- 2024-11-28
- News
Revamping Investments in Tech: Software Stocks in Demand
In the past month, the attitude of tech investors has undergone a substantial shift: software stocks are in high demand, while semiconductor manufacturers are not.
Wall Street is pulling back from the chip sector due to inflated valuations. This outspoken critic of the CHIPS Act vowed on Monday to impose additional tariffs on countries like Canada and Mexico. In contrast, the software industry has been climbing. Investors are optimistic about this sector, as it is less impacted by tariff risks, and the momentum driven by artificial intelligence seems to be shifting from infrastructure to services.
Bill Stone, Chief Investment Officer at Glenview Trust, stated, “The software sector lagged behind, but it looks poised to become the next winner in the AI arena. If the new administration takes a more lenient approach to regulation and mergers, the software industry could also benefit.” On the other hand, “the chip sector has too much good news, particularly regarding AI chips, and its valuations are already stretched amid increasing uncertainty.”
Recent earnings reports highlight the shift in market sentiment. The stock price of data analytics software firm Snowflake surged driven by strong forecasts, while demand for AI software propelled Palantir's robust performance. In contrast, even NVIDIA’s strong results failed to ignite investor interest.
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As of November, a large exchange-traded fund tracking software has risen by 16%, indicating a potential record monthly gain over the past year. Meanwhile, a semiconductor fund has increased by less than 1%. Data from Bloomberg Industry Research shows that inflows into software ETFs have vastly outpaced those into chip funds.
Michael Tumey, Managing Director of Equity Trading at Jefferies, remarked that this impressive performance represents a “record rise for the software industry relative to that of semiconductors.” However, he noted that this shift “has left almost no mark on a 10-year chart,” suggesting there is room for the trend to continue.
The degree of rotation will depend on the unfolding situation. Sean O'Hara, president of Pacer ETF Distributors, believes that “chip manufacturers face a lot of uncertainties regarding tariffs.” This has heightened the potential for volatility, especially since chip stocks have experienced significant gains associated with AI. “At the same time, I expect we will see more focus on AI software,” he stated.
So far, the benefits of the AI theme have disproportionately favored chip manufacturers over software companies, with firms investing heavily to develop the chips and servers needed to operate the technology. Meanwhile, only a few software companies, such as Palantir, Microsoft, and Oracle, have witnessed substantial positives related to AI. However, software and services may represent the next inflection point for AI growth.
Meanwhile, as the first major beneficiaries of AI investments, chip manufacturers' valuations have also become expensive. The Philadelphia Semiconductor Index trades at a price-to-earnings ratio of 24 times, well above its 10-year average of 18 times, with stocks like ARM and NVIDIA among the highest-valued. If headwinds arise, this could signal a greater downside risk, as NVIDIA's reports indicate that more impetus may be necessary to continue uplifting the industry.
It is certain that semiconductor stocks remain a popular growth area. According to Bloomberg Intelligence, earnings for chip firms are expected to grow by 40% by 2025, while earnings in the software and services sector are anticipated to grow by around 12%. Sales growth for semiconductor companies is also expected to be even stronger.
The next significant test for the software industry will come in early December when Salesforce will report its earnings. Tech industry expert Jordan Klein noted that the company has been actively recruiting talent to promote its new generative AI agent products, and strong results from the company will help sustain the momentum for the sector.
“Generalist investors and tech investors are grappling with the dilemma of holding more software (and fintech) and fewer semiconductors,” he wrote. “Missing out on these moves could put some people in a tough spot.”
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