While fears of AI disruption driving the software sell-off are not yet over, the sector has made a comeback in May.
US software stocks rallied last week on strong results from Snowflake and Okta, rounding out a stronger May as investors reassessed which companies are best placed to navigate AI disruption.
Solid results lifted the iShares Expanded Tech-Software ETF 8 per cent last week, taking it to a 21 per cent gain in May and marking its strongest monthly performance since a rebound during the dot-com bubble in October 2001.
The comeback follows a software sell-off that has plagued markets for much of this year.
Dubbed the “SaaS-pocalyse”, some market commentators believe that AI presents an existential threat to the subscription models that software-as-a-service (SaaS) businesses depend on, particularly due to the advent of “vibe coding” that allows anyone to build an app much quicker than they once could have.
But data platform provider Snowflake’s performance illustrates how the broad-based sell-off is making room for companies with stronger competitive moats and those adapting to AI.
Having gained about 50 per cent over the past week, the rally reflected not only strong results but also investor enthusiasm for its US$6 billion cloud and chip deal with Amazon.
This echoes the narrative seen when ASX-listed software company Xero announced its partnership with US AI giant Anthropic a few months ago, with analysts arguing at the time that the software sell-off was entering an “integration phase” between AI and software firms.
Though the S&P/ASX 200 All Technology Index is still down 13 per cent year-to-date to 1 June, it has, like its US counterpart, improved over the past month to rise about 5 per cent.
Analysts including Morningstar’s Lochlan Halloway and Forager Fund chief investment officer Steve Johnson have long argued the broad sell-off has been too indiscriminate, with some companies far better positioned than others to adapt to an AI-driven environment.
Back in January, Johnson told Investor Daily he was anticipating a correction in Australian tech stocks driven by the “AI loser” narrative.
He argued that if prices were to pull back significantly, investors in certain software companies would likely be “well compensated” for the risks involved.
The small-cap fund manager has since entered software investments that had sold off, both in Australia and overseas, including UK-based Auto Trader Group, an equivalent of ASX-listed Carsales.
The idea that software stocks may now represent a “hunting ground” for value investors has been gaining traction, with Schroders publishing a piece on the theme last month.
As author and fund manager Simon Adler pointed out, technology is not an area most investors typically associate with value investing, but tech stocks have already demonstrated they can span the full range of valuations.
“At the start of 2000, just as dotcom mania was reaching its peak, the 10 largest tech stocks in the US were, in size order, Microsoft, Cisco, Intel, IBM, AOL, Oracle, Dell, Sun Microsystems, Qualcomm and HP,” Adler said.
“So how many of these businesses have we had exposure to in one or more of our contrarian value portfolios in the intervening years? Since 2000 – and each time buying in on deeply discounted absolute valuations that placed them in the cheapest parts of the market – we have held positions in no fewer than seven of that group: Cisco, Dell, HP, IBM, Intel, Oracle and Microsoft.”
As such, he argued that now may be a time for contrarian investors to find selective opportunities, provided they remain disciplined and focus on companies trading on low multiples of their proven earnings and cash flow.
He added that this involves targeting areas where sentiment is depressed and share prices have fallen to what he sees as “irrationally low levels”.
“Fundamental valuation remains our north star. A share price that’s fallen a long way from peak simply isn’t enough.”
