Software stocks face the biggest short-selling wave since 2010; Goldman Sachs exclaims: The market is "nowhere to hide"!

U.S. software stocks are experiencing the most intense wave of short-selling in over a decade. According to data from Morgan Stanley, the daily short volume in the software and SaaS sectors on Wednesday and Thursday hit one of the highest levels since 2010, following a brief rally from short covering that quickly fizzled. Goldman Sachs’ trading desk described the market as exhibiting a panic sentiment of “sell first, ask questions later.”

Hedge funds restarted their short-selling strategies swiftly after a brief round of covering. Morgan Stanley's report shows that the newly added shorts from Wednesday to Thursday were only slightly below the historical peak on January 29, and new shorts in the software sector even exceeded the levels at the end of January. Infrastructure software stocks that had previously seen heavy short covering are now once again under heavy short-selling pressure.

Concerns about AI replacing human jobs are spreading to more sub-industries. Market sentiment was hit by the statement of Microsoft’s AI division CEO that “most white-collar positions will be replaced by AI in 12 months,” and transportation logistics company CH Robinson plunged eight standard deviations due to potential reduction of workforce needs from AI chatbots. The S&P 500 index fell about 1.55% overnight, marking its second largest drop in the past three months.

Defensive sectors are outperforming cyclical stocks at an accelerating pace, and Goldman Sachs’ cyclical-vs-defensive pairs trade recorded its worst two-day performance since “Liberation Day,” with cumulative losses exceeding 350 basis points over two days. The yield on the 10-year U.S. Treasury approached a three-month low of around 4.08%, the VIX index closed above 20, and risk aversion in the market intensified.

Goldman Sachs technology trading head Callahan said this is one of the most volatile trading environments he has seen. With the Russell Tech Index falling back to its 200-day moving average, many stocks in the tech/growth sectors are showing oversold signals, making it worth discussing which stocks are excessively discounted.

Morgan Stanley: Historic Short-Selling Wave Returns

Morgan Stanley, in its report titled “Hedge Funds Restart Shorts, Single-Day Software Shorts Reach Largest Increase Since 2010,” notes that hedge funds turned aggressively short on Wednesday and Thursday, reversing the recent trend of short covering in U.S. stocks. New shorts were highly concentrated in the software sector, ranking among the top five single-day increases in history since 2010.

The software and SaaS sectors have become the focal point for short-selling, with new shorts exceeding levels seen at the end of January. Infrastructure software stocks, which had previously seen substantial short covering, have not escaped renewed heavy short pressure. In contrast, long position reductions were limited, making overall net selling pressure still clearly weaker than the event at the end of January.

Morgan Stanley's data shows that last week marked a record for the largest single-stock short-selling in history. Although covering at the end of the week and early this week was intense, it lasted far less than expected. The market quickly shifted from a “dead cat bounce” rally to a new round of selling.

Goldman Sachs: Nowhere to Hide in the Market

The Goldman Sachs trading desk wrote in its closing summary: “There was nowhere to hide today, and the market was suffused with a ‘sell first, ask questions later’ mentality.” Selling accelerated at the close, and aside from AI concerns spreading to more sub-industries, there was no clear catalyst.

Some traders attributed the sell-off to a Financial Times report that Microsoft’s AI division CEO said “most white-collar positions will be replaced by AI within 12 months,” as “model programming capabilities have surpassed humans.”

Transportation logistics company CH Robinson became another pain point, with a stock price drop of eight standard deviations as the market debated whether the company would become a loser due to AI chatbots matching freight and boosting efficiency (reducing workforce needs).

Another Goldman Sachs trader previously noted, “The volatility has severely impacted market sentiment, and no one wants to bottom-fish (see CBRE, which reversed to decline intraday despite solid results).”

Index Plunge, Tech Stocks Widely Sold Off

The S&P 500 index fell about 1.55% overnight, marking its second worst performance over the past three months. Goldman Sachs’ cyclical-vs-defensive pairs trade recorded its worst two-day performance since “Liberation Day,” down more than 350 basis points in two days, with risk aversion becoming increasingly evident.

The 10-year U.S. Treasury yield dropped to around 4.08%, nearly a three-month low. Defensive sectors performed strongly, with Verizon up in 16 of the past 18 trading days. The VIX index closed above 20 again.

The market has become extremely sensitive and nervous about the potential “compound,” disruptive, and spreading impact of AI. Meanwhile, major tech AI spenders and computing power companies are also facing declining valuations—Amazon fell for eight consecutive days, down in 11 of 12 days, Google dropped on seven of eight days, Nvidia and Broadcom have remained flat since last summer.

Defensive stocks continue to break out (Verizon, AT&T, Johnson & Johnson, Walmart, etc.); “AI infrastructure” themes are diverging (Compute vs EMS vs Memory); “growth stocks” in software, internet, and payments are caught in highly correlated sell-offs (SaaS, fintech, e-commerce, advertising, gaming, marketplace platforms, etc.).

Is the Valuation Correction Overdone?

Goldman Sachs technology trading head Callahan said this is one of the most volatile trading environments he’s ever seen. From his perspective, during this earnings season and market backdrop, stock price movements are more about the narrative of the AI ecosystem (large language model updates, blogs, snippets of comments, etc.) than the earnings themselves.

The market is quickly pricing in perceived technological change, but now it's worth discussing whether the market is “too far ahead” in certain areas (i.e., stock price moves outpacing business changes). Callahan cited two company earnings calls as examples (Tyler Technologies and Take-Two Interactive, both have not returned to pre-earnings levels):

Tyler Technologies said in its earnings call:

“There’s a lot of noise in the market, but in the public sector, you can’t win by technology alone. For more than 25 years, Tyler has guided customers through waves of change, and our approach has always been consistent… Customers don’t want add-on tools that increase complexity. They want practical AI that is deeply integrated into existing systems, properly governed, and solves real problems in a reliable and trustworthy way.”

Take-Two Interactive, in response to questions about Google Genie, said:

“Frankly, I’m a bit confused—video game industry has been built on machine learning and artificial intelligence since its inception. We use technology to create games inside computers. Since generative AI emerged 18 months ago, I have been excited about what’s to come… This is just a small part of our work. If this product, this tool, comes to fruition, it will make part of our work better and more efficient.”

Callahan said that as the Russell Tech Index falls back to its 200-day moving average, many stocks in the tech/growth sectors show oversold signals, making it worth discussing which stocks are excessively discounted.

As a reference, large-cap technology stocks (the Mag 7) have lagged the market by about 7.5 percentage points over the past few months, a pullback driven by non- “market event” factors (previous 10%-12% corrections happened during market events).

Callahan is watching to see if the Mag 7 can stabilize, as a potential anchor for stability in tech stocks (catalysts include Nvidia/Broadcom earnings, conference season, GTC, etc.).

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