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U.S. software enters a critical debate over whether a major comeback is possible

Institution
Barclays
Date
2026-07-31
Authors
Raimo Lenschow, CFA, Saket Kalia, CFA, Eamon Coughlin
Company
-
Ticker
-
Industry
U.S. Software
Rating
U.S. Software Positive
BullishLow confidenceBarclays maintains a Positive industry view on U.S. Software, believing that valuation and positioning offer rebound potential, although insufficient organic growth catalysts and the strong momentum in semiconductors remain the primary obstacles to sustained software outperformance.
AuthorsRaimo Lenschow, CFA, Saket Kalia, CFA, Eamon Coughlin
CoverageUnited States
Asset classesEquity
Business segmentsSoftware - Application、Software - Infrastructure、Observability、AI infrastructure、Cloud software
Research firm divisions/subsidiariesBarclays（Other）

AI summary card

U.S. software enters a critical debate over whether a major comeback is possible

The report argues that software valuations are low and short positioning is elevated, creating room for a rebound, but a genuinely sustained rally still requires accelerating organic growth, realized AI revenue contributions, and overcoming competition from semiconductor capital momentum.

Barclays’ industry view on U.S. Software is Positive; the report discloses Datadog as Overweight/Positive, Microsoft as Overweight/Positive, and Snowflake as EqualWeight/Positive.
U.S. softwareAIcloud computingvaluation recoveryKubernetesObservabilityMicrosoftDatadogSnowflake
  • The software sector has recently posted a significant rally, prompting investors to revisit whether the sector is “coming back.”
  • Low valuations and elevated short positioning create conditions for a rebound, but the lack of clear catalysts continues to limit its durability.
  • Microsoft’s 4Q26 results showed Azure growth accelerating to 43% YoY cc, providing a positive example of cloud and AI demand translating into results.
  • The semiconductor sector remains strong relative to software, and the AI infrastructure build-out theme continues to attract capital.
  • Datadog’s performance is viewed as potentially benefiting from Kubernetes adoption and observability demand driven by AI workloads.

Report interpretation

Overview

This Barclays weekly review of the U.S. software industry focuses on whether the sector’s recent rebound is sustainable. The report notes that software valuations are below historical averages and short positioning is above historical levels, creating potential for an upward recovery. However, the sector still lacks clear catalysts capable of driving sustained rerating, particularly as accelerating organic growth at SaaS companies and AI-related revenue contributions have yet to materialize broadly.

Core views

The report’s core view is that the software sector has a foundation for a rebound, but there is not yet enough evidence to confirm a broad-based comeback. Positive factors include compressed valuations, light investor positioning, short-squeeze risk, and favorable share-price reactions from companies such as Microsoft and Snowflake after delivering results. Constraints include insufficient growth catalysts, an early-stage SaaS recovery, and continued market momentum in semiconductors driven by the AI infrastructure build-out theme.

Analysis framework

The report cross-validates the conditions and obstacles for a rebound in U.S. software through industry valuation, short positioning, relative performance of IGV and SOX, recent earnings events, cloud and AI infrastructure data, web-traffic trends, and Kubernetes observability demand.

Methodology notes

  • relative_valuationEV/NTM Revenue multiple comparison

    relative valuation recovery

    Uses the software sector’s EV/NTM revenue multiple relative to historical levels to assess whether valuation has room for mean reversion.

  • positioningshort_interest_analysis

    short positioning and squeeze risk

    The report views elevated short positioning in software as potential fuel for a rebound, but does not equate it with fundamental improvement.

  • cross_asset_relative_performanceIGV versus SOX comparison

    relative momentum between software and semiconductors

    Compares IGV and SOX performance over the month to date, three months, year to date, and since the release of ChatGPT to assess whether capital is rotating from the AI infrastructure theme toward the software application layer.

  • alternative_dataweb_traffic_and_pypi_trends

    alternative indicators of software demand

    The report cites web traffic, total visits, unique visits, and PyPI data from Raimo’s Trend Spotter to observe demand trends for software companies.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

  • IGV
    Representative ETF and relative-performance proxy for the U.S. software sector
    Strengths
    Low valuations, elevated short positioning, and room for recovery if AI application revenue materializes.
    Weaknesses
    Lack of clear catalysts, with accelerating organic SaaS growth still at an early stage.
    Comparison
    It remains behind SOX year to date and since the release of ChatGPT.
    Risks
    Continued semiconductor attraction of AI infrastructure capital could delay the recovery in software valuations.
  • SOX
    Reference for relative momentum in the semiconductor sector
    Strengths
    AI infrastructure construction remains a core market theme, and overall momentum remains strong.
    Weaknesses
    The report cautions that past performance does not necessarily represent future returns.
    Comparison
    It remains ahead of IGV across multiple time periods.
    Risks
    If the market shifts toward monetization in the AI application layer, the semiconductor sector’s relative advantage could narrow.
  • MSFT
    Positive example of cloud and AI demand translating into results
    Strengths
    Accelerating Azure growth, improving M365 Commercial Office performance, Copilot emerging as a new growth driver, and continued capital discipline.
    Weaknesses
    The share price had previously underperformed year to date.
    Comparison
    Relative to some hyperscalers, the report considers Microsoft’s investment discipline stronger.
    Risks
    If AI-related growth or the free cash flow target fails to materialize, valuation support could weaken.
  • DDOG
    Beneficiary of Kubernetes and observability trends
    Strengths
    The report believes its strong performance may be related to rapid Kubernetes adoption and demand for cloud-native monitoring.
    Weaknesses
    Demand remains dependent on enterprise AI workloads and the expansion of cloud-native architectures.
    Comparison
    It competes with Dynatrace, Elastic, Grafana/Prometheus, and others for the Kubernetes observability opportunity.
    Risks
    Intensifying competition or slower enterprise deployment could affect growth.
  • SNOW
    Software company related to AI data and security innovation
    Strengths
    The launch of Cortex AI Gateway and AI security innovations could support trusted agent interoperability and enterprise-scale adoption.
    Weaknesses
    The disclosed rating is EqualWeight/Positive rather than the highest stock rating.
    Comparison
    Its recent post-earnings share-price reaction is cited by the report as an example of a positive market response after numerical delivery.
    Risks
    If commercialization of AI products progresses more slowly than expected, valuation recovery could be limited.

Key data

  • Industry viewU.S. Software PositiveBarclays maintains a positive view on the U.S. software industry.
  • Microsoft Azure growth43% YoY cc4QFY26 Azure growth exceeded 39% in the prior quarter, while Q1 guidance is approximately 45%.
  • M365 Commercial Office growth16% YoY underlying ccThis exceeded 15% in Q3 and 14% in Q2, with Copilot described as a new AI growth accelerator.
  • Microsoft CY26 capex$190bnManagement maintained its capital expenditure outlook and reiterated its goal of achieving positive free cash flow in FY27.
  • Microsoft year-to-date performanceMSFT -19% YTD vs S&P +7%Against the backdrop of relative underperformance, the report believes better growth and investment discipline could be welcomed by investors.
  • Kubernetes and generative AI66%The report cites Cloud Native Computing Foundation data stating that 66% of organizations run generative AI workloads on Kubernetes.
  • Bain & Company survey sample951 companiesThe report cites this survey in discussing funding sources and obstacles for AI projects, with self-funding and data issues receiving the most attention.
  • Disclosed price and rating: DDOGUSD268.56; Overweight/PositiveThe price date for Datadog, Inc. is 2026-07-30.
  • Disclosed price and rating: MSFTUSD451.10; Overweight/PositiveThe price date for Microsoft Corp. is 2026-07-30.
  • Disclosed price and rating: SNOWUSD298.10; EqualWeight/PositiveThe price date for Snowflake Computing is 2026-07-30.

Impact & implications

For investors, the near-term opportunity in software is more a valuation- and positioning-driven recovery than an upside cycle already fully confirmed by fundamentals. If more companies demonstrate accelerating organic growth, AI revenue contributions, and improved capital efficiency in upcoming earnings seasons, software could attract some capital rotation away from strong semiconductor trades. Conversely, if growth remains unrealized, the rebound may prove difficult to sustain.

Risks

  • The software sector lacks clear catalysts, particularly as accelerating organic growth at SaaS companies has yet to become sufficiently visible.
  • If AI-related revenue contributions fail to translate into financial results, the valuation recovery may prove difficult to sustain.
  • Strong momentum in semiconductors may continue to weigh on software’s relative performance.
  • Web-traffic data show that growth slowed for most software companies in Q2, and underlying demand remains to be monitored.
  • Elevated short positioning may create a short-term squeeze, but does not equate to long-term fundamental improvement.

What to watch

  • Growth guidance from DigitalOcean, Paylocity, Dynatrace, Klaviyo, HubSpot, Datadog, and other companies in upcoming earnings seasons.
  • Whether organic growth at software companies accelerates, particularly whether AI-related revenue begins to contribute visible incremental growth.
  • Whether the relative performance of IGV versus SOX undergoes a sustained reversal.
  • The sustainability of subsequent growth in Microsoft Azure, M365 Commercial Office, and Copilot.
  • Whether Kubernetes, LLM inference, and MLOps workloads continue to drive observability demand.
  • Funding sources and key obstacles for enterprise AI projects, especially the impact of data issues on software procurement.
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