Investors are going to have to get a lot more discerning when it comes to artificial intelligence bets, because the inclusive narrative that drove the widespread boom in U.S. tech stocks last year is over. AI's rising tide no longer lifts all boats, and those that are sailing along smoothly one quarter could find themselves sunk the next.
This week's so-called 'software-mageddon' has wiped roughly $800 billion of market capitalization from the S&P 500 software and services index, with notable losses among companies like Oracle, Intuit and ServiceNow. According to SocGen, the software sector is having its worst performance against the wider S&P 500 index in 25 years.
The root of the latest churn appears to be a new tool from the AI leader Anthropic, a legal plug-in for its Claude AI service that can automate a lot of legal work and, over time, services provided by software firms in sales, marketing, and data analysis.
But this week's slump is not simply about a new, mostly unproven, plug-in. It's a sign of investors' realization that the AI revolution is entering a new phase where the tech world is splintering, between AI disruptors and AI casualties.
Simply buying an index fund and watching it rise on the back of the megacap tech boom is no longer an optimum strategy. Investors will have to pick winners and eschew losers, determining where AI will enhance and where it will disrupt. In other words, after a decade of bumper passive investing returns, active management may once again have its day.
The problem, of course, is that no one knows how this particular cookie will crumble. AI technology is in its infancy, and its ultimate impact is still unknown. What that means is that today's winners may be tomorrow's losers – such is the bewildering pace of change.
Look at how shares in Facebook owner Meta have traded the day following their last two earnings releases. Promises of hefty investment in AI and data center construction sparked an 11% slump on October 30, while a similarly aggressive spending pledge triggered a 10% surge on January 29.
Take Microsoft. Its apparent first-mover AI advantage among the 'Magnificent 7' helped push its market cap above $4 trillion last year, but its share price has tanked 25% in the last three months as investors have questioned whether its massive capex will pay off.
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RECORD BEARISHNESS IN SOFTWARE SECTOR
This week's volatility may shine a spotlight on the divergence among sectors and individual names, but, in reality, this trend has been building for a while.
Over the last three months, the S&P 500 tech index is up 9%, while the communications services index is down 10%. And the correlation between the six biggest U.S. tech firms - Amazon, Apple, Alphabet, Meta Platforms, Inc., Microsoft, and Nvidia - has collapsed to the lowest in at least a decade, according to Barclays equity strategists.
They expect the shift away from the 'rising tide' narrative to continue, creating a "high-tech, high-stakes market" that should give fund managers scope for more individual stock and thematic investment strategies.
Manish Kabra at SocGen reckons the picture essentially boils down to this: a global software sell‑off on one side, and a global semiconductor boom on the other.
In theory, this should be good news for investors. In times of sectoral dislocation, correlation breakdowns and fluid price moves, bargains and arbitrage opportunities can be found. It's the proverbial 'stock picker's market.'
Michael Toomey, managing director of equities trading at Jefferies, calculates that a record 73% of software stocks and 45% of all tech stocks are oversold, and he argues that the IGV iShares tech-software ETF is the most oversold it has ever been relative to the broader S&P 500 index.
"I have never seen sentiment this negative in any group in my career," Toomey wrote on Wednesday. "I think we're due for a vicious rally in software."
The problem for these 'stock pickers,' however, is that despite their access to copious amounts of data and research, the rapid change in AI and tremendous uncertainty about its impact leaves them essentially flying blind.
Tech is in a state of flux and looks likely to remain so for some time. Investors should buckle up - there'll be more days and weeks like this.
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