3 factors that could get software stocks going again after a brutal stretch

By Hannah Pedone

It may not be a quick turnaround for the software sector, but here are three themes investors should monitor as they consider whether to re-engage

Microsoft and other software stocks have struggled for momentum recently.

It won't necessarily be easy for software stocks to break free of a "negative feedback loop," but Evercore ISI analyst Kirk Materne sees a few factors that could eventually shake the sector out of its rut.

Software stocks are coming off of "a quarter to forget," according to Materne. The iShares Expanded Tech-Software Sector ETF IGV, which lost 24.3% in the first quarter, just got clobbered relative to the S&P 500 SPX to a degree not seen since 2002, according to Dow Jones Market Data.

"Apathy and confusion abound, and in our view, investors need to stay selective and have some patience," he said.

But all hope isn't lost, especially for those who widen their time horizon. According to the analyst, there are three themes investors can monitor as they assess whether to dive back into the software sector.

For one, Materne thinks growing adoption of "usage-based" performance metrics is one potential catalyst. This is one way software companies can demonstrate that they are truly monetizing their artificial-intelligence offerings.

Read more: Here are 12 top tech-themed stock picks from UBS analysts

Another trend that could get investors more excited about software stocks is if they start closing the performance gap relative to chip stocks. The VanEck Semiconductor ETF SMH trounced the iShares Expanded Tech-Software ETF by 30.7 percentage points in the first quarter - the largest bout of quarterly outperformance on record, according to Dow Jones Market Data.

"We don't see software and semis being mutually exclusive, but for many the question becomes, 'Why bother with software if semis are going to outperform on an absolute and relative basis?'" Materne wrote.

He added that it's reasonable to assume the gap will narrow given how "extreme" it's been recently - though it's also difficult to pinpoint an exact reason why the relative performance of the two sectors would change in the immediate term.

Furthermore, software companies will need to make difficult cost-cutting decisions to demonstrate to investors that they can invest in AI while keeping operating margins in check.

Morningstar analyst Luke Yang told MarketWatch that layoffs are one way that companies are looking to achieve this. Still, software companies will still need to prove to investors that all this AI spending is yielding strong financial benefits.

"Until we see strong evidence that enterprises are purchasing AI-based solutions at scale, it is hard to predict a turnaround for enterprise software companies," he said.

Materne sees the most upside for Microsoft (MSFT), Salesforce (CRM), Snowflake (SNOW), Intuit (INTU) and Samsara (IOT).

See also: Microsoft is sitting on a 'treasure chest' that could help lift the stock 20%

-Hannah Pedone

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04-06-26 1518ET