Adobe (ADBE.US) earnings report before AI anxiety heavily burdens software stocks: Wall Street cautious of new wave of selling frenzy.

The recent rally in software stocks has proven to be short-lived. Due to persistent concerns about the disruptive impact of artificial intelligence (AI), investors are preparing for a new round of selling. The iShares Expanded Tech-Software Sector ETF (IGV.US), which tracks the software sector, surged 16% in the early days of this month driven by strong earnings reports, briefly turning positive for the year. However, this momentum came to a halt on June 1st. The ETF has now fallen for seven consecutive trading days, erasing all gains. During this period, the software sector has been the worst-performing sector in the S&P 500 index. The IGV is down over 12% for the year, while the S&P 500 index has risen by 7.9% during the same period. Mike Bell, Head of Market Strategy at RBC BlueBay Asset Management, stated: "Even though we have seen such weakness, we believe there is further downside. The issue is not only whether software companies can maintain their previous growth rates, but they are facing a real existential threat - when AI can do these jobs itself, software products may become unnecessary." Software stocks have been under harsh scrutiny by the market this year. Pressure from start-up companies like Anthropic and OpenAI has led to a widespread withdrawal of funds from this sector, consequently lowering the earnings multiples of software stocks - a metric that was once among the highest in the technology sector. On Tuesday, Anthropic released a new version of its Mythos AI model, causing the IGV to drop by 2.8%, further exacerbating market concerns. Bell said: "When the range of uncertainty is so large, traditional valuation measures are not as useful. It's fair to say that the current uncertainty is much higher than in the past." Despite this, data compiled from the market shows that the performance of software stocks in this earnings season remains encouraging: 90% of software companies in the S&P 500 have exceeded earnings expectations, compared to 82% for the entire index. Bank of America analysts wrote in a report to clients on June 8th that software companies featured at the Bank of America Global Tech Conference earlier this month "displayed a continued optimism overall." Standout companies include Snowflake Inc. (SNOW.US), Datadog Inc. (DDOG.US), DigitalOcean Holdings Inc. (DOCN.US), and JFrog Inc. (FROG.US), all of which reported strong performance, demonstrating their solid position in the software ecosystem. Cybersecurity has also been a major highlight this year. The next earnings report worth watching will come from Adobe Inc. (ADBE.US), scheduled for release after the market closes on Thursday. The software maker, focused on creative professionals, is considered one of the companies most at risk of AI disruption, as AI tools have already shown impressive capabilities in image generation. Adobe's stock has fallen by 32% year-to-date, and its post-earnings performance has been lackluster - with 9 out of 11 previous earnings releases resulting in declines. Last quarter, long-time CEO Shantanu Narayen announced he would step down, raising doubts about the company's ability to successfully navigate the AI transformation. Following this round of selling, Adobe's valuation is relatively cheap - with a price-to-earnings ratio of less than 10 times (based on expected earnings), compared to an average price-to-earnings ratio of around 30 times over the past decade. Nevertheless, investors are still hesitant to enter the market. Fiona Ker, portfolio manager at Ruffer with assets under management totaling around $26 billion, said: "It's hard to imagine what Adobe's moat is, which means it looks like a company that could be displaced." She has started building positions in beaten-down software stocks like Salesforce, Inc. (CRM.US), but remains cautious about Adobe. The expected IPOs of OpenAI and Anthropic could also pose pressure on traditional software stocks. Anthropic, the developer of the chat Siasun Robot & Automation Claude, could potentially go public as early as October, while OpenAI is reportedly eyeing a listing in the fall. Bell from RBC BlueBay said: "These IPOs could have a direct impact, as investors seek to avoid losers in the AI field and over-weight companies with the potential to perform well. These are clearly potential winners that everyone is willing to allocate to." Ker from Ruffer believes that companies with large enterprise clients that may face legal or compliance issues when switching suppliers are more likely to inspire confidence in their prospects. She said: "The boundaries of AI capabilities are constantly evolving, and if you're trying to infer what sustainable growth looks like from that, that's a big problem. But when I look at these software stocks, I see attractive combinations of free cash flow yield and valuation multiples below market averages. It's an enticing opportunity, and I think you're being compensated for this uncertainty."