Key Points
UBS lowered its outlook on the U.S. IT sector on Tuesday, striking a more cautious tone as it warned of “mixed investor reactions” to high capital expenditure and AI disruption. The Swiss investment bank downgraded the sector to neutral from attractive, citing three key reasons, including investors becoming more selective toward tech stocks, a rotation away from the sector, and fears that AI will replace software tools. The sell-off in software stocks was triggered by AI firm Anthropic releasing new AI tools that it said could handle professional workflows, which many traditional software companies sell as core products. Tech stocks rallied Monday as investors were hopeful the market could sustain its upward advance after the sell-off. The S & P 500 Software & Services Index, which has 140 constituents, was up around 3% on Monday. UBS noted that “software uncertainty could linger,” as well as competition increasing for software companies. This makes it difficult for investors to “have conviction in the growth rate and profitability of firms in the software industry,” UBS said in a note. “The amount of revenue being generated by AI at the moment doesn’t stack up relative to the amount being spent,” Mark Hawtin, head of global equities at Liontrust Asset Management, told CNBC’s “Squawk Box Europe” on Tuesday. “So that’s just creating a picture out into the future, which is way more uncertain, way harder to predict, and investors don’t like unpredictability.” UBS also outlined that cloud service providers are reaching an unsustainable level of capital expenditure, which could be an “overhang” for investors, especially as spending is increasingly being funded by “external debt or equity financing,” it wrote in the note. Hawtin also told CNBC’s Steve Sedgwick and Ben Boulos that the spending plans of many Magnificent Seven companies have been a cause for concern. The four biggest hyperscalers, Alphabet , Microsoft , Meta , and Amazon , are set to spend almost $700 billion combined on AI this year. Amazon expects to spend $200 billion this year and is therefore looking at negative free cash flow of nearly $17 billion in 2026. “If I’m an investor, and I’m being offered $60 billion of cash flow today versus some cash flow in the future as a result of that spending, that creates uncertainty, and I should pay less for that,” Hawtin said. “So the key for me with many of these Mag Seven names is that the risk has increased. They’re becoming very capital-intensive. We don’t know what the outcome of that capital expenditure is going to be, and therefore, we should pay less for them.” The final reason UBS cited for the downgrade was that “tech hardware valuations look full,” signaling that stocks are becoming increasingly expensive for investors. Investors should diversify exposure UBS clarified that ultimately the downgrade doesn’t reflect a “negative view on technology as a whole,” but stressed that there are more opportunities in AI than just in the tech and IT sectors. “We do think investors should review current exposures to U.S. technology or diversify exposures that are above benchmark level… investors should also review concentrated exposures to individual software firms, and particularly those ‘pure play’ companies that do not have diversified business models,” UBS said. The bank recommended that investors diversify towards areas like banks, healthcare, utilities, communication services, and consumer discretionary.
