Chip Stocks Lose Shine as Hedge Funds Snap Up Software Amid 67% Rally

Key Takeaway

• Hedge funds shifted from semiconductor to software stocks, with semiconductors being the most net sold and software the most net bought.
• S&P Software and Services index had its best week since January, while semiconductor stocks continue a 67% rally in 2024.
• Analysts see potential for further gains in both sectors, but semiconductors maintain strong upside momentum relative to software.

Hedge Funds Shift Focus

Hedge funds made a significant shift in their investment strategies last week, moving away from semiconductor stocks, which have been major beneficiaries of the artificial intelligence boom, and instead increasing their positions in software stocks. According to Goldman Sachs Group Inc.’s prime brokerage desk, fund managers net sold US technology stocks for the third consecutive week. Within the tech sector, semiconductors and semiconductor equipment stocks were the most notionally net sold for the week ending June 7, while software names were the most net bought. This marks a reversal from the previous week’s trading strategy.

Both sectors saw gains over the five-day span, with the S&P Software and Services index logging its best week since January. Despite this, the software gauge has lagged behind semiconductor peers and the broader market, with a less than 6% advance in 2024. In contrast, the S&P 500 Semiconductors and Semiconductor Equipment index continues to set all-time highs, boasting a roughly 67% rally this year.

Software Stocks Rebound

The recent shift in hedge fund positioning comes as software stocks showed signs of slower growth from AI, while semiconductor stocks soared on strong demand and confidence in companies like Nvidia Corp. and other chip stocks. Goldman’s Vincent Lin noted a "potential change of stance on an industry level," with the healthy bounce in software catalyzed by better earnings from CrowdStrike Holdings Inc. and Guidewire Software Inc., as well as oversold positioning dynamics.

Richard Ross, senior managing director and head of technical analysis at Evercore ISI, highlighted the positive chart signals for the software sector. "Sentiment and positioning in software couldn’t get much worse at this point," Ross said, adding that any flows into the group should be viewed as a positive buying opportunity for software rather than a chance to trim semiconductor holdings. Ross also pointed out that the software gauge recently neared a relative strength index reading that would have indicated a rebound was imminent and appears to have some support around its 200-day moving average.

Semiconductor Stocks' Momentum

Despite the shift towards software, semiconductor stocks still have strong upside momentum. Ross and other analysts believe that semiconductors are ready to break out again after three months of consolidation, positioning them for further growth both tactically and structurally. "Semiconductors still have strong upside momentum relative to software from short- and long-term perspectives, so there isn’t enough evidence of a shift in leadership within tech in our work yet," said Will Tamplin, senior analyst at Fairlead Strategies.

The broader tech rally, however, remains concentrated in a few AI winners amid an uncertain macroeconomic backdrop. An equal-weight version of the Nasdaq 100 Index has trailed its cap-weighted peer for seven consecutive weeks, the longest streak of underperformance since early 2020. Alec Young, chief investment strategist at Mapsignals, noted that for equal weight to perform better, there needs to be a sense that the Federal Reserve will cut rates. However, Friday’s strong jobs report dampened hopes for multiple rate cuts this year, with Fed swaps no longer pricing in a cut before December.

Street Views

• Richard Ross, Evercore ISI (Bullish on Software):

  "Sentiment and positioning in software couldn’t get much worse at this point. I would view any flows into the group as a positive buying opportunity for software (which we endorse), rather than opportunity to trim semiconductors which we continue to recommend."

• Vincent Lin, Goldman Sachs (Neutral on Software):

  "A potential change of stance on an industry level... The healthy bounce in software was catalyzed by better earnings from CrowdStrike Holdings Inc. and Guidewire Software Inc. as well as by oversold positioning dynamics."

• Will Tamplin, Fairlead Strategies (Bullish on Semiconductors):

  "Semiconductors still have strong upside momentum relative to software from short- and long-term perspective, so there isn’t enough evidence of a shift in leadership within tech in our work yet."