After enduring months of persistent weakness and a historic valuation compression, the U.S. software sector experienced a strong rebound this week. The market is engaged in a fierce battle between the extreme pessimism of the "AI disrupts everything" narrative and the contrarian investment logic that fundamentals have been unfairly punished. The iShares Expanded Tech-Software Sector ETF (IGV.US), which tracks the software industry, rose 6.4% over the past two trading sessions. Oracle (ORCL.US) saw its stock price surge by 18%, while Microsoft (MSFT.US) and Palantir Technologies (PLTR.US) also recorded gains of approximately 6%.
This rebound occurred against a backdrop of a severe sector pullback. The IGV ETF had just closed at its lowest level since November 2023 last Friday, with a year-to-date decline that had reached 25%. Even after this week's recovery, Oracle remains down 16% for the year, and Microsoft's 19% decline makes it, alongside Tesla, the worst-performing component among the "Magnificent Seven" tech giants so far this year.
The previous sustained sell-off stemmed from deep market worries that AI-native companies (like Anthropic and OpenAI) would disrupt traditional software business models. Investors feared that AI would permanently weaken enterprise software pricing power, revenue growth, and profit margins, thereby eroding the sector's long-standing high valuation premium. However, this disruptive risk has been reflected more in market sentiment than in actual company financial data. Furthermore, the prior selling has significantly depressed valuations, leading some investors to see a buying opportunity.
Emily Roland, Co-Chief Investment Strategist at Manulife Investment Management, commented on the situation: "The idea that AI is going to destroy every software company is a little hard for me to swallow, or at least premature." Roland further noted that panic has largely overshadowed fundamental realities, suggesting the market sell-off was an overreaction.
From a valuation perspective, excessive pessimism has driven software stock valuations to historically low levels. Industry data shows the forward P/E ratio for the S&P North American Expanded Technology Software Index, tracked by IGV, is approximately 21x. This is not only far below the near 40x peak seen in July but also significantly below its 10-year average of 34x. For specific stocks, Salesforce (CRM.US) trades at a P/E below 13x (compared to a 10-year average of 45x), and Adobe (ADBE.US) has seen its P/E fall below 10x (10-year average: 30x), with both approaching historical valuation lows.
Supporting the inflow of capital is not just cheap valuation but also a marginal improvement in profit expectations. Industry research data indicates that Wall Street analysts have quietly raised their outlook for the software sector, now projecting a 16.5% profit growth rate for software and services companies in 2027, up from a 15.7% forecast at the end of February. Revenue expectations have followed a similar upward trajectory.
"The fundamentals of the software industry are not all bad," said Jonathan Dane, Chief Investment Officer at Defiant Capital Group, which manages over $1 billion in family wealth. However, all these stocks "have been lumped into the same disruptive change narrative." He added that while he expects greater volatility in the sector, "Microsoft and Oracle are becoming increasingly attractive."
Technical signals also provide a basis for the rebound. Adam Turnquist, Chief Technical Strategist at LPL Financial, pointed out that the S&P North American Technology Software Index found key support around the 1,600 level. "While the software industry remains in a downtrend and needs to repair technical damage before confirming a bottom, improvements in momentum and volume trends suggest selling pressure may be diminishing at the margin," Turnquist analyzed. A decisive break above the 1,908 resistance level would potentially form a double-bottom breakout pattern technically.
Market sentiment indicators have also reversed. Prominent investor Michael Burry, famous for betting against the subprime crisis, publicly endorsed his portfolio of software companies on Monday, including Veeva Systems (VEEV.US), Autodesk (ADSK.US), and Adobe (ADBE.US). Notably, Adobe is down 33% year-to-date and is seen as a prime example of AI disruption risk. Last week, veteran strategist Ed Yardeni also stated that U.S. tech stocks, after retreating from last year's record highs, have reached levels attractive to investors willing to make long-term commitments.
Bill Baruch, President of Blue Line Capital, also emphasized that software stocks have been "unfairly punished," citing names like ServiceNow (NOW.US), Oracle, and Microsoft as attractive and noting he has deployed half of his cash reserves to increase exposure to the software sector.
Furthermore, Wall Street investment banks have issued bullish views through research reports. Goldman Sachs strategist Peter Oppenheimer explicitly stated that the tech pullback presents a "value opportunity," citing evidence that the forward PEG ratio for global tech stocks has fallen below 1, with the rolling PEG metric at its lowest level since 2005. He also noted that analyst earnings estimates for 2026 and 2027 continue to be revised upward, and high returns on equity support current valuation levels. Wells Fargo also views Information Technology stock valuations as having reached attractive levels. The Wells Fargo Investment Institute has upgraded its rating on the sector from "neutral" to "favorable," citing its underperformance relative to the S&P 500 and the supportive long-term prospects from the widespread adoption of AI.
Despite the bullish counterattack, some institutional investors remain cautious given the uncertainty of AI's exponential evolution. Admittedly, facing challenges such as slowing revenue growth and the rapid advancement of AI—where each update seems to signal a leap in capability—many investors are wary of buying software stocks on dips. In other words, a company that appears safe or cheap today could become problematic tomorrow.
Jonathan Dane of Defiant Capital Group acknowledged increasing valuation appeal but also warned of systemic risk: "The software industry's fundamentals are not entirely negative, but almost all related stocks have been grouped into the same narrative framework of disruptive change." He added that he is relatively more positive on infrastructure-like companies such as Microsoft and Oracle.
Brad Conger, Chief Investment Officer at Hirtle Callaghan & Co., expressed more pronounced hesitation: "We prefer assets with low valuations, and typically the software sector would attract us. But the more time we spend on this, the greater the uncertainty becomes. I'm not obsessed with finding the exact bottom."
Regarding the sector's future evolution, Brian Kersmanc, a Portfolio Manager at GQG Partners, which manages approximately $162.5 billion in assets, offered a vivid analogy: "It's like a forest fire. Everyone must go through the pain for the industry to clear out. There might be a batch of zombie software companies. This is like a forest fire that burns away the underbrush. Eventually, we will be able to see which trees are the most resilient."
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