A new automation tool launched by AI startup Anthropic on Tuesday triggered a panic-driven sell-off in software stocks, causing a broad retreat across the three major US stock indices. Intraday, the S&P 500 fell more than 1.6%, the Nasdaq Composite saw its losses widen to approximately 2.4%, the Nasdaq 100 also dropped over 2%, and the Dow Jones Industrial Average plunged nearly 1.2% at its lowest point. This wave of selling disrupted the market's rebound momentum from Monday, pulling the Nasdaq and S&P down from recent highs. Legal software and data service companies bore the brunt of Tuesday's sell-off. Thomson Reuters (TRI) plummeted as much as 20.7% intraday, LegalZoom.com (LZ) also fell over 20%, the London Stock Exchange Group's UK shares closed down 12.8%, its US pink sheet stock dropped over 10% intraday, and CS Disco (LAW) also declined more than 10% during the session. The iShares Expanded Tech-Software Sector ETF (IGV), which tracks the technology software sector, hit a new daily low with a 5.6% intraday drop, marking its sixth consecutive day of declines by Tuesday, accumulating a loss of over 14% over the six-day period. The ETF had already fallen approximately 15% in January, its worst monthly performance since 2008. Investors are concerned that the core businesses of software companies are facing threats of replacement by AI technology. Analysts, including Toni Kaplan from Morgan Stanley, noted in a research report that Anthropic's new features for the legal field intensify industry competition, stating, "We view this as a sign of increasing competition and therefore a potential negative." The panic also spread to Business Development Companies (BDCs) with software exposure, with stocks like Blue Owl Capital Corp. declining as market worries intensified over companies holding significant exposure to the software industry. Reports indicated that concerns about such industry turmoil have already triggered volatility in global credit markets, causing loan prices to fall last week in the syndicated loan market, where many software companies participate. The performance of the software sector during earnings season has also lagged behind the broader technology industry. Data compiled by media shows that among the S&P 500 software component companies that have reported earnings so far this season, only 71% posted quarterly revenue above Wall Street expectations, compared to a beat rate of 85% for the overall tech sector. Stephen Yiu, Chief Investment Officer of the Blue Whale Growth Fund, stated, "This year will be crucial in determining which companies are AI winners or victims; the core skill lies in avoiding the losers. Until the dust settles, being on the wrong side of AI is a dangerous move."
Software Stocks Face 'SaaS-pocalypse' Style Sell-off Wall Street's pessimism towards software stocks has evolved from caution to an apocalyptic panic. Jeffrey Favuzza, a trader at Jefferies' equity trading desk, commented, "We're calling it the 'SaaSpocalypse,' the apocalypse for Software-as-a-Service (SaaS) stocks. The trading style is purely 'get me out' selling." Tuesday's anxiety escalated further after AI startup Anthropic released a productivity tool for in-house corporate lawyers. This tool triggered a sharp decline in the stock prices of legal software and publishing companies, with selling pressure sweeping across the entire sector. This worry has been brewing for months. The launch of Anthropic's Claude Cowork tool in January significantly amplified fears of industry disruption. Last week, video game stocks were also dragged into the sell-off after Alphabet began rolling out Project Genie, a tool that can create immersive virtual worlds from text or image prompts. The S&P North American Software Index has fallen for three consecutive weeks, plunging 15% in January, its largest monthly drop since October 2008. Favuzza said, "I ask clients, 'Where is your pain threshold?' Even with a massive capitulation-style sell-off, I haven't heard any clear answers. People are just selling everything, regardless of price." This concern has also spread to the private equity arena. Media learned on Tuesday that firms including Arcmont Asset Management and Hayfin Capital Management are hiring advisors to scrutinize their investment portfolios for potentially affected businesses. Apollo reportedly cut the software exposure of its direct lending fund nearly in half for 2025, significantly reducing it from around 20% at the start of the year.
Anthropic's Unique Advantages Fuel Market Worries Anthropic is one of many AI startups developing tools for the legal industry, but its unique position has intensified market concerns. Long before Anthropic's plugin launch, startups like Legora and Harvey AI were already flooding the legal sector with tools claiming to free lawyers from tedious tasks. For over two years, investors have poured substantial funds into AI products for the legal industry, with Harvey AI reaching a $5 billion valuation last June and Legora raising funds at an $1.8 billion valuation last October. However, Anthropic's distinction lies in building its own models, which can be customized for industry-specific needs. As a primary model developer, its position within the AI ecosystem grants it a unique advantage to disrupt traditional legal news and data services, as well as new legal AI entrants. Companies like Legora rely on the underlying models from developers like Anthropic. On its plugin website, Anthropic's legal tool is described as automating tasks like contract review and legal brief drafting. The website states, "All outputs should be reviewed by a qualified attorney." Products from other companies, like Alphabet's Project Genie launched last week, have also fueled the sell-off. "This year is about defining which companies are AI winners or victims; the key skill is avoiding the losers," Stephen Yiu reiterated.
Microsoft's Slide Highlights Industry Woes Even software giants are not immune to AI skepticism. Microsoft reported solid earnings last week, but investors focused on slowing cloud sales growth, subjecting its AI spending to renewed scrutiny. This caused its stock to plunge 10% last Thursday and fall over 3% intraday on Tuesday, marking its fourth consecutive lower close. January was Microsoft's worst month for stock performance in over a decade. Meanwhile, earnings from ServiceNow and SAP gave investors further reason for caution regarding software companies' growth prospects. Thomas Shipp, Head of Equity Research at LPL Financial, which manages $2.4 trillion in brokerage and advisory assets, said, "The fear with AI is increased competition, greater pricing pressure, and their competitive moats getting shallower, meaning they're easier to displace with AI. The range of outcomes for their growth has widened, making it harder to assign a fair valuation or see what's cheap." These AI-related concerns prompted Piper Sandler to downgrade software companies like Adobe, Freshworks, and Vertex on Monday. Analyst Billy Fitzsimmons wrote, "We worry that seat compression and the 'vibe coding' narrative could cap valuation multiples." Vibe coding refers to using AI to write software code. Although all software stocks have exceeded profit expectations this earnings season, this seems almost irrelevant in the face of long-term growth concerns. According to Bloomberg compiled data, only 67% of S&P 500 software companies have beaten revenue estimates so far this season, compared to 83% for the overall tech sector.
Palantir Emerges as a Rare Bright Spot Despite the broad market decline, most S&P 500 constituents still advanced. Federal Express (FedEx), an economic bellwether, extended its record-breaking rally, and Walmart's market capitalization surpassed $1 trillion. Steve Sosnick, Chief Strategist at Interactive Brokers, noted that US stocks are "experiencing sector rotation. The tricky question is whether this is a benign reallocation of exposure or a signal of some underlying instability." Among AI-related stocks, big data analytics firm Palantir Technologies bucked the trend with a significant rise. The company reported after Monday's close that its fourth-quarter revenue grew 70%, exceeding Wall Street expectations, and provided annual revenue guidance for this year that far surpassed estimates. Its stock closed nearly 7% higher on Tuesday. Some investment professionals view the software sell-off as an opportunity. The European open-end fund Sycomore Sustainable Tech, which has outperformed 99% of its peers over the past three years, bought Microsoft stock during the downturn, anticipating the company will ultimately emerge as an AI winner. Microsoft's valuation now appears attractive, trading at less than 23 times estimated earnings, its lowest level in about three years. Technically, its 14-day Relative Strength Index (RSI) is in oversold territory. More broadly, the software index's valuation multiples are at multi-year lows, and its RSI also indicates oversold conditions. Jonathan Krinsky, Chief Market Technician at BTIG, wrote in a client note last week that the software sector "may be oversold enough for a bounce." However, he added that "it will take a long time to repair and build a new base," and "given the deterioration in relative strength that truly accelerated in Q4 last year, we are less sanguine on software." The core challenge for investors is distinguishing AI winners from losers. Clearly, some of these companies will thrive, meaning their stocks are effectively on sale after the recent sharp decline. But it might still be too early to determine the winners. Jefferies' Favuzza stated: "A pessimistic view suggests that, in terms of growth prospects, the software industry could become the next print media or department stores. The market sentiment is so extremely skewed towards selling everything that it indicates some highly attractive investment opportunities will emerge. We're all waiting for growth to re-accelerate, and when I look at the data for 2026 or 2027, it's hard to see the upside. If even Microsoft is struggling, you can imagine how bad it could be for companies more vulnerable to disruptive technology or lacking that kind of market dominance."
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