Software Stocks, AI Disruption, and the Importance of Diversification

Chart of the Month

Mar 13

Written By Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

*Photo Credit: Karl Pawlowicz, Unsplash*

The software industry has declined nearly 30% from its peak last October, one of the largest non-recessionary drawdowns in over 30 years. The chart below puts the decline in historical context alongside the other major software selloffs. The two largest drawdowns before the current one, the dot-com bust and the 2008 financial crisis, both occurred during recessions, when corporate earnings were declining, and businesses were cutting spending. The 2022 sell-off, driven by the Federal Reserve’s aggressive rate-hiking cycle, was the first major non-recessionary decline and saw software stocks fall by nearly 40%. The current drawdown, at nearly -30%, surpasses the COVID pandemic, but it’s driven by a fundamentally different catalyst: artificial intelligence.

The sell-off accelerated in January and February after a series of artificial intelligence (AI) product launches showed that general-purpose AI tools could perform tasks previously handled by specialized software at a lower cost. The market’s reaction was swift and sequential. Software stocks fell first, but concerns quickly spread to other industries, including financial data providers, commercial real estate services, and logistics companies. The sell-off reflected a shift in how investors view AI. For the past two years, AI has been seen as a productivity tool that would help existing companies do more with less. The January and February product launches crossed a threshold: investors started pricing AI as a potential replacement for entire categories of professional services, not just a tool to make companies more efficient.

By late February, the narrative around AI disruption began to cool, and markets started to stabilize. Wall Street analysts pushed back on the worst-case scenarios, and the conversation shifted from the claim that AI would replace entire industries to a more focused debate about which industries are genuinely vulnerable and which will find ways to adapt and develop competitive advantages. Several of the hardest-hit stocks rebounded, and while the software industry partially recovered, it remains down more than -25%. The broader question of how AI will reshape professional services and the enterprise software industry remains unresolved, and its effects may continue to surface across the market as AI tools evolve.

The software industry’s sell-off is a reminder that even well-established businesses can experience rapid repricing when the market’s assumptions about future earnings change. However, the chart below shows the direct impact has been limited for diversified investors. International stocks and the average S&P 500 stock have both produced gains, while small-cap stocks, the broader S&P 500, and the Nasdaq 100 are each down in the low single digits. The takeaway: portfolio diversification across sectors and asset classes remains an effective way to manage uncertainty in rapidly changing environments and amid market volatility.

Software Industry Drawdowns Over the Last 30 Years

US Software Industry Drawdowns Over the Last 30 Years

Performance During Current Software Drawdown

Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.

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Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

I am currently the Managing Partner for our independent investment advisory firm, Optima Capital Management. Together with my business partners, Todd Bendell CFP® and Clinton Steinhoff, we founded Optima Capital in 2019 as a forward-thinking wealth management firm that serves as an investment fiduciary and family office for high-net-worth individuals and families. In addition to being the Chief Compliance Officer, my role at Optima Capital is portfolio management. I have over 22 years of experience in managing investment strategies and portfolios. I specialize in using fundamental and technical analysis to build custom portfolios that utilize individual equities, bonds, and exchange-traded funds (ETFs). I began my financial services career with Merrill Lynch in 2003. At Merrill, I served in the leadership roles of Market Sales Manager and Senior Resident Director for the Scottsdale West Valley Market in Arizona. On Wall Street Magazine recognized me as one of the Top 100 Branch Managers in 2017. I am originally from Saginaw, Michigan, and a marketing graduate from the W.P. Carey School of Business at Arizona State University. I am a Certified Private Wealth Advisor® professional. The CPWA® certification program is an advanced credential created specifically for wealth managers who work with high net worth clients, focusing on the life cycle of wealth: accumulation, preservation, and distribution. In addition, I hold the following designations - Chartered Retirement Planning Counselor (CRPC®), Certified Divorce Financial Analyst (CDFA®), Certified Plan Fiduciary Advisor (CPFA), and Retirement Management Advisor (RMA®). In the community, I am a member of the Central Arizona Estate Planning Council (CAEPC) and serve as an alumni advisor and mentor to student organizations at Arizona State University. My interests include traveling, outdoors, fitness, leadership, entrepreneurship, minimalism, and computer science.