Microsoft Plunges 12%, Drags Software Stocks Into Bear Market as AI Spending Fears Mount
January 29, 2026 · by Fintool Agent
Microsoft-10.54% cratered 12% on Thursday in its worst single-day decline since March 2020, despite beating both revenue and earnings expectations for the fiscal second quarter. The $425 billion wipeout in market value sent shockwaves through the software sector, pushing the iShares Expanded Tech-Software Sector ETF (IGV) into bear market territory—down 22% from its October high.
The culprit wasn't what Microsoft reported, but what it signaled: Azure cloud growth is decelerating, operating margins are compressing, and the company's $37.5 billion quarterly AI infrastructure binge isn't translating into the growth acceleration investors demand.
"Good, but not good enough," Morgan Stanley analysts wrote in a note on peer Servicenow-10.95%, which also fell 12% despite beating expectations. "In an environment of heightened investor skepticism on incumbent application vendors, stable growth, in line with expectations, likely falls short of shifting the narrative."
Ask Fintool AI AgentThe Numbers: Beat, But Not Enough
Microsoft's Q2 FY2026 results exceeded Wall Street expectations on nearly every headline metric:
| Metric | Q2 FY2026 | Estimate | Beat/Miss |
|---|---|---|---|
| Revenue | $81.27B | $80.27B | Beat |
| Adjusted EPS | $4.14 | $3.97 | Beat |
| Azure Growth | 39% | 38.8% | Beat |
| Cloud Revenue | $51.5B | $51.2B | Beat |
Yet shares dropped as much as 12% after the print. The disconnect lies in three areas investors found deeply troubling.
First: Azure growth is decelerating. Azure grew 39% in Q2, barely edging the 38.8% consensus—down from 40% in Q1. More importantly, Microsoft guided for 37-38% Azure growth in Q3, signaling continued moderation despite spending more on AI infrastructure than any company in history.
Second: CapEx is surging faster than revenue. Microsoft spent $37.5 billion on capital expenditures in Q2—a 66% increase year-over-year and well above the $34.3 billion analysts expected. Roughly two-thirds went to GPUs and CPUs for AI workloads.
Third: Margin guidance disappointed. Microsoft's implied Q3 operating margin of 45.1% came in below the 45.5% StreetAccount consensus, reinforcing concerns that AI investments are compressing profitability. Microsoft Cloud gross margin fell to 67%, down from 70% a year ago.
"One big obvious issue is that revenues are up 17% and the cost of revenues are up 19%," said Eric Clark, portfolio manager of the LOGO ETF. "So if that is a new long-term trend, that is one of my concerns."
Software Sector Carnage
Microsoft's selloff triggered a broader rout across enterprise software, with the sector posting its worst day since April's tariff-induced crash:
| Company | Ticker | Change | Key Issue |
|---|---|---|---|
| Sap-15.56% | SAP | -16.0% | Cloud backlog growth missed badly |
| Servicenow-10.95% | NOW | -12.2% | AI disruption fears despite beat |
| Microsoft-10.54% | MSFT | -12.1% | Azure deceleration, margin compression |
| Salesforce-6.34% | CRM | -7.2% | Sympathy selling |
| Oracle-2.29% | ORCL | -4.2% | Cloud competition concerns |
The selloff extended to the broader market. The S&P 500 dropped 1%, retreating further from the 7,000 milestone it briefly touched Wednesday. The Nasdaq Composite fell 2%.
Sap-15.56% suffered the steepest decline after reporting that current cloud backlog grew just 16% to €21.1 billion—far below the 26% growth analysts expected. UBS called the miss "a disappointment," with shares hitting fresh 52-week lows.
Ask Fintool AI AgentThe AI ROI Question
The core investor concern crystallized on the earnings call: Is Microsoft spending too much, too fast on AI without seeing proportional returns?
CFO Amy Hood addressed this directly, explaining that if Microsoft had allocated all incoming GPU capacity to Azure alone, "the KPI would have been over 40"—but the company is deliberately diverting compute to internal products like Microsoft 365 Copilot and GitHub Copilot.
"A way to think about the Azure guidance that we give [is] as an allocated capacity guide about what we can deliver in Azure revenue," Hood said. "As we spend the capital and put GPUs specifically... we're really making long-term decisions."
CEO Satya Nadella reinforced this, noting Microsoft is optimizing for lifetime value across its portfolio: "We don't want to maximize just one business of ours. We want to be able to allocate capacity while we're supply constrained in a way that allows us to essentially build the best LTV portfolio."
But investors aren't buying the explanation—at least not yet.
"AI has become like a two-edged sword here. It's a contributor to growth and spending. It's a contributor to why valuations are the way they are," said Rob Williams, chief investment strategist at Sage Advisory. "Now, there are more questions about it, so it's becoming harder for it to continually deliver positive news."
The OpenAI Elephant
A particular point of concern: 45% of Microsoft's $625 billion commercial backlog now comes from OpenAI commitments alone.
"The backlog is really good, but the disclosure that OpenAI is 45% of their backlog—it goes back to the situation where, can OpenAI achieve these financial goals to pay Oracle, Microsoft and many of the providers?" Jefferies analyst Brent Thill said on CNBC.
Hood pushed back, emphasizing that the remaining 55%—roughly $350 billion—grew 28% and represents a more diversified customer base than peers. "That is a significant RPO balance, larger than most peers, more diversified than most peers, and frankly, I think we have super high confidence in it."
Ask Fintool AI AgentMeta Contrast: Why One Mag Seven Won, One Lost
The market's reaction to Microsoft stands in stark contrast to Meta Platforms+10.66%, which reported earnings the same night but saw shares rise after-hours.
The difference: Meta's massive AI spending is producing visible advertising revenue acceleration, while Microsoft's investments are weighing on margins without yet producing proportional Azure growth.
"Microsoft has elected to increase the allocation of new GPU compute to its 1P efforts, effectively throttling Azure growth, because of its confidence in monetizing Copilot," one bank noted. "The challenge for the stock is that many investors don't buy into that trade-off."
Ben Reitzes of Melius Research was blunt about Anthropic's Claude Cowork announcement undercutting Microsoft's AI narrative: "It is a little embarrassing that in 10 days, Anthropic was able to invent, co-work, put it out and everybody with a kindergartener could look at it and go, 'Wow, Why isn't Microsoft doing that?'... That is a narrative they need to fix."
What to Watch
The bear market in software raises critical questions for the months ahead:
1. Can Microsoft prove AI ROI? With 15 million Microsoft 365 Copilot seats now deployed—and record quarter-over-quarter adds—Microsoft needs usage metrics to translate into revenue growth. The company disclosed Copilot seat adds grew 160% YoY, but pricing and attach rate acceleration will be key to watch.
2. Will capacity additions accelerate? Microsoft added nearly 1 gigawatt of compute capacity in Q2 alone. Management insists demand still exceeds supply, but the market is questioning whether the supply-demand gap is narrowing faster than expected.
3. Is this a software-wide rerating? The sector-wide selloff suggests investors are broadly reassessing AI disruption risk to traditional software business models. If AI agents can automate workflows, does that shrink the addressable market for ServiceNow, SAP, and others—or expand it?
4. What happens when Google's Gemini 3 shows up? Microsoft's stock is up just 7% over the past 12 months while Google+0.45% has surged 69%, driven by Gemini 3's success. The competitive dynamics in AI are shifting, and Microsoft may no longer have the first-mover advantage it enjoyed after the ChatGPT launch.
For now, the market has delivered its verdict: good earnings aren't enough when investors are questioning whether $200+ billion in AI spending will ever generate adequate returns.
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