The Reversal Amid the AI Craze: Semiconductor Giants Fall Out of Favor, Software Stocks Welcome Spring?

According to data from the bulk brokerage department of Goldman Sachs Group, fund managers have been net selling U.S. technology stocks for the third consecutive week. Hedge funds have started selling semiconductor stocks benefiting from the boom in artificial intelligence, and have instead been buying software stocks. This is in stark contrast to the trading strategy of the previous week.

Key data and trends

1. Continuous net selling of tech stocks: Fund managers have been net selling U.S. technology stocks for the third consecutive week. In particular, semiconductor and semiconductor equipment stocks saw the highest nominal net selling as of the week ending June 7, while software stocks saw the highest net buying.

2. Hedge fund strategy shift: At the end of May, chip stocks were still the darlings of hedge funds, while software stocks faced the fate of being sold off. However, just one week later, hedge funds began selling semiconductor stocks and started buying software stocks.

3. Market performance: The S&P Software and Services index recorded its best single-week performance since January, but its gain for 2024 is less than 6%, lagging behind the semiconductor sector and the overall market. The S&P 500 Semiconductors and Semiconductor Equipment index continues to hit new all-time highs, rising by about 67% year-to-date.

Expert Opinions

• Richard Ross, Senior Managing Director and Head of Technical Analysis at Evercore ISI: Currently, sentiment and positioning in the software market couldn’t be worse. He believes that any inflow of funds into the sector presents a positive opportunity to buy software stocks, but this does not mean semiconductor stocks should be reduced.

• Vincent Lin, Analyst at Goldman Sachs: The stance within the industry may change. The healthy rebound in the software business is being driven by profit improvements at computer security firm CrowdStrike Holdings Inc. and U.S. software company Guidewire Software Inc., as well as dynamics from oversold positions.

Market Outlook

Market observers are cautious about whether last week’s positioning adjustments represent tactical trading or a fundamental shift. Wil Tamplin, Senior Analyst at Fairlead Strategies, suggests that in the short and long term, semiconductor stocks still show strong upward momentum compared to software stocks, and there is currently not enough evidence to suggest a change in the technology sector’s leadership position.

Conclusion

The current market sentiment and strategies indicate that hedge funds are shifting from semiconductor stocks to software stocks, reflecting a reassessment of different sectors under the AI boom. As the market continues to adjust, investors will closely monitor the impact of these changes on their overall portfolios.

The reasons behind hedge funds and investors transitioning from chip hardware stocks to software stocks may include several factors:

1. Valuation and Profit Taking

• Valuation Pressure: Semiconductor stocks have risen significantly this year, especially driven by the prosperity of artificial intelligence (AI). This has led to relatively high valuations of semiconductor stocks, prompting motivations for profit taking.

• Profit Taking: Investors may wish to lock in some profits at highs, especially when semiconductor stocks have already experienced significant gains.

2. Market Rotation

• Sector Rotation: Market funds often rotate between different sectors. After the semiconductor sector has seen substantial gains, funds may flow towards sectors with relatively lower valuations and yet to fully rebound, such as software stocks.

• Oversold Condition: Software stocks may have been in an oversold condition previously, and investors believe they have bottomed out, presenting a rebound opportunity.

3. Performance and Prospects

• Expected Improvement: Despite some software companies falling short of expectations, the market anticipates that their future performance may improve. For example, signs of profit improvement from companies like CrowdStrike Holdings Inc. and Guidewire Software Inc. indicate a healthy rebound in the software industry.

• AI Applications: With further development of AI technology, the position and potential of software stocks in future AI application scenarios are gradually becoming evident. Companies like Datadog with clear visions and development plans in the AI field may attract investors.

4. Technical Analysis

• Technical Indicators: Technical analysis shows that software stocks have rebounded from oversold territory and show signs of breaking through the 200-day moving average, indicating a bullish outlook from a technical perspective.

• Risk Hedging: In high volatility markets, investors may seek diversified investments to reduce risks associated with single sectors, and shifting towards software stocks can be part of a hedging strategy.

5. Market Psychology

• Sentiment Shift: Changes in market sentiment can also lead investors to reassess their portfolios. With growing concerns about the sustained growth of semiconductor stocks, investors are turning to software stocks, which may be relatively subdued but have significant potential.

In summary, despite the recent underperformance of software stocks, investors may consider shifting towards software stocks as a more reasonable choice from various perspectives such as valuation, market rotation, technical analysis, and future prospects. This strategic adjustment reflects the dynamic changes in the market and investors’ expectations for future trends.

Investment Strategy for the Software Services Sector

• Opportunities in Adjusted Allocation: The recent sharp decline in the software services sector, coupled with doubts about the monetization prospects of AI, has led to a significant increase in the market value of hardware giants like NVIDIA. This indicates that the deployment of AI infrastructure will drive down computing power leasing prices, token and API prices in the second half of the year, thereby boosting growth on the software side.

• Long-term Allocation Opportunities: Recent observations show a decline in token call prices, a result of infrastructure development. After the stabilization of the phase adjustment, there will be a good opportunity for layout on the software services side. It is recommended to realize profits on the hardware side at this stage and lock in gains.

Strategic Recommendations: Seize the moment when others abandon

1. Profit-taking on hardware and AI infrastructure at highs: It is advisable to take profits on investment opportunities in the hardware sector and AI infrastructure, especially for leading companies like NVIDIA.

2. Bottom-fishing in the software services sector: Following the adjustment in the software services sector, it is recommended to bottom-fish for quality companies, especially those with strong R&D capabilities and market competitiveness.

3. Diversified Investment Portfolio: Maintain a diversified investment portfolio to cope with market fluctuations and spread risks.

With the deployment of AI infrastructure and the decrease in computing power costs, the software services sector will see growth opportunities in the second half of the year. We should closely monitor market dynamics, seize post-adjustment layout opportunities, and maximize returns.

Continued focus on IAAS giants and SaaS services on the application side: With the development and widespread application of AI technology, IaaS and SaaS companies are in a unique position to provide necessary computing resources and platform services to support enterprise AI transformation. They can not only derive direct economic benefits from this but also deepen cooperation with customers by promoting their success, achieving sustainable business growth. In the future, we can foresee that AI will become a key force driving further innovation and growth in the cloud computing and SaaS industries.