AI is injecting genuine uncertainty into software business models, and the share price reactions have been extreme. Today, we saw Xero (XRO) down –15.9%, WiseTech (WTC) -10.68%, Carsales (CAR) -7.36%, Technology One (TNE) -10.47% & REA Group (REA) -7.5% to name just a few, though pretty much all of tech was sold indiscriminately, after the same played out overnight in the US. Xero’s main competitor Intuit was off 12%, Saleforce –8%, Atlasian –8% and so on.
While we suspect the sell-off is too acute based on what we actually know today, with very little hard evidence yet of widespread displacement of traditional software platforms, momentum in markets go can further than many expect, particularly given the multiple year bull market for tech.
As we’ve highlighted before, building software with AI is one thing; maintaining it, updating it for regulation, and embedding it deeply into client workflows is another. On that front, AI isn’t there yet, but it’s clearly advancing quickly creating a lot of unknowns for existing software platforms – and markets are attempting to price that risk.
This is important because of the equity risk premium (ERP) — the extra return investors demand from equities over a risk-free asset such as government bonds. When uncertainty around future outcomes rises, the ERP rises with it. Higher ERP = lower valuations, all else being equal.
As risk increases at a stock or sector level, position sizes generally come down, and that mechanical de-risking creates selling pressure. That process is now washing through the technology sector.
So, what do we do?
We don’t pretend to know the ultimate impact AI will have on software, or how this plays out in the months ahead. As investors, we have two choices: hold our nerve, or take a more prudent path and reduce exposure while uncertainty is elevated.
For now, we’re leaning towards the latter, and will likely trim our exposure to technology-related positions. Not because we’re convinced of a dire outcome, but because visibility is low, risk premia is rising, and capital preservation matters. As always, our view can and will change as new information emerges, but for now, that’s our likely approach, with more detail to be provided in tomorrow mornings note.
