AI's Disruptive Impact Sweeps the Market: Software Stocks Suffer Trillion-Dollar Plunge and Industry Bad Loans Surge

In the three years since ChatGPT entered the mainstream, there have been numerous sell-offs triggered by artificial intelligence (AI), but none compare to the market crash that swept through the stock market this week.

First, the speed and breadth of this downturn are astonishing. In just two days, the value of stocks, bonds, and loans of companies big and small across Silicon Valley evaporated by hundreds of billions of dollars. Software stocks bore the brunt, plunging so sharply that the value tracked by the iShares ETF for software stocks shrank by about $1 trillion over the past seven days.

Moreover, unlike many previous major slumps, this decline was not triggered by bubble concerns, but rather by fears that AI is about to disrupt the business models of numerous companies—something doomsayers have long warned these firms are at risk of.

"I don't think this is an overreaction," said Michael O’Rourke, Chief Market Strategist at Jonestrading. "For two years we've been talking about how AI will change the world and that it's a cross-generational technology. In the past few weeks, we've seen its impact in practice."

On the surface, the spark for this selloff may seem insignificant: AI startup Anthropic PBC released a new tool for legal work, such as contract review. For the company itself, this product was not considered a disruptive innovation. However, over the past year, Anthropic's coding tools have helped transform software development, so this four-paragraph announcement drew significant market attention.

"Today it might be legal tech, tomorrow it could be sales, marketing, or finance," said KeyBanc analyst Jackson Ader.

Beyond investor unease, even companies long seen as primary beneficiaries of the AI boom are showing signs of strain. Alphabet Inc. indicated in its earnings report that AI capital expenditures would exceed expectations, while Arm Holdings Plc issued revenue guidance that fell short of forecasts. Both stocks declined in after-hours trading.

"What started as just selling software stocks is now a broad selloff," said Gil Luria, Managing Director at D.A. Davidson. "The decline is self-perpetuating: as stocks fall to a certain level, negative effects are triggered, and then others follow suit and sell."

Credit Market

As the disruptive threat of AI rapidly drives credit market repricing, software debt has also been sold off, pushing about $10 billion in related loans into distressed territory.

According to industry research compilations, more than $17.7 billion in U.S. tech company loans tracked by a Bloomberg index have fallen to distressed levels in the past four weeks, the lowest since October 2022. The majority of this debt comes from software-as-a-service (SaaS) companies, bringing the tech sector's total distressed debt to about $46.9 billion. With AI replacing tasks such as coding and data analysis, the SaaS sector is seen as particularly vulnerable.

In the "SaaS Doomsday," companies whose debt has dropped to distressed levels include bonds from healthcare software company FinThrive and loans held by Perforce Software. Others nearing distress include leveraged loans held by Dayforce, a Thoma Bravo company providing human resources management software, and leveraged loans held by call center technology firm Calabrio.

Jack Parker, portfolio manager at Brandywine Global Investment Management, said this is a "shoot first, ask questions later" moment. "It's undoubtedly painful for the sector: investors are selling across the board with little attention to how much disruption AI will actually cause these companies, or how long that disruption will take."

Editor: Yu Jian SF069