Morgan Stanley believes application software stocks could see improving sentiment in 2026 after a tough 2025. The sector lagged the broader market due to fears that generative AI would compress growth. The bank notes the valuation discount for these stocks has widened to about 37%.

Morgan Stanley recommends a barbell strategy, favoring vendors positioned within its AI Success Framework alongside companies with strong growth at reasonable prices. In front-office software, it favors HubSpot, Klaviyo, and Amplitude. For back-office, Descartes Systems Group is a new top pick, and Navan is highlighted as an idiosyncratic growth opportunity.

The bank argues that incumbent vendors must prove application software will act as the primary delivery layer for AI, expanding total addressable markets. It sees 2026 as a potential inflection point but remains selectively opportunistic until AI-driven revenue upside becomes visible across estimates.