MW Why choppy bond yields are the hidden danger that could crush software stocks

By Laila Maidan

Software was 'somewhat immune' from tariff turmoil, but investors with exposure to the sector need to beware of a key risk threshold on bond yields

President Donald Trump's tariff policies have caused extreme volatility in markets, sending technology investors scrambling for places to ride out the uncertainty. But there's another threat that investors should mind as well.

Software stocks have seemed like a relatively safe place to be given all the turmoil, since the companies aren't selling physical goods shipped in from overseas. Case in point: The iShares Expanded Tech-Software Sector ETF IGV held up better than the iShares Semiconductor ETF SOXX in the period between when Trump unveiled sweeping tariffs on last week and announced a 90-day delay midday Wednesday.

Both ETFs rallied on Wednesday, but the tariff angst is likely here to stay, as Trump's latest measures are only a pause and don't apply to China, which will be subject to even steeper tariffs than before.

That said, while investors may have thought software was "somewhat immune" from the tariff turmoil, there's really no place to hide in this market, according to Baird technology-sector strategist Ted Mortonson.

That's because there's one factor that tech investors may overlook: Volatile bond yields could pose a risk to software stocks.

Are software stocks safer?

The answer depends on many factors, but a key one is bond yields.

Yields rise when demand for bonds drops - and things have been choppy on that front. Tuesday's auction on the 3-year Treasury BX:TMUBMUSD03Y showed signs of dwindling demand, sending yields spiking - including on the 10-year Treasury BX:TMUBMUSD10Y, which touched 4.5% Tuesday night. Thankfully, increased demand in Wednesday's 10-year auction pushed yields back down to 4.4%.

The next stop for bond yields will be Thursday's auction for 30-year Treasurys BX:TMUBMUSD30Y. And all eyes will be on that event, noted Gennadiy Goldberg, head of U.S. rates strategy at TD Securities. Investors will be trying to gauge whether there are signs of a buying strike among foreign investors. That's a threat that will remain so long as tariff wars are on the table.

U.S. government bonds are seen as the lowest form of risk investors can get in markets, hence the term "risk-free rate." The 10-year Treasury yield, the main benchmark used as a barometer, is pegged against the returns of a stock to decide if taking on more risk is worth it. So, if the yield rises, the return on any given stock needs to be higher to remain attractive.

Longer-duration stocks, which have most of their value in expected future cash flows, are more sensitive to the yield since that future value gets discounted back to the present. Software companies that are ramping up revenues and expect bigger earnings in the future are especially prone to rising yields.

Below is a chart from J.P. Morgan that shows how the rise in the 10-year yield is negatively correlated with multiples of enterprise value to forward 12-month revenue, a metric used to value software-as-a-service companies. EV/FTM revenue peaked at 20 times when the 10-year yield was near zero, but reversed course when the yield began to rise.

Mortonson estimates that a key threshold which would affect software stocks is 4.5% on the 10-year yield. The problem is, bond yields have been choppy.

However, it doesn't mean that every software company is a bust or a bad bet, says Julie Biel, chief market strategist and portfolio manager at Kayne Anderson Rudnick. She highlighted that the correlation between yields and stocks is less extreme for mature SaaS companies with stronger current earnings and sticky revenue. Software can still be a good place to park, but investors will need to be discerning about what they're buying.

-Laila Maidan

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April 09, 2025 18:01 ET (22:01 GMT)

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