3 factors that could get software stocks going again after a brutal stretch

The iShares Expanded Tech-Software ETF (IGV) plunged 24.3% in Q1, marking its worst relative underperformance versus the S&P 500 since 2002. Evercore ISI analyst Kirk Materne calls it "a quarter to forget" and outlines three themes that could eventually revive software stocks, but he cautions the sector faces a negative feedback loop and a quick turnaround is unlikely.

Analysis

Software’s selloff has created a classic liquidity/valuation death spiral: downgrades and guidance cuts force multiple compression and outflows, which in turn pressure discretionary renewals and new customer acquisition budgets. That mechanism disproportionately hits mid-cap and high-burn SaaS names with heavy S&M and sub-12 month cash runways, while increasing optionality for strategic buyers who can finance deals off stronger balance sheets.

Second-order winners are predictable but underappreciated: large cloud infra and security vendors that capture incremental spend as customers consolidate vendors to reduce TCO, and investment banks/M&A advisory shops positioned to monetize deal flow when budgets shift from growth to consolidation. Conversely, professional services firms that rely on new platform rollouts will see a lagged revenue collapse — creating an opportunity for vertically integrated software vendors to upsell maintenance and managed services.

Key catalysts that could break the loop are identifiable and time-boxable: a Fed policy pivot or clear easing in real rates (3–6 months) that re-rates long-duration cashflows; material enterprise AI budget approvals from 100–300 large buyers (6–12 months) that lift cohorts with strong product-market fit; or a visible M&A wave of tuck-ins that re-prices mid-caps into strategic multiples (6–18 months). Tail risks include persistent high rates and a macro hit that forces permanent churn and write-offs, which would extend the reset into years for weaker names.

For positioning, favor asymmetric exposures that buy the recovery optionality without paying full valuation for cyclical growth: long durable cash-generative software and advisory businesses, pair shorts on weak mid-cap SaaS, and use structured options to monetize elevated implied volatility on momentum names. Time horizons vary by idea — immediate liquidity trades (days–months), catalyst-driven selections (6–12 months), and structural consolidation plays (12–24 months).

Key Decisions for Investors

• Pair trade (3–6 months): Short IGV ETF vs long MSFT (size 1:0.6 by beta). Target 15–25% relative return if mid-cap SaaS continues to underperform; stop-loss at 8% relative adverse move. Rationale: hedge sector beta while owning durable cloud cashflow exposure.
• Event/sector hedge (0–6 months): Buy IGV 3-month put spread (10–15% OTM) to protect existing software exposure; fund by selling 1–2 month out-of-the-money calls on highest-convex single-name holdings. Risk: defined premium; reward: protection against accelerated downside from guidance shocks.
• M&A/alpha long (6–12 months): Long EVR (Evercore) stock or 12-month call (buy-write if preferred). Thesis: advisory fees & deal flow spike during consolidation; upside 25–40% on modest pickup in announced deals, downside ~20% in severe market selloff — use 12% stop-loss.
• Selective recovery long (6–18 months): Accumulate high-NRR (>120%), FCF-positive software names on 20–30% pullbacks (e.g., ERPs/security vendors). Position size concentrated and trailed — target IRR 30–60% if sector re-rates; cut positions if net retention falls below 100% or FCF turns negative.