Software stocks have collapsed, and no one dares to "take the plunge" anymore.

The U.S. software sector experienced its worst sell-off since 2022 on Wednesday, but the “bottom-fishing funds” that typically jump in during tech stock crashes were notably absent.

After the S&P 500 Software and Services Index plunged nearly 4% on Tuesday, it declined another 1% on Wednesday, marking the sixth consecutive day of decline. Unlike previous market pullbacks, this sell-off failed to attract any obvious bottom-fishing buying.

Options traders are also avoiding software stocks, with trading flows indicating investors are increasing defensive positions rather than seeking buying opportunities. Even Microsoft, traditionally seen as a safe haven, has not been spared, with short sellers increasing their positions against it.

This sell-off in the software sector is the most severe since 2022. Rising interest rates in 2022 dealt a heavy blow to software stocks, but current market sentiment has shifted from valuation concerns to deep anxiety over AI technology potentially disrupting traditional software business models. The collective avoidance of buying on dips suggests the market’s view of the software sector may be shifting from a short-term correction to a structural revaluation.

Bottom-fishing funds go missing

Interactive Brokers Chief Strategist Steve Sosnick said that, in stark contrast to precious metals and semiconductors, their clients’ enthusiasm for bottom-fishing in software stocks is clearly lacking. “Overall, our clients are much less eager to bottom-fish in software stocks than in precious metals and semiconductors,” he said, “although some clients may be buying software stocks, it’s definitely not a focus of their trading activity.”

This cautious attitude is even more evident in the options market. Chris Murphy, Co-Head of Derivatives Strategy at Susquehanna Financial, pointed out that the software sector remains under pressure, with options trading flows still favoring defensive strategies.

In the options trading of the iShares Expanded Tech-Software Sector ETF and ARK Innovation ETF, traders are increasing their downside exposure rather than buying on dips. On Wednesday, IGV fell 3%, and the ARKK ETF plummeted nearly 7%. Murphy said that the overall tone of the software sector remains defensive.

Microsoft is the only bright spot, but short sellers are flocking

Sosnick noted that Microsoft is one of the few exceptions in the sector. Although not a pure software company, it still attracted some buyers. Since reporting earnings on January 28, Microsoft’s stock has fallen about 15%, but it rose slightly by around 1% on Wednesday.

However, even Microsoft has not escaped the hunt of short sellers. Leon Gross, a research analyst at S3 Partners, said that short sellers are encouraged by the sector’s sharp decline and are increasing their short positions even as the stock remains under pressure.

“Historically, Microsoft has behaved like a turnaround stock, with short sellers covering on the way down. But now, it’s acting more like a momentum-driven distressed stock, with short sellers adding to their positions as the price weakens,” Gross said. Data shows that Microsoft’s short positions increased by about 20% over the past week.

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