Software stocks suffer worst day in 10 months, widening the gap with hot chip stocks

By Emily Bary

A look at the best and worst S&P 500 stocks this year shows how tech investors have piled into semiconductor plays and bailed on software

ServiceNow's stock got hit hard after earnings.

The technology sector's great divide has only gotten starker this earnings season.

Chip stocks have been some of the hottest in the S&P 500 SPX this year, while software stocks have been among the weakest - and Thursday's dramatic escalation of the software selloff underscores the deeply pessimistic view Wall Street has taken of the sector.

Heading into Wednesday's earnings reports from Microsoft (MSFT) and ServiceNow (NOW), a Mizuho trading-desk analyst joked about whether things could really get much worse for the beaten-down software sector. But on Thursday, he revisited that idea, writing in a note to clients that "maybe it can actually get a lot worse."

Don't miss: Why Microsoft's stock is getting punished after earnings

Investors have worried that software companies, despite their own efforts to integrate artificial-intelligence features, could get disrupted by free or low-cost AI tools. Software companies have been spending up on AI development, but Wall Street isn't sure those investments are appropriately translating into revenue. So far, the financial benefits of AI are more apparent in the chip sector, catalyzing a rotation out of software stocks.

The reports from Microsoft and ServiceNow - and SAP (SAP) the next morning - did little to soothe investors.

"The beats needed to either be really good, or the guides needed to be really good," Klein wrote. "Otherwise, investors expected the worry and fear of AI threat and risk to remain a [dead] weight on sentiment and multiples across the sector."

While Microsoft saw 38% constant-currency growth in its Azure cloud-computing business for the December quarter, Klein said that the lack of acceleration relative to the September quarter meant investors were left unconvinced that the company's heavy AI spending will improve growth prospects.

And when factoring in contributions from acquisitions, ServiceNow's outlook wasn't as robust as some investors wanted "given all their AI and spend on acquisitions," Klein wrote.

See also: ServiceNow says AI is 'really kicking in' - but it's not enough to help the stock

Shares of Microsoft and ServiceNow were two of the S&P 500's weakest performers on Thursday, with each down about 10%. Shares of SAP, which came up short on its cloud backlog, were down more than 15%.

That weakness rippled through the software sector. Salesforce shares (CRM) were off more than 6%, while Workday (WDAY) shed over 7% and Figma shares (FIG) were down 10%. The iShares Expanded Tech-Software Sector ETF IGV declined nearly 5%.

Intuit (INTU) and ServiceNow shares are the S&P 500's worst performers this year, with both down nearly 25%. Shares of Workday, Salesforce and AppLovin (APP) also rank in the bottom 10.

Meanwhile, some of the best performers are stocks in the chip sector or adjacent to it, including S&P 500 leaders Sandisk (SNDK), Western Digital (WDC) and Seagate Technology Holdings (STX). Micron Technology (MU), Lam Research (LRCX), KLA (KLAC), Applied Materials (AMAT) and Intel (INTC) are also among the top 10.

-Emily Bary

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