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Software stocks: Citi survey shows 'further signs of potential weakening demand'

Pummeled software stocks may not get much of a reprieve as signs emerge on another leg down in demand from big corporations.

A new survey of CIOs from Citi on Thursday found that IT spending trends continue to trend downward, led by growing weakness out of Europe. IT budget growth expectations ticked down to a 1.8% rate from 2.2% growth in June, when Citi ran the last survey. The increase is well shy of the 5.4% growth rate peak notched in September 2021.

"We believe that the survey indicates further signs of potential weakening demand," Citi analyst Tyler Radke wrote.

IT demand is weakening.
IT demand is weakening. (Citi)

A more cautious tone around software demand reflects the economic headwinds hammering C-suites at the moment.

The Dow Jones Industrial Average (^DJI), S&P 500 (^GSPC), and Nasdaq Composite (^IXIC) remain stuck in double-digit percentage declines for the year as the Federal Reserve aggressively raises interest rates to beat back inflation.

Economic growth as measured by Gross Domestic Product (GDP) contracted in the first half of the year, and many Wall Street economists have pegged the U.S. to enter recession by early 2023 if it isn't already in one currently.

A stronger U.S. dollar, meanwhile, has weighed on market sentiment and the top and bottom lines of multinationals, causing many to rethink their investment plants.

Stubbornly high supply chain costs are also doing no favors for corporate budgets.

In turn, software stocks — once a market darling fetching major valuation premiums — have been shredded this year amid the dimming outlook for growth. The Invesco Dynamic Software ETF (PSJ) is down 31% year to date, worse than the roughly 25% drop for the S&P 500.

"CFOs have a lot of power right now," Salesforce co-CEO Bret Taylor told Yahoo Finance Live at the company's Dreamforce conference recently. "People are focused not just on top-line growth, like they were for the past few years, but also bottom-line growth. ... It’s obviously a more measured environment, but I think technology is the solution."

The logo of U.S. software company Palantir Technologies is seen in Davos, Switzerland, May 22, 2022. Picture taken May 22, 2022.   REUTERS/Arnd Wiegmann
The logo of U.S. software company Palantir Technologies, which is down 55% so far in 2022, is seen in Davos, Switzerland, May 22, 2022. (REUTERS/Arnd Wiegmann)

Citi's Radke does see a few winners in the more muted demand backdrop that Taylor suggested.

"For consumption-based software solutions, we saw a similar pattern to last quarter with >80% of respondents indicated their spending is tracking consistent to better than last year," Radke explained. "We believe this offers signs of relative cloud consumption stability and could be a slight positive for MSFT, SNOW, MDB, CFLT, ESTC, and DDOG."

Brian Sozzi is an editor-at-large and anchor at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.

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