What Leveraged Loans Reveal About the Software Selloff

When software stocks plummet 20-30% in a matter of weeks, where should savvy investors look for the real story? Not at earnings calls or analyst upgrades, but at a market most retail investors never touch: leveraged loans.

The Market That Speaks First

Leveraged loans are floating-rate debt issued by below-investment-grade companies. While equity investors chase growth narratives, loan investors focus on one thing: can this company pay its bills? That cold-eyed perspective makes the leveraged loan market a leading indicator of corporate distress.

Recent software selloffs have created a fascinating divergence. While Snowflake and Cloudflare stocks remain at elevated valuations, their leveraged loans are trading at 95-97 cents on the dollar—a clear signal that credit investors are pricing in real default risk.

The Numbers Don't Lie

Software companies gorged on cheap debt during the zero-rate era. Now they're facing 5-6% interest rates while revenue growth slows dramatically. The math is brutal: a company that borrowed $500 million at 2% now pays $25-30 million annually in interest instead of $10 million.

Credit spreads tell the story. Software company loan spreads have widened by 200-300 basis points over Treasuries, compared to just 50-100bp for established tech giants like Microsoft. The market is drawing clear lines between the financially robust and the vulnerable.

Winners and Losers Emerge

The leveraged loan market is performing triage on software companies. Cash-rich giants see their borrowing costs actually decline as investors flee to quality. Meanwhile, growth-dependent companies without positive free cash flow face a funding crisis.

This isn't just a temporary repricing—it's a structural shift. The era of "growth at any cost" is ending, replaced by "show me the cash flow." Companies that can't adapt face potential bankruptcy, not just stock price volatility.

What Equity Investors Miss

Stock analysts still debate whether Palantir or Unity are "cheap" after their declines. Loan investors already have their answer: they're demanding 400-500bp over risk-free rates to lend to these companies. That's distressed territory.

The disconnect reveals a fundamental truth: equity markets price dreams, but credit markets price reality. When the two diverge this dramatically, credit usually wins.

The Broader Implications

This software shakeout mirrors broader economic forces. Rising rates don't just affect mortgage payments—they restructure entire industries. Companies built on the assumption of perpetually cheap capital are discovering that assumption was wrong.

For investors, the lesson is clear: don't just watch stock prices. Credit markets provide early warning signals that equity investors often miss until it's too late.