The US software sector experienced its most severe sell-off since 2022 on Wednesday, yet the "dip-buying" funds that typically rush in during tech stock plunges were conspicuously absent.
Following a nearly 4% plunge on Tuesday, the S&P 500 Software & Services Index fell another 1% on Wednesday, marking its sixth consecutive day of decline. Unlike previous market pullbacks, this sell-off failed to attract any significant bargain-hunting activity.
Option traders are also steering clear of software stocks, with trading flows indicating investors are building defensive positions rather than seeking buying opportunities. Even Microsoft, traditionally seen as a safe haven, was not spared, as short sellers are increasing their bearish bets against it.
This software sector rout is the most severe since 2022. While rising interest rates battered software stocks in 2022, the current market sentiment has evolved from valuation concerns to a deeper anxiety that AI technology could disrupt traditional software business models. The collective investor avoidance of buying the dip suggests the market's view of the software sector may be shifting from a short-term correction to a structural reassessment.
Dip-buying funds have collectively vanished.
Steve Sosnick, Chief Strategist at Interactive Brokers, noted a stark contrast, stating that his firm's clients showed significantly less enthusiasm for buying software dips compared to precious metals and semiconductors. "Overall, our clients' appetite for bottom-fishing in software stocks is far weaker than for precious metals and semiconductors," he said, adding that while some clients might be buying, it is certainly not the focus of their trading activity.
This cautious stance is even more pronounced in the options market. Chris Murphy, Co-Head of Derivative Strategy at Susquehanna Financial, pointed out that with continued pressure on the software sector, options trading flows remain dominated by defensive maneuvers.
In the options trading for the iShares Expanded Tech-Software Sector ETF and the ARK Innovation ETF, traders are increasing their downside exposure rather than buying the dip. The IGV fell 3% on Wednesday, while the ARKK ETF plummeted nearly 7%. Murphy stated that the overall tone for the software sector remains defensive.
Microsoft emerges as a lone bright spot, yet short sellers swarm.
Sosnick indicated that Microsoft is one of the few exceptions in the sector, attracting some buyers even though it is not a pure-play software company. Microsoft's stock, which had fallen approximately 15% since its earnings report on January 28, saw a slight increase of about 1% on Wednesday.
However, even Microsoft could not escape the attention of short sellers. Leon Gross, a Research Analyst at S3 Partners, said short sellers are encouraged by the sector's sharp decline and are increasing their short positions even as the stock price remains under pressure.
"Historically, Microsoft traded like a reversal stock, where short sellers would cover on the way down. But now it's trading like a momentum-driven distressed stock, where short sellers add to positions as the price weakens," Gross explained. Data shows that short interest in Microsoft has increased by approximately 20% over the past week.
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