CITIC Securities: The current rebound in the U.S. software sector is supported by fundamentals, and AI commercialization provides new growth momentum

According to the Zhitong Finance APP, CITIC Securities released a research report stating that the recent performance of the US stock software SaaS sector has been weak, and the market has begun to worry about the sustainability of the current recovery in software sector demand. The analysis believes that the current recovery in software sector demand is significantly different from the impulse rebound in Q4 2023, with more solid fundamental support behind it, mainly including the improvement of macroeconomic expectations in the US after the election, the elimination of policy uncertainties, the accelerated introduction of AI Agents, the opening of interest rate reduction channels, and the natural clearing of demand bubbles during the pandemic. Over the next 12 to 24 months, the firm views software SaaS as the top pick in the US technology sector and recommends focusing on: foundational software with outstanding performance elasticity, application software with rapid AI Agent introduction, and information security sub-sectors expected to benefit from the network firewall update cycle.

CITIC Securities' main viewpoints are as follows:

Report Origin: The market is concerned about the sustainability of the current recovery in US stock software SaaS demand.

Since October 2024, the overall performance of the US stock software sector has been outstanding, with the IGV.ETF (North American Software Services) accumulating a gain of 16.9% from October 2024 to date, significantly outperforming the market benchmark during the same period, as well as the outstanding performance of the US semiconductor sector in the first half of the year. However, since December, the persistent stickiness of US inflation, the Federal Reserve's hawkish stance on the subsequent interest rate reduction path, and the conservative guidance from a few companies have led the market to begin worrying about the sustainability of the current recovery in the US stock software sector demand. The firm believes that the dynamic changes of factors such as technological innovation, macroeconomic expectations, policy uncertainty expectations, and corporate funding costs at different times jointly shape the scale and structure of corporate IT investment, which are also the core factors affecting the sustainability of software demand recovery.

Q4 2023: Inflation rebound and weak fundamentals lead to a fleeting demand recovery.

The firm found that the rebound in the performance of US software companies in Q4 2023 was mainly due to the market's expectation of a decline in inflation at that time, while the IT budgets accumulated by European and American companies in the first half of the year were released in Q4, creating a significant illusion in the market. However, entering 2024, the still stubborn inflation levels, high interest rate environment, and various uncertainties in an election year have slowed the recovery process of corporate IT spending. At the same time, the surge in software spending during the pandemic and the rapid growth of employee seats have also forced companies to digest and integrate their historical orders, with "conservatism" becoming the main theme of performance guidance for most software companies in 2024.

In addition, with the development of AI technology, companies are continuously increasing their investments in the AI field, which will erode other software spending when overall IT spending tightens. However, the monetization process of AI in software companies is slow; as of Q2 2024, most software companies have not disclosed clear contributions from AI, making it difficult for corporate investments in AI in the first half of 2024 to quickly translate into performance. Under the combined effect of these factors, the software sector performed weakly in H1 2024.

Q4 2024: The current demand recovery has more solid fundamental support. Based on a comprehensive analysis of macroeconomic and industry factors, the bank assesses that this round of demand recovery has significant differences compared to Q4 2023. On the macro front, following the conclusion of the elections, the policy direction in the United States has gradually become clearer, bringing higher certainty to the economy and markets, significantly boosting market confidence, and leading to continued improvement in economic expectations. Although the pace of interest rate cuts has slowed, the overall trend of funding costs remains downward, providing support for capital-intensive industries.

In terms of industry demand, based on statements from software companies in their Q3 2024 earnings reports and average guidance levels, the bank has observed significant signs of improvement in the current spending environment's market expectations compared to the same period last year. Considering that corporate spending trends often have sustainability once the direction is clear, the bank believes that U.S. enterprise software spending has gradually entered a recovery cycle.

Regarding AI, unlike the difficulty in measuring the return on investment for AI Assist products in the first half of 2024, AI Agent has gradually gained market recognition in the second half of 2024 due to its clearer ROI model. By significantly lowering the barriers for enterprises to adopt AI technology, it provides quantifiable efficiency improvements and cost savings, marking a key step in the commercialization of AI applications. Breakthroughs by representative companies in this field also bring new growth momentum to the U.S. software sector in 2025.

Risk Factors:

Risks of AI core technology development and application scenario expansion falling short of expectations; risks of continued tightening of policy regulation in the technology sector; risks of tightening policy regulation related to private data; risks of global macroeconomic recovery falling short of expectations; risks of macroeconomic fluctuations leading to lower-than-expected IT spending by European and American companies; potential ethical, moral, and user privacy infringement risks associated with AI; risks of corporate data breaches and information security; risks of intensified industry competition, etc