A significant sell-off in software stocks continues to ripple through the market. According to recent reports, as technology and software shares face intense selling pressure, short sellers have realized paper profits reaching approximately $240 billion (around 1.66 trillion yuan).

Data analytics firm S3 Partners indicated that hedge funds are increasing their short positions in major technology stocks, even as many leading companies within the sector have experienced substantial price corrections.

Short sellers have profited handsomely from a broad market rotation pressuring the technology sector since the beginning of the year, with the recent sell-off in software stocks exacerbating the situation. On the opposite side of these losses for long investors, short sellers have reaped substantial gains.

A report from S3 Partners revealed that short sellers have secured significant paper returns by betting that tech stocks would retreat from extremely high valuations. The firm noted that while short sellers had been targeting giants within the software industry throughout the year, they recently increased their short positions amid changing conditions and heightened market volatility.

S3 Partners stated, "Year-to-date, U.S. software stocks have provided short sellers with $240 billion in mark-to-market profits, while the sector has seen $1 trillion in market value evaporate."

The analytics firm highlighted several software stocks that have been persistently targeted by short sellers, including Microsoft, Amazon, Oracle, and Broadcom. Among these tech stocks, Microsoft was particularly notable, as short sellers' strategies towards the company shifted noticeably during its declining share price. "Historically, Microsoft traded more like a reversal stock, where shorts would cover during declines; now it behaves like a sentiment-driven problem stock, where shorts add to their positions on weakness," S3 Partners wrote.

Despite recent skepticism surrounding the artificial intelligence theme, S3 Partners believes the prevailing bearish sentiment is primarily concentrated in the software sector. Short interest in the Invesco QQQ ETF, which tracks the Nasdaq 100 Index, and in the "Magnificent 7" stocks as a group has not increased significantly.

However, S3 Partners emphasized that hedge funds continue to build larger short positions in major technology stocks, even after significant price corrections in many industry leaders. The firm stated, "There are clear signs of short positioning spreading; short interest in Microsoft is up 20% this year, Oracle has seen a 10% increase, while Broadcom and Amazon have experienced rises of 15% and 10%, respectively."

Wall Street's fervent pursuit of popular trades is fading—from tech stocks to gold and cryptocurrencies, the hottest investments are facing sudden capital outflows and a shift towards risk aversion.

Bloomberg pointed out that, unlike the panic-driven spiral before April of last year triggered by trade war fears, there is no single catalyst this time. Instead, a series of accumulating news events has sparked anxiety over valuations. Many investors, already skeptical that asset prices had risen too high, ultimately led to a concentrated withdrawal of funds.

Trading activity on Thursday in the U.S. stock market further illustrated this trend: the S&P 500 index fell 1.2%, marking its third consecutive day of decline, while the Nasdaq 100 index extended its deepest losses since April. Software stocks accelerated their decline after AI startup Anthropic introduced a new model designed specifically for financial research, marking the second time this week the company has stirred the market and highlighting the competitive threat posed by new technologies.

"Investors are clearly shifting to a defensive posture," said Brian Frank, President and Portfolio Manager at Frank Funds. "The current market environment feels more like selling first and asking questions later."

This sentiment starkly contrasts with the optimistic atmosphere on Wall Street at the beginning of the year. At that time, strategists predicted the stock market would experience its longest winning streak in nearly two decades, based on three key pillars: the ongoing AI boom, economic resilience supporting corporate earnings beyond expectations, and the Federal Reserve beginning an interest rate cutting cycle.

Recent robust corporate earnings reports suggest this fundamental outlook remains unchanged. However, the market has begun refocusing on multiple risks: potential displacement within the AI wave, policy shift risks if Kevin Warsh, nominated by former President Trump, were to replace Jerome Powell as Fed Chair, and concerns that elevated valuations for assets like gold, Bitcoin, and even tech giants like Alphabet may be unsustainable.

On Thursday, Dan Ives, an analyst at Wedbush Securities, commented that Wall Street is punishing software stocks like Salesforce, ServiceNow, and Microsoft as if they have become irrelevant in the AI era.

Discussing the persistent decline in software shares, Ives said in an interview, "I can tell you, in the last 25 years, I have never seen a structural sell-off in software like this." He added that investors are treating software companies as if "software is dead in today's AI world." He further noted that these valuations suggest some companies might lose about 5% of their customers.

While Ives acknowledged that AI is impacting the software industry, he described the view that the software sector has become obsolete as exaggerated. He pointed to Palantir Technologies as an example of a company demonstrating that software can still achieve success in the current era.

Previously, at the Cisco AI Summit, Nvidia CEO Jensen Huang also dismissed concerns about software becoming outdated. He called such views illogical, stating that AI relies on software and is not a replacement for it.