US software stocks have staged a sharp rebound recently, but Goldman Sachs argues that this is merely a technical short squeeze following oversold conditions, with fundamental headwinds still intact.
Over the past two trading sessions, the IGV Software ETF has rallied sharply from lows, lifting private credit-related stocks in tandem. Nelson Armbrust, a trader at Goldman Sachs, noted that he received "a high volume of inquiries regarding yesterday’s software rally." While the Goldman Sachs Software Tracked Index (GSTMTSFT) rose 5.07% in a single day, it remains down roughly 25% year-to-date.
Rich Privorotsky, head of Goldman Sachs Delta One, stated bluntly that the driver of this rebound is likely simple oversold mean reversion: the divergence of software stocks relative to hardware stocks "had become extremely extreme last week."
However, Goldman Sachs also warned that the AI-driven drag on long-term profit margins and returns across the software industry remains unaltered—a headwind to valuations that spans the broader market and is not unique to the software sector. At the same time, hedge fund positioning in software stocks is retesting historical lows, with short-selling pressure still dominating market structure.
Technical Rebound Sparked by Oversold Conditions
From a technical perspective, the rebound carries some pattern-based support. Goldman Sachs pointed out that the software sector still trades 30% to 35% below its November 2021 peak, and historical patterns over the past two years show that the sector typically sees a short-term bounce whenever declines reach this range.
The Relative Strength Index (RSI) of the Goldman Sachs Software Tracked Index shows the rebound emerged right at the edge of oversold territory. Nevertheless, the firm cautioned that the index fell into an even deeper oversold condition in early February this year, meaning the current technical signal carries limited predictive value.
Additionally, renewed market scrutiny of the "Mythos" technological breakthrough has provided some support to rebound sentiment. Privorotsky noted that growing skepticism has emerged over whether Mythos is truly as disruptive as initially advertised, with some investors questioning the credibility of the so-called "Mythos narrative."
Extreme Short Positioning Fuels Short-Squeeze Dynamics
Goldman Sachs’ core assessment is that this rally is essentially a short squeeze, rather than a trend reversal driven by improving fundamentals.
Data from Goldman Sachs Prime Brokerage indicate software positioning is retesting historical lows. Last week, the US information technology sector witnessed its largest dollar-denominated net selling in more than five years, standing 2.9 standard deviations below the average—the second most extreme reading in the past year, only behind September 2024. The selloff was heavily skewed toward shorting, with a short-to-long selling ratio of 3.3 to 1.
Within the sector, software accounted for roughly 60% of total net selling in IT, driven almost entirely by short positions. Software’s share of total US equity net exposure has plummeted from 7% at the start of the year to 1.4%, while the long-short ratio has dropped from 2.0 to 1.14—both hovering near historical lows last seen in late February.
AI Pressures Valuations; Fundamental Concerns Persist
Beyond technical factors, structural headwinds facing the software sector cannot be overlooked. Goldman Sachs highlighted intensifying debate over AI’s impact on terminal valuation multiples for software stocks: rapid AI evolution is clouding visibility into long-term profit margins and returns on capital for software firms, complicating valuation frameworks.
The firm emphasized that this challenge is not confined to software but represents a market-wide valuation paradigm shift. As AI reshapes business models, investors face a widened range of uncertainty when forecasting future cash flows for software companies, pushing risk premiums higher.
In sum, Goldman Sachs’ conclusion is unequivocal: this rebound is just another episode of forced short covering. Once there are insufficient remaining short positions to squeeze, the rally’s momentum will naturally fade.
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