Have U.S. software stocks "bottomed out"? Goldman Sachs: This is just a "technical rebound."

US software stocks have seen a dramatic rebound recently, but Goldman Sachs believes this is just a technical short squeeze after being oversold, and fundamental concerns have not been alleviated.

Over the past two trading days, the IGV software ETF has surged strongly from its lows, leading to a simultaneous recovery in private credit-related stocks. Goldman Sachs trader Nelson Armbrust stated that he has received "a large number of inquiries about yesterday's software stock rebound"—although the Goldman Sachs software sector tracking index (GSTMTSFT) jumped 5.07% in a single day, it remains down roughly 25% year-to-date.

Rich Privorotsky, head of Goldman Sachs Delta One business, pointed out bluntly that the driving force behind this rebound may simply be an oversold correction: the divergence between software and hardware stocks had become "extremely extreme" last week.

However, Goldman Sachs also warned that the suppressive effect of AI on long-term profit margins and return rates in the software sector has not changed. This valuation pressure spans the entire market and is not unique to the software sector. Meanwhile, hedge funds’ positions in software stocks are approaching historical lows again, and short-selling power continues to dominate market structure.

Overselling triggers technical rebound

From a technical perspective, this rebound has certain pattern-based support. Goldman Sachs pointed out that the software sector remains about 30% to 35% below its November 2021 high, and history from the past two years shows that whenever the drop reaches this range, the sector often experiences a short-term rebound.

The relative strength index (RSI) of the Goldman Sachs software sector tracking index indicates that this rebound happened right at the edge of the oversold territory. However, Goldman Sachs notes that the index fell even further into an oversold zone earlier in February, which means the current technical signals have limited reference value.

Additionally, the market’s renewed scrutiny of "Mythos" technology breakthroughs has also helped fuel rebound sentiment to some degree. Privorotsky pointed out that the market has recently seen increasing debate as to whether Mythos is truly as disruptive as initially expected, and some investors have begun to question the so-called "Mythos legend."

Extremely bearish positions, short squeeze logic dominates

Goldman Sachs’ core view is: This round of rebound is essentially a "short squeeze" and not a fundamentally driven structural recovery.

Goldman Sachs Prime Brokerage data shows that software stock positions are again testing historical lows. Last week, the US information technology sector suffered the largest net sell-off in more than five years (in dollar terms), diverging from the mean by -2.9 standard deviations, ranking second over the past year, only behind September 2024. This round of net selling was primarily driven by short-selling, with a short-to-long sell ratio as high as 3.3 to 1.

Within the sector, selling of software stocks accounted for about 60% of the total net sell amount in information technology, and nearly all of it was driven by short-selling. Currently, the proportion of software stocks in the total net exposure of US equities has plunged from 7% at the beginning of the year to 1.4%; the long-short ratio has dropped from 2.0 at the start of the year to 1.14, both falling back near the historic lows recorded at the end of February this year.

AI suppresses valuation, fundamental concerns unresolved

Beyond technicals, structural pressures facing the software sector remain significant. Goldman Sachs notes that debate over AI’s effect on terminal valuation multiples for software stocks continues to heat up—AI’s rapid evolution is reducing market visibility for software companies’ long-term profit margins and capital return rates, making valuation pricing increasingly difficult.

Goldman Sachs emphasizes that this problem is not limited to the software industry, but rather is a systemic valuation challenge that affects the entire market. Against the backdrop of AI reshaping business models, investors are forced to broaden their prediction range for software companies’ future cash flows, raising the risk premium accordingly.

Overall, Goldman Sachs’ conclusion is quite straightforward: this round of rebound is nothing more than another "forced short covering" event. Once the market lacks sufficient short positions to squeeze, the rebound momentum will naturally fade.

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