Software Slump Probably Overdone and This ETF Could Rebound

Among the growth areas that are sagging this year are once-beloved software stocks, but some analysts believe the group has sold off too quickly and could be poised to rebound, a prediction that if accurate, would benefit the SPDR S&P Software & Services ETF (XSW).

XSW seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P Software & Services Select Industry Index, which comprises the following sub-industries: Application Software, Data Processing & Outsourced Services, Home Entertainment Software, IT Consulting & Other Services, and Systems Software.

Important to the XSW thesis is that many components are now trading below their one-year median price-to-earnings rations, which is relevant because the industry was widely viewed as expensive on the way up. Beyond compelling valuations, there are bullish demand factors to consider.

“However, demand for home entertainment and education software is likely to increase as people all over the world practice social distancing and stay at home,” said Matthew Bartolini, SPDR America’s head of research, in a recent note. “Additionally, as more businesses adopt a remote-work strategy as part of their business continuity plans, their reliance on cloud-based infrastructure services and system software will fuel demand for cloud-based enterprise solutions.”

XSW Tracking Method

XSW, which tracks the S&P® Software & Services Select Industry® Index, seeks to track a modified equal-weighted index which provides the potential for unconcentrated industry exposure across large, mid and small cap stocks.

XSW is an ideal play in today’s environment because many of its holdings have solid balance, something the coronavirus outbreak is forcing investors to pay more attention to.

“Although the pandemic is creating a more uncertain macroeconomic environment for Software & Services companies, their strong balance sheets and high-profit margins may help cushion temporary economic shocks,” said Bartolini. “The pandemic might also expedite the shift to cloud-based software solutions for many firms and send the industry growth of Software & Services companies on a growth trajectory path.”

Technology should contribute to a market rebound and the group now offers some value. Additionally, investors are looking to play more defense against volatility. Strong balance sheets help accomplish that objective.

Surging demand for enterprise software as well as cloud and Internet software applications are among the important fundamental factors expected to buoy the software industry in the years ahead.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.