Pedestrians wearing protective masks pass in front of a banner displaying Asana Inc. signage during the company’s initial public offering (IPO) in front of the New York Stock Exchange (NYSE) in New York, U.S., on Wednesday, September 30, 2020.
Michael Nagle | Bloomberg | Getty Images

Cloud software has been one of the best bets for investors over the past half decade. But that trade has rapidly unwound of late.

The slump, which started in November and deepened this week, is part market rotation, part economy reopening from the pandemic, and part concern that the Federal Reserve’s expected interest rate hikes will have an outsized impact on this particular sector.

For years, cloud computing services were some of the top gainers in technology, which itself outperformed the broader market. Since Bessemer Venture Partners created the BVP Cloud Index of publicly traded companies in August 2013, the basket is up 909%, almost triple the gains in the Nasdaq and five times better than the performance of the S&P 500.

Covid-19 proved to be a massive boon, as companies, schools and government agencies sped their transition to the cloud so they could access remote communications, collaboration and storage tools. E-commerce software vendor Shopify, video chat service Zoom and e-signature provider DocuSign were among the big winners, all notching hefty revenue growth in 2020 and stock gains well into the triple digits.

Those software as a service, or SaaS, stocks have since gone out of fashion. While legacy computer and printer maker HP Inc. is touching new highs and the Dow Jones Industrial Average is down only slightly this year, work-from-home darlings are suddenly in a bear market.

Zoom and DocuSign are each more than 50% off their 52-week highs and Shopify is down 34%. Asana was the best-performing U.S. tech stock last year until mid-November. The provider of project management software has since lost 58% of its value.

Cloud stocks as an index are down 29% from their November high.

Byron Deeter, a venture capitalist who invests in software start-ups at Bessemer, said on Tuesday that the market has “taken a 30% after Christmas sale discount” on cloud stocks.

“Across the basket, the cloud industry and software holistically has just been hammered,” Deeter told CNBC’s “TechCheck.” “Fundamentally these businesses remain the drivers of the new economy, and we have to remember that all of those trends that people were excited about a year ago in the 2020 market, when this basket returned almost 100%, those remain today.”

Higher interest rates can spell challenges for much of the market, but they represent a notable roadblock for cloud stocks, especially for companies that aren’t making money yet. Investors value companies based on present value of future cash flow, and higher rates will reduce the amount of that expected cash flow.

Minutes from the Fed’s December meeting, released Wednesday, gave further fuel to investors who are positioning their portfolio for rising rates, as the central bank prepares to dial back its pandemic-era easy monetary policy.

The WisdomTree Cloud Computing Fund declined more than 5% on Wednesday and is down 10% for the week as of Thursday’s close. The index is on pace for its second-worst week since the pandemic began, with the only steeper drop coming about a month ago.

“I think SaaS is just generally down because you’ve got interest rates going up, and there tends to be pretty tight correlation between high-growth software relative to interest rates,” said Khozema Shipchandler, chief operating officer at Twilio, which sells back-end software for communications.

Twilio’s stock price has fallen 46% from its high early last year even though earnings and revenue exceeded estimates every quarter. Sales in the third quarter jumped 65%, while its pile of cash and marketable securities climbed to $5.4 billion from $3 billion at the end of 2020.

“I’m not super worried about it,” Shipchandler said about the share price. “I’ve got $5 billion in cash on the balance sheet. I know I can survive basically any cycle.”

Investors in the space see the same thing.

“I do think this is a buying opportunity,” said Nina Achadjian, a partner at Index Ventures who previously worked at Google. “The fundamentals of these companies haven’t changed.”

The continued revenue growth coupled with the plunge in prices means the sales multiples that investors are paying have been compressed. Last February, cloud stocks were trading at an average of 16 times forward revenue, according to the BVP Index. Now they’re at 10, the lowest since May 2020.

Zoom is trading at 14 times sales on a trailing basis, down from a peak of 189, according to FactSet. DocuSign’s multiple sits at 15, having fallen from a high of 50.

While not every cloud vendor has the cash cushion of Twilio, Zoom or DocuSign, many companies in the space sport high software margins and are boosted by subscription businesses that continue to show strong retention.

“These are recurring-based models,” said Michael Turrin, an analyst who covers cloud companies at Wells Fargo. “They have really good visibility into the underlying business models.”

Turning those fundamentals into good investments may require patience. The Nasdaq index trounced the Dow each year from 2017 to 2021. In the first week of 2022, the Dow has managed to eke out a narrow gain, while the Nasdaq is down 3% and cloud stocks are getting pummeled.

 — CNBC’s Ari Levy contributed to this report.

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