Important points
UBS struck a more cautious tone on Tuesday, lowering its outlook for the U.S. IT sector and warning of “mixed investor reactions” to heavy capital spending and AI disruption. The Swiss investment bank downgraded the sector from “attractive” to “neutral,” citing three main reasons: investors’ increasing selection of tech stocks, rotation out of the sector, and concerns that AI will replace software tools. The decline in software stocks was triggered by the release of a new AI tool by AI company Anthropic that it says can handle professional workflows that many traditional software companies sell as core products. Tech stocks rose on Monday as investors hoped they could sustain gains after the market plunge. The S&P 500 Software & Services index, made up of 140 constituent stocks, rose about 3% on Monday. UBS said competition among software companies will intensify and “software uncertainty may persist.” This makes it difficult for investors to be “confident about the growth rates and profitability of companies in the software industry,” UBS said in a note. “Right now, the amount of revenue being generated by AI is not proportional to the amount of spending,” Mark Hawtin, head of global equities at Liontrust Asset Management, told CNBC’s “Squawk Box Europe” on Tuesday. “So it’s just creating an image of the future, which is much more uncertain and much harder to predict, and investors don’t like unpredictability.” UBS also outlined that cloud service providers’ capital expenditures have reached unsustainable levels, potentially creating an “overhang” for investors, particularly as spending is increasingly financed by “external debt and equity financing.” Hawtin also told CNBC’s Steve Sedgwick and Ben Boulos that the spending plans of many Magnificent Seven companies are cause for concern. The big four hyperscalers, Alphabet, Microsoft, Meta, and Amazon, plan to invest a combined nearly $700 billion in AI this year. Amazon expects to spend $200 billion this year, resulting in negative free cash flow of nearly $17 billion in 2026. “If I’m an investor and I’m offered $60 billion in cash flow today compared to some future cash flow as a result of that expense, that creates uncertainty and I should pay less for it,” Hawtin said. “So what’s important to me about many of these Mag Seven names is that the risk is increasing. They’re becoming very capital-intensive. We don’t know what the outcome of that capital expenditure is going to be, so we need to pay less for them.” UBS’s final reason for the downgrade was that “valuations for high-tech hardware look full,” suggesting that the stock is becoming increasingly expensive for investors. Investors need to diversify their exposure UBS ultimately clarified that the downgrade did not reflect a “negative view of technology as a whole,” but stressed that there are more opportunities in AI than just the technology and IT sectors. “We believe investors should review their current exposure to U.S. technology or diversify their exposure above benchmark levels…Investors should also review their concentrated exposure to individual software companies, particularly ‘pure business’ companies without diversified business models,” UBS said. The bank recommended investors diversify into sectors such as banking, health care, utilities, communications services and consumer discretionary.
