Technology: Stocks Still Outperformed in Q3, but Returns Are Normalizing - Morningstar

After another historic rise through early June, driven primarily by semiconductor and AI-related stocks, technology sector returns have cooled somewhat. A combination of geopolitical risks such as the Iran war, worries about the size and sustainability of the AI buildout, and what we viewed as some stretched valuations has contributed to this. The Morningstar US Technology Index is up 32.0% on a trailing 12-month basis, compared with 20.0% for the US equity market, with quarter-to-date returns of 5.4% versus 2.0%, respectively. While some stocks have cooled off, we think the AI buildout remains fundamentally intact. The buildout is still supply-constrained, capex estimates for 2027 have risen, the unit economics on recent compute deals suggest very healthy ROIs for installed compute capacity, and token consumption continues to increase exponentially while model capabilities continue to improve. While we remain positive on the fundamentals, many semis screen as overvalued, so we would be very selective here. Cybersecurity names have run up quite a bit and are overvalued. After the recent partial comeback for software, we see the sector as closer to fairly valued.