Why software leaders ServiceNow, Snowflake and UiPath gathered today

Software leaders ServiceNow (NOW 3.04%), Snowflake (SNOW 3.85%)And UiPath (PATH 4.52%) rose 3.1%, 3.7% and 4.4% respectively in day trading on Friday.

There was no company-specific news today about these three enterprise software leaders. However, today’s solid jobs report, coupled with still muted commentary from Federal Reserve officials, sent all stocks higher.

Software stocks benefit from a soft landing

The past few years of rising interest rates have generally been tough for software stocks. While ServiceNow has impressively managed to buck the trend and rebound strongly after the 2022 recession, Snowflake and UiPath are still down 62% and 76%, respectively, over the past three years.

NOW data by YCharts

Interest rates had a lot to do with it. When post-pandemic inflation took off and the Federal Reserve raised rates, it affected software stocks in several ways.

First, rapidly rising interest rates caused companies, fearing a recession, to scale back their software spending, especially since there had been a huge amount of software adoption during the pandemic. Second, rising interest rates also have a disproportionately negative impact on software stock valuations, because software stocks tended to trade at very high earnings or revenue rates. Rising interest rates reduce the present value of earnings well into the future, hurting stocks with high share prices, such as software. So software stocks were hit with a “double whammy” of slowing growth and sharply depressed valuations.

What could reverse the trend? Well, a “soft landing” in which inflation and interest rates fall without a recession would be the ideal scenario. More trust and more staff could lead to more software licenses or, in the case of Snowflake’s pay-as-you-go model, more computing. Meanwhile, lower interest rates would increase valuations.

Inflation has been declining lately, prompting the Federal Reserve to cut the Federal Funds Rate by 50 basis points last month on September 18. While some thought lower inflation could go hand in hand with a slowing economy, today’s jobs report shows. exceeded expectations, adding 254,000 jobs, well above the forecast of 150,000 and up from the revised 159,000 jobs added in August.

Solid job growth and lower interest rates provide the ideal environment for equities in general, but especially for the interest-rate-sensitive software sector.

Of course, the hot jobs report could mean that inflation has not yet been subdued and could keep interest rates high. But Federal Reserve Governor Austan Goolsbee showed up Bloomberg TV said today that the strong jobs report does not mean inflation is rising. He still sees inflation returning to the Fed’s 2% target and also stated that there is no change in the outlook for sustained rate cuts over the next twelve to eighteen months.

The next problem for software: AI disruption

While the interest rate and economic picture looks great for software stocks right now, there are still a few things to consider. First, while interest rates are likely to return to “neutral” levels soon, they are unlikely to go all the way back to the pandemic-era lows. So you shouldn’t expect software companies to reach the inflated valuations of 2020 and 2021 again.

Furthermore, the AI ​​revolution has the potential to benefit or disrupt certain software companies. ServiceNow has done quite well because it serves at the intersection of enterprises’ private on-premise data and the external cloud, and can therefore serve as a steward of enterprise AI while also integrating external LLMs. Interestingly, UiPath and Snowflake are more cloud-based, and while they’ve seen growth, they haven’t benefited as much from AI – at least not yet.

So while the yield picture for software gets much brighter, investors will have to be picky about which stocks will have AI as value-add and which stocks may face more competition from the AI ​​revolution.