Market Performance and Sector Dynamics
The software sector experienced notable volatility in the first quarter of 2026, with the iShares Expanded Tech-Software Sector ETF (IGV) declining 20% year-to-date despite a 4% quarter-on-quarter recovery. This performance significantly lagged the S&P 500’s 8% gain, reflecting investor concerns about higher capital expenditure guidance and a rotation towards AI infrastructure plays.
Within the ETF, performance diverged sharply across different software categories. Cybersecurity leaders Palo Alto Networks (PANW) and CrowdStrike (CRWD) outperformed, alongside data analytics companies MongoDB (MDB) and Snowflake (SNOW). However, traditional software-as-a-service (SaaS) companies faced significant pressure, with Palantir declining 40%, Adobe falling 44%, and Salesforce dropping 43% amid SaaS derating and concerns about agentic AI disruption.
Fundamental Strength Persists
Despite market pessimism surrounding potential AI disruption, the underlying fundamentals of the software sector remain robust. SaaS companies delivered their strongest revenue performance in 14 quarters, with last-12-months revenue growth accelerating to 17% year-on-year in the first quarter of 2026, representing a 4.4 percentage point improvement from the previous year.
Large-cap SaaS companies demonstrated particular resilience, maintaining 17% year-on-year growth while preserving superior profitability metrics. This performance suggests that market leaders have experienced limited disruption from AI technologies, contrary to broader market concerns about sector-wide displacement.
Investment Strategy and Outlook
Phillip Securities Research maintains an OVERWEIGHT rating on the software sector, focusing on three key areas positioned to benefit from AI adoption: SaaS infrastructure, cybersecurity, and data analytics. Top stock picks include Microsoft, Oracle, Palantir, and Palo Alto Networks, supported by strong AI and cloud adoption trends, robust demand visibility, and growing cybersecurity requirements.
The current valuation environment presents opportunities, with large-cap SaaS companies trading at EV/Sales ratios of 9.5 times, representing the negative one standard deviation level despite rising software revenue and net income. The strategy emphasizes companies that provide essential AI infrastructure, maintain mission-critical cybersecurity functions, and offer data analytics capabilities crucial for enterprise AI implementation.
Frequently Asked Questions
Q: How did the software sector perform in Q1 2026 compared to the broader market?
A: The IGV software ETF fell 20% year-to-date despite a 4% quarter-on-quarter rebound, significantly underperforming the S&P 500's 8% gain and remaining 25% below its September 2025 peak.
Q: Which software companies outperformed during this period?
A: Cybersecurity companies Palo Alto Networks (PANW) and CrowdStrike (CRWD) led gains, with PANW becoming the ETF's largest holding, whilst data analytics stocks MongoDb (MDB) and Snowfalke (SNOW) also outperformed the broader software sector.
Q: What were the worst-performing software stocks?
A: Traditional SaaS companies faced the most pressure, with Palantir declining 40% YTD, Adobe falling 44%, and Salesforce dropping 43% due to SaaS derating and agentic AI concerns.
Q: How strong are the fundamental metrics for SaaS companies?
A: SaaS fundamentals remain resilient with LTM revenue growth accelerating to 17% YoY in Q1 2026, up 4.4 percentage points from a year ago and representing the strongest pace in 14 quarters.
Q: What is the investment recommendation for the software sector?
A: The research maintains an OVERWEIGHT rating on software, favouring SaaS infrastructure, cybersecurity, and data analytics as key AI beneficiaries, with top picks being Microsoft, Oracle, Palantir, and Palo Alto Networks.
Q: How are large-cap SaaS companies performing relative to AI disruption concerns?
A: Large-cap SaaS companies delivered 17% YoY growth whilst maintaining superior profitability, suggesting limited AI disruption impact among market leaders despite broader market concerns.
Q: What is the current valuation level for large-cap SaaS companies?
A: The EV/Sales ratio for large-cap SaaS is currently trading at 9.5 times, which represents the negative one standard deviation level, despite rising software revenue and net income.
Q: Why does the research favour SaaS infrastructure, cybersecurity, and data analytics?
A: These sectors are direct beneficiaries of AI spending as infrastructure provides the backbone for AI deployment, cybersecurity remains mission-critical as AI expands attack surfaces, and data analytics is essential for turning enterprise data into AI outcomes.
This article has been auto-generated using PhillipGPT. It is based on a report by a Phillip Securities Research analyst.
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