Why software leaders ServiceNow, Snowflake and UiPath came together today

Software leaders Service Now (NOW 3.04%), Snowflake (SNOW 3.85%)and UiPath (WAY 4.52%) rose on Friday, up 3.1%, 3.7% and 4.4% respectively in today’s trade.

There was no company-specific news today about these three enterprise software leaders. However, today’s strong jobs report, combined with still dovish comments from Federal Reserve officials, sent every stock higher.

Software stocks to benefit from a soft landing

The past few years of rising interest rates have been generally difficult for software stocks. While ServiceNow has impressively bucked the trend and rebounded strongly from the 2022 recession, Snowflake and UiPath are still down 62% and 76% respectively over the past three years.

NOW data by YCharts

Interest rates had a lot to do with it. When post-pandemic inflation kicked in and the Federal Reserve raised interest rates, it hit software stocks in more ways than one.

First, the rapid rise in interest rates caused companies, fearing a downturn, to pull back on software spending, especially since there was a huge amount of software adoption during the pandemic. Second, rising rates also disproportionately affected software stock valuations, as software stocks tended to trade at very high multiples of earnings or sales. Rising rates lower the present value of earnings far into the future, which has hurt multi-stock stocks like software. So software stocks were hit with a “double whammy” of slowing growth and sharply reduced valuations.

What could reverse the trend? Well, a “soft landing” where inflation and interest rates fall without recession would be the ideal scenario. Increased trust and employment could drive more software subscriptions or, in the case of the pay-as-you-go Snowflake model, more computing consumption. Meanwhile, lower interest rates would lift valuations.

Inflation has recently eased, prompting the Federal Reserve to cut the federal funds rate by 50 basis points last month on September 18. However, while some thought lower inflation could go hand in hand with a slowing economy, today’s September jobs report shattered expectations, with 254,000 jobs added, well above the forecast of 150,000 and up from the revised 159,000 jobs added in August.

Solid job growth and lower interest rates are the ideal environment for stocks in general, but for the rate-sensitive software sector in particular.

Of course, the hot jobs report could mean that inflation may not yet be subdued and could keep rates high. But Federal Reserve Governor Austan Goolsbee appears on Bloomberg TV today, said the strong jobs report does not mean inflation is rising. He still sees inflation returning to the Fed’s 2% target and also said there was no change in the outlook for further rate cuts over the next 12 to 18 months.

The next problem for software: AI disruption

While the interest rate and economic picture looks great for software stocks right now, there are still a few things to consider. First, while interest rates may soon return to a “neutral” rate, they likely won’t return to pandemic-era lows. So we shouldn’t expect software companies to recapture the inflated valuations they saw in 2020 and 2021.

Additionally, the AI ​​revolution has the potential to benefit or disrupt certain software companies. ServiceNow has done quite well because it serves as the link between companies’ private on-premises data and the external cloud, and can therefore serve as the manager of enterprise AI, incorporating outside LLMs as well. Interestingly, UiPath and Snowflake are more cloud-based, and while they’ve seen growth, they haven’t benefited as much from AI — at least not yet.

So while the interest rate picture is getting better for software, investors will have to choose which stocks will have AI as value-add and which could see increased competition due to the AI ​​revolution.