(Bloomberg) — There’s been a big change among technology investors in the past month: Software stocks are hot, while semiconductor makers are not.
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Wall Street is exiting the chip sector, deterred by high valuations and trade war-related risks under Donald Trump. The president-elect has already been an outspoken critic of the Chips Act and vowed Monday to impose additional tariffs on China, Canada and Mexico. Software, on the other hand, is on the rise. Investors are bullish on the group given its lower exposure to rate risk, and as the AI tailwind appears to be shifting from infrastructure to services.
“Software has lagged behind, but looks set to be AI’s next winner, while it could also benefit if the new administration were more lenient on regulations and M&A,” said Bill Stone, Chief Investment Officer at Glenview Trust Co . “There is so much good news in chips, especially AI chips, that valuations have become steep at a time when there is more uncertainty.”
Recent earnings reports underscore the shift in sentiment. Shares of data analytics software company Snowflake Inc. (SNOW) soared on robust forecasts as demand for AI software fueled Palantir Technologies Inc.’s blowout report. fueled. In contrast, even Nvidia Corp.’s strong results could (NVDA) does not excite investors.
So far in November, a major exchange-traded fund that tracks software is up 16%, putting it on track for the biggest one-month gain in a year, though it was flat on Tuesday. A semiconductor fund, meanwhile, is up less than 2% this month. Flows into the software ETF have also far eclipsed the chip fund, according to data from Bloomberg Intelligence.
This outperformance represents “an all-time record move for software versus intermediates,” said Michael Toomey, director of equities trading at Jefferies. Still, the shift “barely leaves a mark on the 10-year chart” of their relative performance, suggesting there is room for the trend to continue, he said.
The extent of the rotation will depend on how things play out under Trump. Sean O’Hara, president of Pacer ETF Distributors, sees “a lot of uncertainty for chipmakers around the pricing side of things.” That has created the potential for volatility, especially as chip stocks have already had a big AI-related rally. “At the same time, I think we’ll see more focus on AI software,” he said.
So far, the AI theme has benefited chipmakers far more than software companies, with companies pumping money into the chips and servers they need to run the technology. Meanwhile, only a few software companies – such as Palantir, (PLTR), Microsoft Corp. (MSFT) and Oracle Corp. (ORCL) – significant AI-related tailwinds known. But software and services could be the next place to see a sea change in AI growth.
At the same time, the fact that chip makers are the first big beneficiary of the AI business has made it look expensive. The Philadelphia Semiconductor Index trades at 24 times estimated earnings, above the 10-year average of 18, with stocks like ARM Holdings Plc and Nvidia among the most expensive. That could mean more downside risks if headwinds emerge, while Nvidia’s report suggests even bigger moves could be needed for the sector to continue rising.
To be sure, semiconductor stocks remain a hot growth spot. Chip companies’ profits are expected to grow 40% by 2025, compared with about 12% for those in the software and services sector, according to Bloomberg Intelligence. Sales growth is also expected to be much stronger for semiconductor companies.
The next big test for software will come in early December, when Salesforce Inc. reports the results. The company has been hiring aggressively to promote its new generative AI agent product, and strong results from the company will help support the sector’s rally, said Jordan Klein, technology sector specialist at Mizuho Securities.
“After the election, generalist and technology investors face the struggle to own a lot more software (and fintech) and a lot less intermediates,” he wrote. “If you miss these moves, some people end up in a bad place.”
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