The "Pain Trade" Has Officially Arrived for Software Stocks

The pain was indiscriminate for software stocks on Thursday, as Wall Street took no prisoners—regardless of how good or poor earnings reports were.

Coming off earnings this week, HubSpot sank 19%, Datadog dropped 16%, and AppLovin Corp. declined 19%, while Figma dropped 16% and Duolingo fell 12%.

It was a rare day when both software and chip names were selling off—a change from the usual dynamic where one sector slides while the other rises.

“On the software side, earnings reactions are ugly,” Daniel O’Regan, managing director at Mizuho Securities, wrote Thursday, calling it the “pain trade.”

O’Regan added that software went from “bad to worse” after HubSpot “started the hard roll last night” by cutting its full-year revenue outlook.

Ad-technology platform AppLovin also contributed to the pain trade after reporting on Wednesday in-line second-quarter earnings, but missed revenue expectations. Guidance was also below the consensus forecast.

O’Regan wrote that investors are shorting “applications software” and that Datadog’s earnings, released early Thursday, were “jet fuel to the dumpster fire.”

Unlike HubSpot and Applovin, there wasn’t anything necessarily bad in Datadog’s financial report. The monitoring and analytics platform announced better-than-expected second-quarter earnings and increased full-year guidance. But it wasn’t enough for Wall Street’s lofty expectations—and O’Regan noted that investors were looking for more after the stock’s recent strong run to to record highs.

The Mizuho analyst added the Datadog’s earnings “could spook bulls across infrastructure software where folks are super long.” He noted Snowflake, Cloudflare, Twilio, CrowdStrike, and Palo Alto Networks could all feel some pain.

The one outlier in the onslaught on software might be Unity Software: The stock was up 11% at $39.51 on Thursday after the cross-platform gaming engine developer posted strong second-quarter earnings and quarterly guidance that impressed Wall Street.

Jeffrey Favuzza, a member of Jefferies equity trading desk, called Unity’s earnings “arguably the best print of the last 24 hours,” adding that it could have also been “the best quarter in Unity’s history as a public company.”

Whether the pain trade is completely justified is another question—and Wall Street seems somewhat divided on the question.

“The bottom line is the initial reaction seems a bit extreme,” Evercore ISI analyst Kirk Materne wrote Thursday of Datadog.

But sometimes it’s not about if a reaction is warranted or not. “The Street was obviously hoping for more,” Materne added.