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US Investors Shift Focus from Chipmakers to Software Amid AI Investment Evolution

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As the AI investment boom slows, U.S. chip stocks, which were the biggest beneficiaries of last year’s surge, are struggling in 2025. The spotlight has shifted to software companies, which are now seen as the next big play in AI. This shift comes as volatility driven by tariffs and concerns about diminishing demand, coupled with the rise of lower-cost AI models from China’s DeepSeek, have weighed on semiconductor shares.

The shift towards software is being viewed by several analysts as a long-term evolution of the AI investment landscape. According to David Russell, global head of market strategy at TradeStation, there’s been a noticeable “rotation” in investor focus, especially in light of the developments surrounding DeepSeek, the semiconductor outperformance of 2024, and the ongoing restrictions on U.S. chip exports to China. “Investors are looking for the next three-to-five-year stories… those companies that will benefit from what Nvidia has already done,” he added.

So far in 2025, the Philadelphia SE Semiconductor index has fallen 5.6%, with Nvidia, a major player in the industry, down nearly 13%. In contrast, several software companies have seen significant gains, with stocks like Atlassian, CrowdStrike Holdings, Palantir Technologies, and Cognizant rising between 7% and 19%. Exchange-traded funds (ETFs) tracking software companies have also seen substantial inflows. For example, the iShares Expanded Tech-Software Sector ETF has attracted over $1.87 billion in 2025, already surpassing last year’s total inflows.

Analysts argue that this shift is a natural progression for AI investments, as the primary use cases for AI technology are in software. Adam Turnquist, chief technical strategist at LPL Financial, emphasized that LPL prefers software stocks over semiconductors, a sentiment shared by Morgan Stanley. “The second stage of the innovation cycle is when people start utilizing products, and that’s when the software companies start getting paid… we’re now starting to see the ascendancy of the software part of the equation,” said Keith Weiss, equity analyst at Morgan Stanley.

This trend is driven by concerns about how long chip stocks can sustain their growth rates, with some investors rethinking the value of these stocks as software companies continue to improve their market position. The rise of DeepSeek’s more affordable chatbot, which competes with expensive direct-to-consumer AI products, is one factor contributing to a more cautious outlook on semiconductors. According to Brian Mulberry, portfolio manager at Zacks Investment Management, competition will likely reduce profits for these products, while enterprise software companies may find it easier to monetize new AI technology.

The shift toward software stocks is also influenced by the ongoing Sino-U.S. trade tensions, which have hurt semiconductor companies. Analysts have named companies such as Palantir, Microsoft, Oracle, and Salesforce as key players in the software space, though their performance has been mixed in 2025. Palantir, which offers AI software to businesses, has seen its stock rally, while Microsoft and Salesforce have struggled, down 4.9% and 12.6%, respectively.

Despite these fluctuations, some investors remain optimistic about the long-term prospects for software companies. While valuations for software giants like Microsoft and Oracle are still considered high—trading at 27 and 23 times forward earnings, respectively—investors like Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, argue that the focus should be on AI applications, not just chips. “We don’t need more Nvidia chips, we need applications,” she said.

AI Stock Shock Could Spark Broader Market Gains

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A recent shock in artificial intelligence stocks, driven by concerns over the low-cost Chinese AI model, could set the stage for broader gains in the U.S. stock market, potentially moving beyond the narrow group of tech shares that have dominated the current bull market.

The tech sector, led by mega-cap companies, has been the primary driver of market growth. Over the past two years, the S&P 500’s tech sector has surged about 90%, far outpacing the broader index. However, stocks of major tech firms like Nvidia, Broadcom, and Oracle took a hit on Monday as investors reacted to the impact of DeepSeek’s AI model, a new low-cost competitor from China.

Despite the drop, there are signs of a broader market rotation. While the S&P 500 fell by 1.5%, roughly 70% of the index’s constituents saw gains, indicating a shift away from the dominance of big tech. The S&P 500 growth index, which is tech-heavy, dropped about 3.6%, while the value stock index rose by nearly 1%, marking the largest one-day advantage for value stocks over growth in decades.

This development has led some analysts to predict a more balanced market leadership, which could benefit investors by diversifying opportunities beyond the tech sector. Keith Lerner from Truist Advisory Services pointed out that this shift would provide a broader range of profitable areas for investors.

The Magnificent Seven tech stocks—Nvidia, Apple, Microsoft, Google, Amazon, Meta, and Tesla—have been the cornerstone of market gains, accounting for 55% of the S&P 500’s total return since 2022. However, these stocks have recently underperformed, leading to speculation that other sectors may begin to lead market growth.

While many investors remain bullish on tech, there is growing sentiment that the earnings strength of the Magnificent Seven may start to level with the rest of the market. In 2025, earnings for these stocks are expected to rise 19%, compared to 12.3% for the broader index. As quarterly earnings reports come in, including from Microsoft, Meta, and Tesla, investors will be closely watching for signals that the market is broadening.

Peter Tuz, president of Chase Investment Counsel, remarked that Monday’s market drop acted as a wake-up call for investors who had viewed tech stocks as invincible, potentially leading to a shift in investment towards other sectors.

While tech bounced back on Tuesday, increasing by over 3%, analysts like Robert Pavlik from Dakota Wealth Management see an opportunity for a rotation into companies that could benefit from more affordable AI, particularly software firms. The impact of DeepSeek could ultimately lead to a shift in market dynamics, though it may take time for a broader market expansion to fully materialize.