Software stocks recorded a notable downturn in the first quarter, culminating in a -1.9% drop for March as tracked by the iShares Expanded Tech-Software Sector ETF (IGV). That decline capped a brutal three-month stretch, with IGV down -24% cumulatively after losses of -14.5% in January and -9.7% in February. TD Cowen characterizes this period as the weakest for the software benchmark since the fourth quarter of 2008.
Investor sentiment remains predominantly negative, TD Cowen reports, with market feedback indicating a prevalent trading stance of long semiconductors and short software. The research firm describes a dynamic where semiconductor de-grossing prompts covering of software shorts, while renewed grossing in semiconductors leads to rebuilding short positions in software names.
Announcements from AI research groups have added pressure on the software sector, TD Cowen said. Developments cited include new releases from Anthropic’s Claude family and details around a leaked Mythos model, which the firm views as continued headwinds for software equities.
Large-cap software-as-a-service companies endured a difficult earnings season. TD Cowen highlights booking shortfalls at Adobe (ADBE), Salesforce (CRM), Workday (WDAY) and SAP (SAP) as concrete examples of underperformance during the reporting period. Many SaaS stocks reached new year-to-date lows on March 27 before registering a bounce in early trading this week.
Sector and sub-sector performance diverged in March. The IGV outpaced the iShares Semiconductor ETF (SOXX) by 5.0% in March, reversing prior underperformance of -11.4% in February and -29.5% in January. Within software, infrastructure software fell -4.0%, lagging applications software, which declined -2.9% - a notable change given infrastructure’s relative resilience earlier in the year. Against this backdrop, select marketing software names performed well: Braze (BRZE) gained 24% and Klaviyo (KVYO) rose 12% during the period.
Valuation metrics moved lower as prices fell. TD Cowen’s broader software basket traded at about 4.1 times enterprise value to next-twelve-months sales at month-end, down from 4.5 times in February and 5.6 times in January, marking a new five-year low for that multiple.
TD Cowen also notes historical outcomes following large IGV drawdowns: the average return for the index in the three months after such drawdowns is 1.9%, while the median return is 5.2%. Those figures offer a reference point for potential short-term recovery, though they do not constitute a forecast.
Key points
- IGV posted a -24% return over the first three months of the year, the worst three-month performance since Q4 2008.
- Negative investor positioning is centered on a long-semiconductor, short-software trade; AI model announcements and booking misses at major SaaS firms contributed to weakness.
- Valuations fell to roughly 4.1x EV/NTM sales, a five-year low for TD Cowen’s broader software basket; historical three-month returns after large drawdowns average modestly positive.
Risks and uncertainties
- Investor sentiment remains negative, which could prolong selling pressure in software stocks and impact related equity sectors.
- Continued short covering or re-grossing in semiconductors may alter software positioning, creating volatility across technology subsectors, including semiconductors and cloud software.
- Booking shortfalls at large-cap SaaS companies introduce earnings risk for applications and enterprise software segments, potentially affecting broader market confidence in tech earnings.