Key Takeaways
- After a powerful run, tech and AI stocks are treading water while valuations remain elevated.
- In December, Morningstar Wealth strategists reduced their exposure to US tech and communication services stocks in favor of other areas, including small caps and emerging-market stocks in Latin America.
- The changes were driven by differences in relative valuations.
Even as the powerful tech-driven rally has stalled, many technology and big data stocks—especially those involved in the AI trade—look expensive. Strategists say the AI theme still has more room to run over the long-term, but risks are mounting in the short and medium terms.
The Morningstar Global AI & Big Data Consensus Index, which includes stocks that are widely held by funds and ETFs focused on the AI theme, is up 22.0% for 2025 but down 1.2% over the last month. The wider Morningstar US Technology Index is up 17.0% for the year and down 2.7% over the past month, though it remains on track for double-digit gains in 2025 to beat the broader market.
Against that backdrop, the question for investors is whether it’s time to take some profits out of tech and reinvest in less-loved areas of the market, especially while year-end rebalancing is top of mind.
Portfolio managers at Morningstar Wealth have reduced holdings exposed to the AI theme, including the US-based “hyperscalers” in the information technology and communications services sectors. The group made changes to its positions in its model ETF portfolios around three themes: a sector rotation, large caps vs. small caps, and international allocations.
For these managers, it all comes down to relative valuations. While tech valuations have fallen from their peak since the selloff began, the team’s belief is that other sectors like healthcare and energy now look more attractive. They also reduced exposure to large-cap growth stocks in favor of small-cap stocks, and trimmed some Chinese tech stocks in favor of Latin American stocks.
The shift has been “from things that are now overvalued into areas we believe are undervalued,” says Dominic Pappalardo, chief multi-asset strategist at Morningstar Wealth.
Trimming Tech Exposure
Morningstar Wealth portfolio managers are trimming exposures in both the communication services and information technology sectors, which they say have delivered strong results over the past year but look less attractive going forward. Together, those sectors include the major players in the AI arms race, including Nvidia NVDA, Microsoft MSFT, Broadcom AVGO, Alphabet GOOGL/GOOG, and Meta Platforms META.
“We’ve been underweight the actual tech sector for quite some time,” Pappalardo explains. “We had bought communication services back up overweight coming out of the April ‘Liberation Day’ selloff, and then we took those gains to go back to neutral in that sector.” His team is now maintaining an underweight in both areas.
The team’s analysts find that, as measured by cyclically adjusted price-to-earnings ratios, valuations in the information technology and communication services sectors have expanded at a faster pace than the broader US market and at a significantly faster pace than some other sectors.
At the beginning of 2024, the communications services sector carried a CAPE ratio of 26.2. By the end of November, that valuation had ballooned to 38.4 (an increase of more than 46%). Over the same period, CAPE ratios in the information technology sector climbed more than 31% and the total market saw a rise of 24%. On the other hand, the healthcare sector started 2024 with a CAPE ratio of 25.2 and ended November 2025 with an even lower valuation of 24.7.
That’s part of why Morningstar Wealth portfolios are currently overweight healthcare stocks, which look much cheaper than both tech stocks and the US market. They also boast higher expected annual returns over the next decade: 7.6%, according to Morningstar Wealth’s internal analysis. That’s compared with 5.1% expected annual returns for the US market and 3.6% expected annual returns for information technology (the lowest of any sector).
In early April, following the tariff-related selloff in equities, communication services had the highest expected annual returns of any sector—9.5% over the course of a decade—followed closely by the information technology sector, which had an expected annual return of 8.6%, according to Morningstar Wealth’s analysts.
“We think healthcare [now] ranks at or near the top of the sector stack in terms of opportunities, and technology is very much at the bottom,” explains Pappalardo, who describes sector-by-sector portfolio allocations as “relative valuation decisions.” The amount of dispersion between expected returns among sectors is what helps determine the scope of an underweight or overweight position. “There’s pretty significant dispersion right now, so we’re comfortable running a large underweight to technology because we think it’s quite overvalued,” he says.
Leaning Into Small Caps
Proceeds from sales of tech and communications services holdings in December were directed to smaller capitalization stocks, which Pappalardo describes as “much more attractive from a valuation standpoint.” Small caps have lagged the broader market for years, but they also boast much cheaper valuations compared with their large-cap peers. That makes for an attractive entry point.
Adding to small-cap holdings while reducing large-cap holdings goes hand in hand with reducing tech stock exposure. “If you’re underweight the technology names, it’s logical that you’d also be underweight large cap growth stocks, because they’re one in the same,” Pappalardo says.
For investors and clients concerned about underperformance in the small-cap category, Pappalardo emphasizes that his team’s return forecasts cover the span of an entire decade: “Ten years sounds like a long time, but over the lifecycle of any individual investor, it’s really not.”
Adding to International Market Exposure
Lastly, Morningstar’s strategists added to their non-US holdings, especially in Latin America and Brazil. Pappalardo says international allocation decisions are based on the same relative valuation and expected return framework as sector-by-sector or market-cap-based decisions. “At the end of the day, everything’s driven first and foremost by valuation, because we want the highest return possible,” he says.
However, he cautions that there are often knock-on effects from changes to international allocations which investors don’t need to consider when adjusting holdings within the United States. “There’s a currency impact, there’s a volatility impact,” he says.
While Morningstar Wealth portfolios are currently underweight US stocks, Pappalardo emphasizes that this “doesn’t mean we’re avoiding the US.” Morningstar Wealth strategies are tied to US benchmarks. Rather, Papplardo says, “we’re trying to be thoughtful about where and what we add to within the US.” It’s the same dynamic playing out within sectors, where strategists are looking for the best opportunities within the US market (healthcare rather than tech, for example).
He reassures investors and advisors who are concerned about a US underweight that a team of strategists are carefully monitoring currency and other risks to match client needs. “We are taking out-of-country positions,” he says, “but we’re very mindful of the risk parameters that come with whatever mandate we’re looking at.”
