Jack Gabb: What’s driving the ASX this week

Here are the main factors driving Australian equities this week, according to investment analyst JACK GABB. Reported by head investment specialist Chris Adams

• Find out about Pendal Focus Australian Share Fund

SOFTWARE stocks continued their sharp fall; using the US tech software ETF as a proxy the sector fell 10% last week, taking year-to-date losses to 22%.

The catalyst has been the proliferation of AI tools, with the latest being a new automation tool by US company Anthropic targeted at the legal sector, this also triggered selling in the legal, publishing and financial data companies.

The potential for contagion also hit the alternative asset managers from over-exposure to credit risk.

Even after a sharp rebound in the US on Friday, the S&P 500 ended the five-day period down 0.1% while the NASDAQ lost 1.8%.

That left the S&P/ASX 300 down 2% last week, pushing the local technology sector down 11.4%. Financials (+1.5%) were the only sector to make gains.

The ASX recovered strongly today.

The RBA hiked rates, as expected, with markets moving to price in another increase by August.

US economic news was limited, with key CPI and jobs data due this week.

Bonds were fairly muted, with rate expectations little changed in the US.

Software meltdown

While Anthropic’s new tool itself is not overly significant, the news reinforced the sector bear thesis, which is that AI lowers the cost of building software, increasing competition from insourcing and AI-native startups.

This, in turn, sees margins compress as incumbents embed AI at lower gross margins than the 75-80% they’ve historically enjoyed.

Seat-based pricing is disrupted as AI agents replace human workflows. Moats erode, growth deteriorates, margins deteriorate.

These fears have become ubiquitous and applied to all software companies, leading to the level of selling being three times anything we have seen in the last 10 years.

The sector is deeply oversold, and while the fears are arguably overdone, the reality is that the burden of proof has shifted: software companies must now demonstrate their ability to navigate the AI transition.

The signposts of this include revenue stabilisation, enterprise preference for incumbents, AI-native failure rates, successful business model transitions, and insider buying.

In our view, while there are escalating threats to the sector, the consequences of them are more nuanced, not uniform and may not be as extreme as inferred in share prices.

Moats in the software space can extend well beyond product – domain expertise, regulatory relationships, distribution, and data “flywheels” (the feedback loop where data is used to refine and improve AI models, encouraging more users, which provides more data) at scale are not easily replicated.

The economics also do not obviously favour disruption: pure-large language model (LLM) architectures carry materially higher costs than hybrid approaches, and AI-native startups face a margin trap in that compute costs are falling but model complexity is increasing, and customer acquisition remains expensive.

The disruption risk is not uniform – small-to-medium businesses lack the resources to insource using AI tools, while enterprises can and will consider alternatives.

There is also a logical gap: for AI to be this disruptive it must be rapidly adopted, and if rapidly adopted it must deliver real value – in which case incumbents controlling the system of record are the logical beneficiaries.

Finally, in our view AI is a total addressable market (TAM) expander, not a TAM destroyer. The addressable market potentially shifts from around $600-700 billion in software to incorporate substituting labour which could add materially to the revenue opportunity.

Looking at valuation, the software sector doesn’t look particularly cheap on revenue multiples. However, price/earnings (P/E) tells a different story.

While consensus is currently expecting 15% two-year revenue growth for the US software sector, the P/E implies the market is expecting a significant decline in growth expectations.

Looking at some of the key Australian stocks: Technology One (TNE) and Xero (XRO) are well positioned, in our view, but Wisetech (WTC) faces higher risks.

Technology One

• External value metric pricing provides natural insulation against seat displacement.
• Direct sales eliminate channel conflict.
• Over 99% customer retention and about 70% share of Australian local councils creates extraordinary switching costs.
• AI has already been deployed across the platform with a sensible dual-pricing approach.

Xero

• Is well positioned but must execute.
• Per-entity pricing avoids seat-based disruption.
• Domain depth in accounting creates vertical-like defensibility, despite horizontal customer reach.
• Early AI adoption metrics are encouraging – 73% customer usage, 300,000+ subscribers on new AI features within three to four months.
• Risks are partner channel tension and competitive pressure from Intuit.

Wisetech Global

• Faces higher risks, in our view.
• The Cargowise pricing transition makes strategic sense, but execution has been poor and there is a risk that their largest customer, DSV, moves to an internal solution.
• There have been delays in delivery of AI capability, raising questions.
• Unlike TNE and XRO, WTC’s pricing model creates friction rather than alignment with customers, in our view.

US policy and macro

US rate cut expectations rose slightly during the week, mostly on the back of softer labour data.

There are now 2.23 cuts implied, versus 2.12 prior.

Initial jobless claims came in at 231,000 versus 212,000 expected and 209,000 prior. Challenger data showed 108,000 layoffs in January (+118% year/year). The December JOLTS job openings rate fell to 3.9% (from 4.3%), the lowest level since April 2020.

More positively, the University of Michigan sentiment survey showed inflation expectations over the next 12 months have fallen to 3.5%, versus 4.0% in January, with the five-to-10-year expectation rising to 3.4% from 3.3%.

In addition, the ISM Manufacturing survey beat expectations, with January coming in at 52.6 versus 48.5 expected and 47.9 prior. That marks a strong turnaround and the strongest number since 2022. New orders and production both surged.

The ISM Services survey also came in stronger than expected at 53.8 versus consensus at 53.5 and 54.4 prior, although underling metrics were less positive than manufacturing with employment 50.3 versus 51.8 expected and prices rising to 66.6 from an upwardly revised 65.1.

Key data this week is January CPI, December retail sales and the January employment report – which will include the annual revision to the jobs count.

Macro and policy Australia

The RBA confirmed its outlier status among global central banks, hiking by 25 basis points to 3.85% in a unanimous decision that was more or less in-line with the 70% hike expectation.

Commentary was also hawkish, with inflation expectations revised sharply higher and the RBA admitting inflation is more broad-based and persistent than first thought.

It is now likely to remain above target for some time, which has prompted markets to more than price in another hike by August.

The decision to hike comes despite RBA forecasts of slowing GDP growth and higher unemployment and suggests it is more willing to accept softer economic outcomes in order to rein in inflation.

The consumer price index (CPI) is now seen at 4.2% to June 2026, versus 3.7% previously.

Assuming two cuts in the first half of the year, growth (and inflation) is likely to reduce in the second half, particularly given the stronger AUD.

The inflation outlook is also likely to add pressure on the May budget to deliver higher taxes (and/or curb spending), which likely also weighs on spending.

Importantly, while ‘short-term inflation expectations have risen in Australia since the November Statement’, ‘longer term inflation expectations remain well anchored,’ according to the RBA.

Moreover, the RBA does expect financial conditions to become modestly restrictive under the assumed path for interest rates.

Find out about

Crispin Murray’s Pendal Focus Australian Share Fund

Read more

Europe and the UK

The Bank of England voted five to four to hold rates steady, with the Chief Economist saying they are on track to bring inflation back to a 2% target in April. Inflation is expected to stay there, or dip lower, over the coming three years.

The European Central Bank also kept rates on hold, with its President saying the stronger Euro could bring inflation down beyond current expectations.

Commodities

It was a volatile week for commodities and mining equities, if not to the same extent as software.

Gold ended up, rebounding from a low of US$4,400/oz to close at US$5,100/oz. Silver sold off again, but rallied sharply on Friday from a low of US$64/oz.

The bounce in the USD and a broader risk off move saw a sharp reversal of commodity momentum trades, but any renewal of the USD’s downward trend is likely to see precious metals rebound.

The biggest moves were in Bitcoin, with a sharp rally on Friday (~12%) not enough to offset steep falls earlier in the week.

De-escalation of Iran tensions also sent oil lower, while iron ore fell on high inventories and slowing demand in China ahead of Lunar New Year.

Lithium spodumene also saw a pullback following a string of Australian producers announcing plans to restart idled production.

About Jack Gabb and Pendal Focus Australian Share Fund

Jack is an investment analyst with Pendal’s Australian equities team. He has more than 14 years of industry experience across European, Canadian and Australian markets.

Prior to joining Pendal, Jack worked at Bank of America Merrill Lynch where he co-led the firm’s research coverage of Australian mining companies.

Pendal’s Focus Australian Share Fund has an 18-year track record across varying market conditions. It features our highest conviction ideas and drives alpha from stock insight over style or thematic exposures.

The fund is led by Pendal’s head of equities, Crispin Murray. Crispin has more than 27 years of investment experience and leads one of the largest equities teams in Australia.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

Find out more about Focus Australian Share Fund

Contact a Pendal key account manager here