US stocks erupt with AI panic! Anthropic's new tool triggers software stock sell-off, Reuters drops over 20% intraday

AI startup Anthropic launches new automation tools on Tuesday, triggering a market panic sell-off in software stocks, with all three major U.S. stock indexes falling across the board. During the session, the S&P 500 index once dropped more than 1.6%, the Nasdaq Composite’s decline widened to about 2.4%, the Nasdaq 100 also fell over 2%, and the Dow Jones Industrial Average dipped nearly 1.2%. This round of selling broke the market’s rebound momentum from Monday, with the Nasdaq and S&P retreating from recent highs.

In Tuesday’s sell-off, legal software and data services companies were hit hardest. Thomson Reuters (TRI) plunged as much as 20.7% during trading, LegalZoom.com (LZ) also fell over 20%, the London Stock Exchange Group’s UK shares declined 12.8%, its US pink sheets dropped over 10% intraday, and CS Disco (LAW) also fell over 10%.

The iShares Expanded Tech-Software Sector ETF (IGV), which tracks the tech software sector, hit a daily low, falling 5.6% intraday, marking its sixth consecutive losing day, with a total decline of over 14% in six days. Since January, this ETF has declined about 15%, its worst monthly performance since 2008.

Investors are concerned that the core business of software companies is facing the threat of being replaced by AI technology. Morgan Stanley analysts like Toni Kaplan pointed out in research reports that Anthropic’s new features for the legal field have intensified industry competition, “We see this as a sign of increased competition, which could have a negative impact.”

Panic sentiment has also spread to business development companies (BDCs), including Blue Owl Capital Corp., whose stocks declined amid growing worries about companies with large software industry exposure. Media reports indicate that such industry turbulence fears have triggered shocks in the global credit markets, leading to a broad decline in loan prices for software company syndicate loans last week.

The performance of the software sector during earnings season has also lagged behind the overall tech industry. Data compiled by media shows that among the S&P 500 software component companies that have reported earnings so far, only 71% beat Wall Street revenue expectations, compared to 85% for the overall tech sector.

Stephen Yiu, Chief Investment Officer of Blue Whale Growth Fund, said, “This year will be critical in determining whether companies are AI winners or victims. The key skill is to avoid the losers. Before the dust settles, standing against AI is a risky move.”

Software stocks face SaaS apocalypse sell-off

Wall Street’s pessimism toward software stocks has evolved from cautious to apocalyptic panic. Jeffrey Favuzza, a trader on Jefferies’ equity trading team, said, “We call it ‘SaaSpocalypse,’ the end of Software as a Service (SaaS) stocks. The trading style is entirely ‘get me out fast’ type of selling.”

Tuesday’s anxiety was further fueled after AI startup Anthropic released productivity tools aimed at in-house legal teams. The tools caused legal software and publishing stocks to plummet, with selling pressure sweeping across the entire sector.

This concern has been brewing for months. In January, Anthropic launched Claude Cowork, significantly intensifying fears of industry disruption. Last week, video game stocks also got caught in the sell-off after Alphabet announced Project Genie, a tool that creates immersive virtual worlds from text or image prompts. The S&P North America Software Index has fallen for three consecutive weeks, dropping 15% in January, its largest single-month decline since October 2008.

Favuzza said, “I ask clients, ‘Where is your breaking point?’ Even with a large-scale capitulation sell-off, I haven’t heard any clear answers. People are just selling everything, regardless of price.”

This concern has also spread to private equity. On Tuesday, media reports indicated that firms including Arcmont Asset Management and Hayfin Capital Management are hiring consultants to review potentially impacted businesses in their portfolios. Apollo has nearly halved its direct lending fund’s software exposure from about 20% at the start of the year.

Anthropic’s Unique Advantages Spark Market Worries

Anthropic is one of many AI startups developing tools for the legal industry, but its unique position has heightened market concerns. Long before Anthropic launched its plugins, startups like Legora and Harvey AI had already been using tools claiming to free lawyers from heavy workloads, flooding the legal industry. Over the past two years, investors have poured large sums into AI products for the legal sector, with Harvey AI valued at $5 billion last June, and Legora raising $1.8 billion in October.

What sets Anthropic apart is its ability to build its own models tailored to industry-specific needs. As a leading model developer, its position in the AI ecosystem gives it a disruptive edge over traditional legal news, data services, and emerging legal AI companies. Companies like Legora rely on foundational models developed by Anthropic and others.

On its plugin website, Anthropic offers legal tools that automate tasks like contract review and legal briefs. The site states: “All outputs should be reviewed by a licensed attorney.”

Other products launched last week, such as Alphabet’s Project Genie, have also fueled sell-offs. Yiu said, “This year is about defining whether companies are AI winners or victims, and the key skill is to avoid the losers.”

Microsoft’s Slump Highlights Industry Dilemma

Even tech giants are not immune to AI skepticism. Microsoft reported solid earnings last week, but investors focused on slowing cloud sales growth and re-evaluated its AI spending, causing its stock to plunge 10% last Thursday, with a further intraday drop of over 3% on Tuesday, marking the fourth consecutive day of declines.

January was Microsoft’s worst month in over a decade. Meanwhile, earnings reports from ServiceNow and SAP have given investors more reasons to remain cautious about the growth prospects of software companies.

Thomas Shipp, head of stock research at LPL Financial, which manages $2.4 trillion in brokerage and advisory assets, said, “The fear brought by AI is increased competition, pricing pressure, and a shallower competitive moat, making it easier to be replaced by AI. Their growth range is widening, which makes it harder to assign fair valuations or see what’s cheap.”

These AI-related concerns prompted Piper Sandler to downgrade ratings on software companies like Adobe, Freshworks, and Vertex on Monday. Analyst Billy Fitzsimmons wrote, “We are concerned that seat compression and vibe coding narratives could set upper limits on valuation multiples.” Vibe coding refers to using AI to write software code.

Despite all software stocks beating earnings expectations this earnings season, concerns about long-term prospects make this almost irrelevant. According to Bloomberg data, only 67% of S&P 500 software companies have exceeded revenue estimates so far this season, compared to 83% for the overall tech industry.

Palantir Becomes a Bright Spot

Despite the broad market decline, most S&P 500 components still rose. FedEx, seen as an economic indicator, continued its record-breaking rally, and Walmart’s market cap surpassed $1 trillion.

Steve Sosnick, Chief Strategist at Interactive Brokers, said, “The US stock market is experiencing sector rotation. The tricky part is whether this is healthy reallocation or a sign of potential instability.”

Among AI concept stocks, big data analytics company Palantir Technologies surged against the trend. The company announced after the close on Monday that its Q4 revenue grew 70%, surpassing Wall Street expectations, and provided an exceptionally strong full-year revenue outlook. Its stock closed nearly 7% higher on Tuesday.

Some professional investors see the sell-off in software stocks as an opportunity. The European open-end fund Sycomore Sustainable Tech, which outperformed 99% of peers over the past three years, bought Microsoft shares during the downturn, expecting the company to ultimately become an AI winner.

Microsoft’s current valuation appears attractive, with a forward P/E ratio below 23, the lowest in about three years. Technically, its 14-day relative strength index (RSI) is in oversold territory. More broadly, the software index’s valuation multiples are at multi-year lows, and its RSI also indicates oversold conditions.

Jonathan Krinsky, Chief Market Technician at BTIG, wrote in a client report last week that the software sector “may be oversold enough to bounce.” However, he added, “a recovery and establishing a new base will take a long time,” and “given the deterioration in relative strength that accelerated in Q4 last year, we are not optimistic about software.”

The key question for investors is to distinguish AI winners from losers. Clearly, some companies will thrive, meaning their stocks are effectively on sale after recent drops. But it may be too early to tell who will be the winners.

Favuzza from Jefferies said:

“A pessimistic view is that, in terms of development prospects, the software industry will become the next print media or department store. Market sentiment is so extremely tilted toward selling everything that some very attractive investment opportunities will emerge. We are all waiting for growth to accelerate, but when I look ahead to 2026 or 2027, it’s hard to see upside. If even Microsoft is struggling, imagine how bad it could get for those more vulnerable to disruptive tech or lacking market dominance.”

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