Investors Shift Focus from Chip Stocks to Software in AI Revolution

(Reuters) – U.S. chip stocks, once the shining stars of last year’s artificial intelligence investment boom, are facing significant challenges in 2023. As the market dynamics shift, investors are increasingly looking towards software companies as the next big play in the AI landscape.

Market Dynamics: From Chips to Software

The volatility driven by tariffs and a dimming demand outlook have led to a notable shift in investor sentiment. The emergence of lower-cost AI models from China’s DeepSeek has particularly impacted the semiconductor sector, prompting a rotation in investment strategies. David Russell, the global head of market strategy at TradeStation, noted, “There has been a pretty clear rotation in part due to DeepSeek, the semiconductor outperformance last year, and restrictions on U.S. chip exports to China.” This shift highlights the evolving nature of AI investments.

ETF Inflows Reflect Changing Preferences

According to Morningstar data, the iShares Expanded Tech-Software Sector ETF has attracted over $1.87 billion in inflows this year through February 28. In stark contrast, both the iShares Semiconductor ETF and the VanEck Semiconductor ETF experienced more than $1 billion in outflows each. This trend indicates a growing preference for software over traditional semiconductor investments.

Furthermore, the inflows to the IGV fund have already surpassed last year’s total net inflows of $446 million, as reported by VettaFi. In comparison, the iShares and VanEck chip ETFs had pulled in $2.46 billion and $6.55 billion, respectively, in 2024. This data underscores the significant shift in investor focus towards software solutions.

The Evolution of AI Investment Strategies

Adam Turnquist, chief technical strategist at LPL Financial, emphasized that this shift is a natural progression in AI investing. He stated, “The use cases for the technology are primarily in software, and we are now starting to see the ascendancy of the software part of the equation.” As the second stage of the innovation cycle unfolds, companies are beginning to utilize AI products, leading to increased revenue for software firms.

Competition and Profitability Challenges

Brian Mulberry, a portfolio manager at Zacks Investment Management, pointed out that DeepSeek’s lower-priced chatbot has underscored the competitive pressures facing direct-to-consumer AI products. This competition may drive down profits for these companies, while enterprise software firms could find it easier to monetize new technologies. Mulberry has even trimmed his holdings of Nvidia since last June, reflecting the changing landscape.

Stock Performance: A Broader Selloff

Despite the growing interest in software, major players like Microsoft and Salesforce have faced declines of 4.9% and 12.6%, respectively. This downturn is attributed to a broader selloff in U.S. stocks, coupled with the fact that AI returns have yet to make a significant impact on corporate balance sheets. Valuations remain high, with Microsoft and Oracle trading at approximately 27 and 23 times forward earnings, respectively, compared to Nvidia’s 24.6.

Conclusion: The Future of AI Investments

As the AI landscape continues to evolve, the shift from chip stocks to software companies marks a significant turning point in investment strategies. Investors are now prioritizing software solutions that can effectively leverage AI technology, indicating a promising future for this sector. For more insights on this topic, check out the original article here.