US Stock Market: Software stocks brace for more volatility as AI uncertainty grows

US software stocks have endured a turbulent year, with AI-driven uncertainty and the growing use of momentum-based and leveraged trading strategies amplifying price swings across the technology sector, Reuters reported.

The S&P 500 software and services index has moved sharply in both directions after reaching a record high on October 28. The index subsequently lost more than 33% of its value by April 10, with selling accelerating after an Anthropic product launch in January raised concerns among some investors that advances in artificial intelligence could make parts of the traditional software industry obsolete.

The sector later rebounded 33% during a broadly strong first-quarter earnings season before another sell-off and partial recovery during the second-quarter reporting season. The index remains down more than 3% for the year and more than 12% below its October peak.


Investors are now turning their attention to upcoming results from Salesforce and CrowdStrike, followed by Oracle in mid-September. The earnings will provide fresh clues on whether software companies can continue to deliver growth as AI reshapes the competitive landscape.

According to Reuters, the sharp swings in software stocks are also being driven by trading strategies that can reinforce existing market momentum. Momentum traders typically buy stocks that are rising and sell those that are declining, potentially intensifying moves that have already been triggered by fundamental developments.

The latest rally illustrates that dynamic. Microsoft, the largest company in the software and services index and one of the world's biggest publicly traded companies, gained 29% over eight sessions following its July 29 earnings report.

Strong quarterly results have provided fundamental support for the sector, but investors remain divided over how much of the recent rebound reflects improving business prospects and how much has been driven by trading momentum, Reuters reported.

The use of leveraged exchange-traded funds and short-dated options has added another layer of volatility. Leveraged ETFs can provide investors with two times the daily return of individual stocks or indexes, while some products offer three times the daily move of major indexes.

The leveraged ETF market has expanded rapidly. Morningstar data cited by Reuters showed that the number of single-stock leveraged or inverse ETFs rose to 486 from just 28 at the end of 2023. Around 40 of these products are linked to software infrastructure companies, while another 23 are focused on software application firms.

These funds generally rebalance their exposure to the underlying assets at the beginning of each trading day. Such activity can magnify short-term market movements, particularly in stocks already attracting heavy momentum-driven trading.

The expansion of derivatives and leveraged products has therefore made software stocks increasingly sensitive to shifts in investor positioning. When momentum strengthens, additional trading activity can push prices higher, while a reversal can accelerate declines.

The ETF market is also seeing an influx of new products. Reuters reported that Corgi Investments, a newcomer to the industry, has launched a range of inverse ETFs tied to individual stocks and indexes, including 11 products linked to individual software companies such as Microsoft, Oracle, AppLovin and ServiceNow.

Despite the market volatility, underlying earnings have remained relatively strong. Based on reported results and estimates, the software and services index is on track for aggregate second-quarter earnings growth of 24.4%, compared with the 16.4% growth expected on July 1 before the earnings season began, according to LSEG data cited by Reuters.

However, strong earnings have not eliminated concerns about the sector's longer-term outlook. Investors remain focused on how quickly AI capabilities are evolving and whether new AI tools could disrupt established software business models.

The key question for software stocks is increasingly whether earnings growth can keep pace with elevated market expectations. If companies continue to post strong results and demonstrate that AI is creating new revenue opportunities, the sector could find further support. But any evidence that AI is eroding demand for traditional software products could trigger another sharp reassessment of valuations, Reuters said.

With momentum trading, leveraged products and options activity adding to price movements, software stocks could remain particularly volatile even when underlying corporate results are relatively healthy.

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