Overview
Software and services stocks around the world experienced a pronounced selloff last week, raising questions about how the recent surge of investor enthusiasm for artificial intelligence may be reshaping market dynamics. The pullback, concentrated in U.S. software names, knocked significant market caps lower and left traders watching for further volatility even after a modest rebound late in the week.
Market reaction and triggers
Investor enthusiasm for an AI trade that had bolstered markets for months ran into a sharp reality check as several software companies saw heavy losses. The immediate trigger cited by market participants was a legal tool released by Anthropic tied to its Claude large language model. That development prompted concerns that rapidly advancing AI capabilities could disrupt conventional software business models and the earnings compounding those models have historically produced.
While broader stock indices recovered some ground on Friday, the outlook for U.S. software shares remains unclear. Participants in options markets continued to price in elevated near-term swings, indicating uncertainty about whether the worst of the selling is behind the sector.
Scale of the slump
The software and services group has underperformed the S&P 500 by almost 24 percentage points over the past three months, a gap that ranks near the widest readings in the dataset that stretches back roughly three decades. That contrast follows a long period of outsized gains for software firms through much of the post-pandemic era, when investors placed heavy bets on digital transformation and cloud adoption.
Historically, the magnitude of this underperformance is comparable to only a few episodes since 1995, including the dot-com collapse of 2000-2001 when the sector lagged by more than 25 percentage points. The historical record shows that such extreme readings have sometimes been followed by sharp capitulatory moves or have presented contrarian buying opportunities, though extended periods of underperformance are also possible.
Notable losers
Since the S&P technology group peaked in late October, many U.S. software companies have suffered steep declines. Oracle has been the largest decliner, falling nearly 50% from October 29 through February 5. ServiceNow and AppLovin each dropped more than 40% over that span. Other significant names swept up in the selloff included Gartner, Palantir, Intuit, Datadog, and Workday.
Rotation across sectors
The weakness in software coincided with a broader reallocation of investor capital toward more value-oriented and cyclical parts of the market. Over the same multi-month period in which software fell, sectors such as energy, materials, consumer staples, and industrials each rose at least 10 percent, and eight of the 11 S&P 500 sectors recorded gains. Despite these sector-level advances, the S&P 500 as a whole was roughly unchanged over that time frame.
Market participants noted that the concentrated weight of technology within the S&P 500 - still close to one-third of the index - raises concerns that sustained weakness in tech could limit the benchmark's ability to move higher.
On Friday, the Dow Jones Industrial Average crossed 50,000 points for the first time, a milestone that market watchers attributed in part to a rally in shares of Nvidia.
Volatility and positioning
Although selling pressure moderated on Friday with the industry index posting gains, measures of expected volatility remained elevated. For the iShares Expanded Tech-Software Sector ETF, 30-day implied volatility was 41 percent, only marginally below the 10-month high of 45 percent touched on Thursday. Those readings suggest traders were still anticipating large near-term share price swings.
Short sellers also appeared positioned to profit from further declines. Through Thursday, short interest in the IGV ETF - calculated as the number of shares short as a percentage of free float - stood at 19 percent, near its highest levels on record according to available analytics.
What this means for investors
The recent slide has left market participants and traders parsing whether the AI-driven bid that lifted many software names is being re-priced in light of new product capabilities and legal developments tied to large language models. Options activity and shorting patterns point to continued uncertainty in the near term. At the same time, the market-wide rotation into sectors including energy and industrials highlights divergent investor strategies as some seek exposure outside of technology-centric bets.
For now, the path forward for software equities will be determined by whether the selloff subsides and how company fundamentals and AI-related developments evolve. Until clearer signals emerge, elevated volatility and concentrated short positions suggest the sector could remain a focal point for market moves.