Software can't shake its reputation as the market's AI Achilles heel

• Software stocks had another difficult day in the market.
• One big reason was the release of a viral report that was bearish on AI, and software in particular.
• The sector can't seem to shake its reputation as the part of the market most vulnerable to AI.

Earlier this month, we wrote about how the software sector had been marked with the scarlet letter of AI disruption. We declared that no matter what it did going forward, it would always have to contend with the perception that it's a sitting duck.

Fast-forward a few weeks, and the picture for software has gotten even bleaker. The most popular ETF tracking the sector has tumbled to the lowest since 2023. Wall Street analysts are taking cleavers to their price targets in the space.

What's more, software has become the new lightning rod for risk-off AI aversion. If investors are in play-it-safe mode and rotating out of tech, they're dumping the group first and asking questions later. At this point, the sector's reputation precedes it.

This dynamic played out on Monday as software stocks sold off sharply as the ever-evolving US tariff situation sparked investor uncertainty. Throwing fuel on the flames was a viral blog post from Citrini Research laying out a drastic bearish scenario for the US market and economy.

I won't drag you into the ominous nitty-gritty of the Citrini report, but I will give you a brief summary. The firm lays out a thought-experiment scenario where AI drives large-scale white-collar displacement, which destroys consumer demand and triggers downturns in markets and the economy.

Not exactly the feel-good read of the year. But while the doomsaying was compelling, what struck me the most was how the blog post treated the decline of software as a foregone conclusion — a formative event for a grander AI bubble across many sectors.

As if the vibes around software weren't negative enough, the sector's narrative is now intersecting with another hot-button topic: private credit. Many of the software companies branded as vulnerable have significant debt loads. And a lot of that debt is due to private credit lenders. Citrini dedicated a whole section of its report to systemic credit risk.

Ben McMillan, the chief investment officer at IDX Advisors, told BI recently that he sees lax private-market underwriting as something that could eventually come back to bite.

Bigger picture, it's clear that software's role as the ringleader of the so-called AI "scare trade" is locked in — but it's far from the only member. Insurance brokers, real estate services companies, and wealth managers have gotten whacked in recent weeks. AI is a fickle, market-value-erasing beast.

But software should still be monitored closely. Its current role as a punching bag makes it even more important to watch as a bellwether of the AI trade.