The software sector's investor base is shifting from growth-focused funds to value-oriented and GARP (Growth at a Reasonable Price) investors. This is because slowing growth is being offset by improved margin expansion and GAAP earnings power, making these historically expensive stocks attractive to a new cohort.

If AI is truly transformational, its greatest long-term value will accrue to non-tech companies that adopt it to improve productivity. Historical tech cycles show that after an initial boom, the producers of a new technology are eventually outperformed by its adopters across the wider economy.

Current market shifts should not be mistaken for the end of the AI investment cycle. Instead, investors are rotating within the AI theme and diversifying into other sectors. It's a reset and a search for value beyond the most crowded names, not an exit.

Contrary to popular belief, the underlying business fundamentals (sales, profits) of value and growth indexes have grown at nearly the same rate this century. The vast performance gap is not due to better business results but rather investors' willingness to pay increasingly higher multiples for growth stocks.

The AI investment case might be inverted. While tech firms spend trillions on infrastructure with uncertain returns, traditional sector companies (industrials, healthcare) can leverage powerful AI services for a fraction of the cost. They capture a massive 'value gap,' gaining productivity without the huge capital outlay.

As AI becomes capable of improving itself, capital may concentrate on these systems, seeking exponential returns. This creates a new paradigm where traditional value investing strategies, which rely on mean reversion, could fail as certain sectors get permanently disrupted while others achieve sustained, compounding growth.

Investor uncertainty about the long-term viability of software business models due to AI is causing a fundamental shift in valuation. Instead of paying a premium for future growth, investors are now demanding immediate returns like dividends, effectively treating established software firms as value stocks rather than growth stocks.

Market-cap weighting turned the S&P 500 into a momentum fund for megacaps, leading to a decade of outperformance versus its equal-weight counterpart—a historical anomaly. Recent signs of equal-weight taking the lead suggest a potential market regime shift back towards value and smaller companies.

Fears that AI will render software and other tech industries obsolete are driving a significant capital shift. Investors are selling tech stocks and buying into sectors perceived as immune to AI disruption, such as energy, construction, and consumer staples. This rotation explains the recent underperformance of tech-heavy indices.