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Key Takeaways
- UBS on Tuesday downgraded the U.S. tech sector to neutral due to persistent concerns about AI-driven disruption in the software industry and an expected slowdown in AI infrastructure spending.
- Jefferies analysts in a recent note identified slower AI spending as a potential catalyst for a rebound in software stocks after last week’s “SaaSpocalypse.”
Software stocks have found their footing after last week’s rout. Some experts say that’s not reason for optimism.
The chief investment office of UBS downgraded the U.S. technology sector to neutral on Tuesday, citing pervasive uncertainty in the software industry and the likelihood that AI infrastructure spending will moderate soon.
UBS says the spending on AI infrastructure that has fueled the AI rally may be nearing a peak after increasing more than fourfold in the past three years. Microsoft (MSFT), Alphabet (GOOG), Amazon (AMZN), Meta (META) and Oracle (ORCL) could report capital expenditures of up to $700 billion this year, a price tag that has at times spooked investors worried that Big Tech will struggle to recoup its investments.
Why This Is Important
The AI boom has been the driving force behind the bull market of the past three years. Investors have been questioning for some time whether stocks can sustain their momentum without Big Tech’s ever-increasing outlays on data center equipment.
UBS expects capex growth to moderate from current levels, “which could improve investor perceptions of those doing the spending, but is a potential negative for some companies in the enabling layer.” That includes some of the biggest companies in the S&P 500, including chip giants Nvidia (NVDA), Broadcom (AVGO) and Micron (MU), all of which have seen their sales and earnings swell amid the data center boom.
UBS expects uncertainty about AI’s impact on the software industry—concerns that sparked last week’s “SaaSpocalypse”—to remain a drag on the tech sector. Software stocks plummeted when AI startup Anthropic released agentic tools that amplified concerns that AI is more of a threat than an opportunity for software incumbents.
“The threat of increased competition makes it difficult for investors to have conviction in the growth rate and profitability of firms in the software industry,” wrote UBS analysts, who expect the uncertainty to “linger for some time.”
Jefferies analysts recently argued the slowdown in capex that UBS considers a tech sector headwind could ultimately help clear the cloud hanging over software stocks. The data center boom, they argue, is taking the air out of the room and making the software industry’s mid-teens revenue growth appear paltry.
UBS and Jefferies agree that some babies were surely thrown out with the bathwater during last week’s sell-off, an assessment shared by retail investors, who bought the dip aggressively, according to data from Vanda Research.
Dip-buyers are being rewarded for taking a risk on stocks at low valuations. Datadog (DDOG) stock soared on Tuesday as investors focused on the software company’s better-than-expected revenue rather than its underwhelming profit forecast, underscoring the benefits investors can reap from low expectations.
On the other end of the spectrum, high expectations for tech hardware stocks is another headwind UBS credits for its tech downgrade. The segment, they say, is dominated by smartphone manufacturers that have benefited from strong sales “driven partly by an aging installed base of phones.” But the group’s forward price-to-earnings ratio is well above its 5- and 10-year averages, setting a high bar for the segment to clear this year.
