns the popular team collaboration service Slack, is down 48% from a record high in December 2024. ServiceNow, which makes software for human resources and information technology operations, has dropped 57% since hitting a peak in January 2025. 

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“I suspect some companies will endure, embrace AI, and prosper, but others will see permanent disruption to their business models or prospects,” said Jim Awad, senior managing director at Clearstead Advisors. “It is very hard to know which is which right now.”

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That fear has investors running for the exits. Software is by far the most net-sold group among all sectors since the start of the year, according to Goldman’s prime brokerage desk data. Hedge funds’ net exposure to software hit a record low of less than 3% as of Feb 3, down from a peak of 18% in 2023.

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However, there’s little fundamental evidence of deterioration. In fact, in the eyes of Wall Street analysts, the outlook for profits is improving. Earnings for software and services companies in the S&P 500 are projected to rise 19% in 2026, up from projections for 16% growth a few months ago, according to data compiled by Bloomberg Intelligence.

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“Everyone is assuming the bottom is going to fall out, in terms of operating metrics. I’m skeptical about that,” said Michael Mullaney, director of global market research at Boston Partners. “It could end up that profits and margins are fine, even if there is disruption. If I were a growth manager, I’d be buying the dip.”

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The relentless selling has pushed software stocks deep into territory where technical-minded traders typically expect a rebound. The 14-day relative strength index on the iShares ETF hit 15 on Thursday, the lowest level in almost 15 years, and is around 24 now. Anything below 30 is considered oversold.  

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Meanwhile, valuations keep getting cheaper. A basket of software stocks tracked by Goldman Sachs sank to a record low of 21 times estimated profits, down from a peak of more than 100 in late 2021, according to data compiled by Bloomberg. Salesforce is trading at 14 times profit expected over the next 12 months, compared with an average of 46 over the past decade.

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“We continue to test the valuation floor and then blow right through it,” KeyBanc’s Ader said. “People are gun-shy and skittish to say that these stocks are too cheap, because based on historical multiples you could have made that argument at every point for many many months now, and it wouldn’t have helped you one bit.”

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—With assistance from Natalia Kniazhevich.

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