Summary
Russ Koesterich explains how tech’s resurgence signals shifting economic expectations and strong earnings, supported by historically reasonable valuations.
Key Takeaways
- As expectations have shifted toward slower growth, higher inflation, and higher rates, investors have rotated back to sectors like large-cap technology and semiconductors, capable of delivering durable earnings in a tougher macro environment.
- Despite the sharp rebound, tech valuations appear justified by strong profitability and elevated return-on-equity, suggesting continued leadership is possible.
Stocks have surged to new highs, but leadership has shifted. Since the start of the Iran war, the U.S. tech sector has advanced roughly 33%*, while semiconductor companies have gained more than 45%*, both easily outperforming the broader market.
Read more: AI Is a Secular Growth Unicorn
When I last discussed technology earlier in the year, things looked very different. Between the end of Q2 last year and the start of the war, the technology sector underperformed both the market and value stocks. Performance was particularly challenged for software companies, with the industry losing more than -25%*. What changed? Two things: the economic landscape and relative earnings.
Less growth, more inflation
As recently as late February, most investors assumed a supportive economic backdrop, one defined by strong growth, falling inflation and lower interest rates. Since the start of the war, expectations have rapidly adjusted. A survey of Bloomberg economists expects 2026 growth of 2.1%, down from 2.5% in early March.
Not only do investors expect slower growth, but faster inflation and a less supportive Fed. The consensus for changes in the consumer price index (CPI) has risen from 2.65% three months ago to 3.5% today. In the process, markets have shifted from expecting two ratecuts to a rate hike.
This shift in economic expectations, coupled with a significant increase in long-term interest rates, has led investors away from many of the themes – European equities, value, small caps – that dominated late last year. In an environment of slower growth and higher rates, investors have rotated back towards secular growth names able to generate earnings even in a less supportive economy.
Earnings surge
Investors have been rewarded for their faith in large tech companies. For Q1, tech sector earnings grew by approximately 50%, twice the pace of the broader market. Parts of tech, notably semiconductors, did even better. Superior growth coupled with the sector’s outsized weight means that tech companies contributed more than half of all earnings growth for the quarter.
Going forward, we believe this is likely to continue. With tech capex continuing to expand, benefiting semiconductor and hardware firms, technology companies should continue to lead the market in earnings and sales growth (see Chart 1).
Not as expensive as you would think
The obvious objection to continued tech leadership is the magnitude of the recent gains. That said, by historical measures the sector does not look particularly expensive. The tech heavy Nasdaq Index is trading at approximately 25x forward earnings, below its 5-year average valuation. Valuations look even more reasonable when adjusting for the market. Currently the S&P 500 technology sector trades at a 40% premium versus the market, well below the 2026 peak. Today’s premium is arguably justified given the sector’s remarkable 34% return-on-equity (ROE). While tech stocks have enjoyed a spectacular rebound, given earnings momentum and the evolution in the economic outlook, they can continue to lead.
A message from Advisor Perspectives and VettaFi: Discover something new! Click here to register for our upcoming webcasts.
To obtain more information on the fund(s) including the Morningstar time period ratings and standardized average annual total returns as of the most recent calendar quarter and current month end, please click on the fund tile.
The Morningstar RatingTM for funds, or "star rating", is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure (excluding any applicable sales charges) that accounts for variation in a managed product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods.
© BlackRock
Read more commentaries by BlackRock
