In the last few days, I’ve received multiple messages about the software stock sell-off and general market volatility we’ve experienced this week. On social media, people are calling it the SaaSpocalypse or SaaSmageddon. But to a degree at least, the sudden price drops in software stocks have been mirrored across a range of financial asset classes, such as bitcoin, momentum stocks, and small-cap stocks. It does look like a broader deleveraging is underway, at least in “risk-on” assets.
Hyperbolic language aside, you can see below that the S&P Software Industry Index is down about 25% since it peaked late last year.
Meanwhile, the Betashares S&P/ASX Australian Technology ETF (ASX: ATEC) is down over 30% since October last year.
And as I press publish just before market open, it looks like the selling will continue today.
What is causing the software stock sell-off?
In my view, the main force acting on high growth stocks more generally in Australia, these days, is higher inflation leading to higher interest rates. This mechanically reduces the value of growth stocks more than steady businesses, because higher interest rates mean a higher discount rate must be applied when calculating the present-day value of future cashflows.
We can take a moment to thank our lucky stars that RPM Global (ASX: RUL) got taken over when it did. Just last month, I sold the last of that stock, and now software valuations are tanking. Caterpillar probably saved us the pain of a 40% drawdown on that one. Of course, in the longer term, that may not have mattered, but the ride would have felt like a kick in the guts.
That kind of thinking alludes to the second major force focusing on software stocks at the moment: a sociological zeitgeist shift.
The dominant narrative over the last decade or so has been that “software is eating the world.” This has caused many people to invest blindly broadly in software stocks, pushing up the price of all of them.
More recently, the “software eating the world” narrative has been replaced by “AI is eating the world.”
The theory is that AI products from Anthropic, Google, OpenAI and others will allow big companies to insource their software development and make huge savings at the expense of software providers, and at the same time, reduce their need for the software by reducing their own employee headcount. How? By replacing employees by AI agents, of course!
Thus, the theory has it, software companies will be hit with a double whammy of higher competition from AI-prompting code geniuses, as well as lower demand for their products from existing customers.
This kind of thematic crash feeds off itself in a way that a broader sell-off might not. Whereas governments face pressure to arrest broad stock market declines, but investors in a single industry taking a world of pain can perpetuate itself in a vicious cycle.
Those fund managers who bet heavily on software stocks have had a terrible quarter, and they are probably more likely to be facing outflows than inflows. If they face outflows, that means they will be forced to sell to fund redemptions, right after prices have already dropped. That could also push down the prices of their stocks, leading to poor performance next month, too.
It is also notable that capital is rotating into other assets (such as oil companies and gold), shining like beacons to the momentum traders and short-term investors. And so hot money is leaving software stocks in a real hurry, as perceived sector tailwinds have suddenly turned into perceived headwinds.
Of course, the hypothetical portfolio of recommendations has not been immune from this downturn. You can see below the sharp drop compared to the index, in the last few days.
We Knew It Would Come (Just Not When It Would)
When I did my 2025 performance review just one month ago, I finished noting my favourite “classic quote from Boethius, which has in it more wisdom than you will find in most articles about investing.” It reads:
“It’s my belief that history is a wheel. ‘Inconstancy is my very essence,’ says the wheel. ‘Rise up on my spokes if you like but don’t complain when you’re cast back down into the depths. Good times pass away, but then so do the bad. Mutability is our tragedy, but it’s also our hope. The worst of times, like the best, are always passing away.”
Master Your Mind
As long-term investors, often the highest cost we pay for holding a stock long-term is a psychological cost.
When the stock prices go down, and you begin to doubt your decisions. Of course, if you always sold during some sort of sector-wide or market-wide panic, then you would never end up holding many stocks for more than a few years. So you can’t really call yourself a long-term investor if you have no ability to weather drawdowns.
Now is when you have to lean on your conviction and focus on whether the reasons you bought a stock in the first place are still valid. If you truly are a long-term investor, then you probably don’t need to worry about the current panic-du-jour.
But the key thing to remember is that you can control your psychology. It only takes a moment to crystallise capital gains forever.
Now, don’t get me wrong. I feel it.
For example, I feel instinctual anger, frustration, and shame for having recommended Kinatico, a small software stock, right before a massive downturn in software stocks. Oooof factor 10. Straight in the guts. Sure would have been nice to buy that around 20c, instead of 30c. Sorry.
On top of that, my actual portfolio is down 10% in the last week. You can cry, or you can laugh.
The truth is that getting too emotional will stress you out and lead to rising panic.
The feeling of panic, in turn, will harm your investing (or, for that matter, just about anything you do). Now, don’t get me wrong, the feeling of rising panic can be an early warning sign to act. That is how it is supposed to work. When you sense danger, your instincts should be telling you to calmly assess the situation. But while the rising panic is useful if it triggers calm reflection, that has to be the mechanism.
Of course, the problem with panic is that it becomes an involuntary physiological and psychological response to perceived threat or extreme stress if allowed to grow. When the stress chemicals overwhelm your brain, the impact is counterproductive in almost any situation, unless, of course, you really do need to take flight, fight, or freeze.
The key to vanquish rising panic is to circuit-break, not to fixate.
If you’re wandering through the jungle at night, trying to find your way back to your treehouse, all alone, you don’t rest your mind on the question of what, exactly, you heard lurking in the shadows; you give thanks for the beauty of the moonlight.
The brave boy who saved his siblings and mother by swimming four kilometers through rough seas, then running another two kilometers to call triple zero, is more qualified to give advice about staying calm in a stressful situation than I am, that’s for sure.
There is something profound in his comment that “…at one point I was thinking of Thomas The Tank Engine… trying to get the happiest things in my head.”
So once we’re all feeling circumspect, it is time to take into account the zeitgeist change. Specifically, the question is whether this is a long-term zeitgeist change or a more temporary fluctuation.
Are Software Companies Doomed By AI?
I’ve outlined above how various people think that large language models are going to doom various software companies. And in some cases, I’m sure that will be true. However, software companies already understand their value as facilitating jobs to be done. Their ability to charge for that depends on how easily and safely their customers can switch to alternatives.
That varies from company to company, but mercifully, we only have to worry about the companies we actually own shares in.
In my case, I actually think that Objective Corporation and Pro Medicus will not be impacted negatively by either a meaningful reduction in demand or a sudden surge of competition. In the case of Objective Corp, there is some possibility it will have a bumpy time in cases where its customers reduce staff numbers, but I think that shows up more as slower growth than actual shrinking revenue. Pro Medicus charges by patient, not by user, and there is a shortage of radiologists, anyway.
Something like Kinatico could definitely be affected, given that it is not an established, well-recognised brand. That said, Kinatico has a product in the market, right now, ready to go. And while it has a long way to go building its brand, it already has users today (and profits), and its newest product suite is already low-cost (and free at the low end).
As we get more information, I’ll definitely be investigating and monitoring the theory that AI capabilities will hurt software companies. My initial view at this point is more that the software companies became overvalued on their own, through the natural emotional process of the market. Then, when rate expectations started rising, the wind started blowing in another direction.
However, one observation I would make is that the market seems to be entirely focussed on the negative impacts of AI on software businesses. This seems unbalanced to me. For example, if one of the headwinds facing software companies is that their clients will be massively reducing employee numbers, then surely they would benefit from a similar cost-out phenomenon?
The bigger problem for software stocks might be inflation and rising interest rates. That’s something I am a little concerned about. Indeed, when we recently took profits on a recommendation, I noted that part of the rationale for selling was that “the mirage that inflation will keep falling is dissipating.” I believe that is the bigger and more important zeitgeist change.
So while I am not overly worried about large language models damaging the software companies I personally own shares in, I do think that an inflationary environment with higher rates could be bad for all growth stocks, of which software and technology companies are a significant proportion. That’s something to be mindful of, and it is part of the reason one might want to own gold.
That said, inflation and interest rates do tend to go in cycles, so while I’m realistic about the possibility of more pain ahead, I don’t want to give in to fear. I remain cashed up thanks to recent sell recommendations, and my goal would be to deploy capital into at least one beaten-down high-quality stock, once I’ve had time to assess all the half-year results in February.
I think there is a real possibility that good results could be initially overlooked if the market remains gripped in fear and panic.
Disclosure: The author of this article owns shares in KYP, OCL and PME and will not trade those shares for at least 2 days following the publication of this article. This article is not intended to form the basis of an investment decision and is not a recommendation. Any statements that are advice under the law are general advice only. The author has not considered your investment objectives or personal situation. Any advice is authorised by Claude Walker (AR 1297632), Authorised Representative of Ethical Investment Advisers Pty Ltd (ABN 26108175819) (AFSL 276544).
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