Soft Software
Software may not have the quickest gains, but they should have lasting gains
I see a lot of people remaining very negative on software. That’s very normal, really. Human behavior is effectively the source of momentum. When something is down, people hate it, and software, while well off lows, is still -12% YTD, while the market is up 9%. Eww.
Further, most people are pretty short-term oriented, for better or worse. Is software the best place for traders when you can potentially make big profits trading quantum, semis, or solar stocks? Probably not. Honestly, with liquidity still looking great, software is not the obvious pick for short-term gains.
With a face only a mother could love, why do I keep promoting software, of late? For starters, I think time horizon is important. For example, some of our biggest holdings are in semiconductor stocks, even after trimming the positions. That’s been a great place to be, and while they got somewhat overheated about a week ago, I don’t see a great reason why the upside shouldn’t continue. However, after a 60% rise to start the year, and more than doubling over the last year, how much longer can semiconductors continue to dominate returns?
But why software? Ideally, I think you want to have a portfolio with multiple time horizons and multiple themes. Semiconductors have been great and the returns have been huge but at some point, that game will stop. What happens then?
To me, that’s where software comes in. We’ve accurately made money over past months by saying liquidity should support high beta stocks. That doesn’t last forever and tends to sow the seeds of its own doom. Eventually, these liquidity rushes can fade, and growth can get replaced by something like cash flow as a source of returns. When liquidity inevitably fades, software may be a leading place to run.
In general, this is just what we do. When we bought stocks like DOW and INTC, we bought them in part because they were priced like their companies’ returns were never going to get better. In both cases, we had massive returns when investor attitudes changed. Similarly, software has terrible sentiment even though the vast majority of the businesses still look quite good and the trend no longer seems to be down.
As I’ve said before, if you want outsized returns, you have to take some risk. I like the risk of software because the businesses largely remain solid and investors seem to be selling them on potential future problems and weak trailing returns. In the event worst-case scenarios fail, I like my odds. Buying fear and despondency can work quite well, particularly if you’re careful.
Ultimately, we’re different from most in that we look for long-term returns that can get beneficial tax treatment. In the short-term, there are probably better places for quick gains. However, if you want to sleep at night and consider what stocks can perform over the next year, as fortunes change, software seems like a reasonable place to be.