By Sam Goldfarb

Software companies' pitch to investors could use an upgrade.

Once a favorite of Wall Street, software stocks have been sliding lately, with investors increasingly concerned about how the sector could be upended by their newest crush: artificial-intelligence companies.

Rocked by the emergence of "vibe coding" -- the practice of using AI tools to quickly produce apps and websites -- software heavyweights Salesforce, Adobe and ServiceNow are all down at least 30% since the start of last year.

An S&P index of small and midsize software stocks is also down more than 20% over that period, with declines accelerating this month after the introduction of Anthropic's Claude Code, an AI tool that industry insiders have said can dramatically shrink the time it takes to build even complex software.

At a time when many investors are wondering if the AI investment boom itself might be a bubble, software's slump is a reminder of how quickly fortunes can change on Wall Street.

"The narrative has really shifted," said Rishi Jaluria, a software analyst at RBC Capital Markets.

Investors, he said, have gone from initially thinking that software companies could benefit from AI to asking, "Is AI just the death of software?"

Investors will gain insight into the overall state of the tech sector in the coming week, with Apple, Meta Platforms and Microsoft set to report earnings. The Federal Reserve will also meet, though it isn't expected to change interest rates.

Just a few years ago, it was software, not AI, that was at the center of an investing frenzy.

Over the previous decade, the sector had seemingly made good on Marc Andreessen's promise that software would come to "eat the world." Fueling its rise was the growth of high-speed internet and cloud computing, in which software companies could rent storage space from the likes of Amazon.com rather than own data centers themselves.

Software startups blossomed to serve every niche imaginable, from helping yoga studios handle scheduling and billing issues to securing businesses from cyberattacks.

Once seen as volatile, software came to be viewed by Wall Street as the paragon of stability, because businesses seemed loath to switch products once they became embedded in their workstreams. Investors also liked the emergence of multiyear subscription contracts that offered steady revenue.

Not only did software stocks soar, the sector became the center of a credit boom, with debt investors eagerly funding a surge of private-equity buyouts. The pandemic only supercharged the dynamic, thanks to the move to remote work and a drop in interest rates, which made it even easier to borrow money.

But enthusiasm began to wane with the rate increases in 2022 and the shift back to the office. For debt investors, software companies also began to look less invincible, with competitive pressures and highly leveraged balance sheets driving more businesses into distress.

Before this decade, software defaults were practically unheard of, partly because lending to software companies was so new. But in the past two years, 13 software companies have defaulted on loans that were broadly syndicated to investors, including both traditional defaults, such as bankruptcies, and out-of-court restructurings known as liability management exercises, according to PitchBook LCD.

One of those companies was Quest, the maker of OneLogin software that authenticates employees logging into their work platforms. Bought by Clearlake Capital in early 2022 with the help of $3.6 billion in loans from investors, the company benefited from the shift to remote work but was pressured by the weight of its debt and competition from the likes of Okta, a larger, publicly traded company. It struck a debt-restructuring deal with lenders last June.

Default rates for software loans are still lower than they are for buyout loans generally, and investors have hardly abandoned the sector. Still, the extra yield, or spread, that investors demand to hold software loans over a benchmark short-term interest rate has ticked higher over the past 15 months, even as overall loan spreads edged lower, according to PitchBook LCD.

"The investor base is definitely scrutinizing these software names much more closely," said Vince Flanagan, a portfolio manager and senior leveraged-finance research analyst at Seix Investment Advisors.

The emerging threat from AI has only added to that caution. The big risks are that existing software companies could face increased competition from new entrants and that businesses could develop more software themselves rather than paying specialists for it.

In reality, few investors and analysts think that software companies will become obsolete in the foreseeable future. The more pressing risk is that it could become more difficult to increase revenue, as customers experiment with other options rather than paying more for the usual updates and add-ons, RBC's Jaluria said.

Ultimately, Jaluria said, AI could damage "fat, lazy incumbents" while helping others that are innovative and can use AI to improve their products.

Uncertainty about the future of software is compounded by the fact that investors lack answers to basic questions about what the emerging AI industry will look like.

Excitement over AI has played a major role in propelling stocks to new records in recent years, with investors especially eager to buy the stocks of so-called AI hyperscalers like Alphabet and Microsoft. Investors, though, have grown more discerning in recent months in choosing what stocks to buy even among those companies.

As companies start borrowing heavily to fund the build-out of AI infrastructure, debt investors have also taken a more cautious approach than they once did with software companies -- forcing big-spending companies like Meta and Oracle to pay high interest rates on new bonds relative to their credit ratings.

"Investor sensitivity is high," said Rich Gross, a senior fixed-income analyst at Columbia Threadneedle Investments.

Investors, he added, are asking "are these investments sustainable? Are they going to be profitable? Are there going to be cash flows, or will there not be?"

Write to Sam Goldfarb at sam.goldfarb@wsj.com

(END) Dow Jones Newswires

January 25, 2026 05:30 ET (10:30 GMT)

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