Important points
- Investors are shifting away from previously strong sectors, leading to a reversal in valuations; items that once seemed expensive are now perceived as cheap.
- The industrial sector has the largest share of overvalued stocks, prompting analysts from Morningstar to advise caution regarding AI-related investments.
- Meanwhile, the tech sector has the highest proportion of undervalued stocks, marking a shift from a time of high overvaluation.
The ongoing rotation in the stock market is sparking significant changes. Historically undervalued sectors are starting to see some gains, whereas those that were previously highly valued are now considered cheap. Recently, tech and consumer cyclical stocks have dropped in value, while industrial goods and raw materials have seen price increases.
This year, the tech industry has faced challenges amid concerns about the impact of artificial intelligence on investments. Notably, despite a strong 2025, tech stocks have seen a slight decrease of 1.97% in the last three months, contrasting with a substantial year-over-year rise of 21.43%.
On the other hand, sectors like industrial products and basic materials, often regarded as “old economy,” are thriving. They’ve delivered impressive returns of 21.92% and 25.68% respectively in recent months.
Tech company valuations decline amid possibly exaggerated AI fears
The beginning of 2026 has not been kind to tech stocks, which experienced a sharp decline early in the month, pulling valuations into seemingly attractive ranges.
February kicked off with a steep drop in software stocks following the release of a new tool by Anthropic for automating legal tasks. Within just three days, software stocks plummeted by double digits, as worries regarding AI disruptions intensified.
Over the past year, tech valuations have notably decreased. Currently, tech stocks make up 26.03% of all undervalued stocks monitored by Morningstar, a significant rise from 8.91% a year prior and 17.33% three months back. Two-thirds of the undervalued tech stocks today are from the software sector, reflecting ongoing price volatility.
Since early February, Workday’s stock has dipped nearly 25%, while Adobe and ServiceNow have both seen around a 12% decline. Salesforce’s stock has decreased by 9%. “The tech sector still has room to grow with the advancements in AI and other innovations. Many stocks are undervalued,” says Dave Sekera from Morningstar.
Morningstar analysts rate several of these stocks as significantly undervalued at 5 stars. Recent earnings reports bolster a positive view of the software sector, with ServiceNow showing better-than-expected fourth-quarter sales, Adobe achieving its sixth consecutive quarter of exceeding expectations, and Salesforce meeting its revenue targets, notably with a 114% increase in annual recurring revenue driven by AI.
Major companies like Meta Platforms also contribute to the undervaluation in the communications sector, which holds 8.9% of today’s undervalued stocks. Sekera highlights that Meta’s planned substantial investments in AI create investor uncertainty.
Despite the tech sector’s recent growth, there seems to be a contrast with the bearish outlook. Meta’s recent earnings report illustrates strong engagement and advertising powered by AI. “As the year progresses, we expect renewed investor confidence in Meta as we gather more data on AI’s impact,” noted Malik Ahmed Khan from Morningstar.
However, Sekera suggests exercising caution, pointing to rising worries that AI could outshine and potentially replace traditional software companies. He argues that while fears exist about AI’s capabilities, it’s unlikely that the technology would eliminate the need for specialized software services. Overall, he believes that the current concerns might be overly pessimistic.
Value-oriented sectors increasing in price
This year has seen substantial returns from value sectors, aligning with their rising valuations. Currently, 26.85% of overvalued stocks are in the industrial sector, marking a nearly 10% increase since last February—now the largest sector.
According to Sekera, the industrial sector’s elevated valuations likely stem from a heightened market interest in AI infrastructure developments. “I think the market may be overestimating potential profits for these companies before they revert to more typical economic conditions,” he cautions.
Entities focused on AI infrastructure are reaping benefits from the market’s pivot away from technology. For instance, GE Vernova has seen its returns climb by 17.26%, while Caterpillar’s has increased by 11.47%. However, GE Vernova’s rating remains at two stars since last February. Meanwhile, Caterpillar’s rating has fallen from a sturdy four stars to just two now.
Given the disparities in returns and valuations, Sekera suggests a balanced approach. It’s wise for investors to dabble in both technology and value stocks, such as food and consumer goods, which should perform well if tech stocks face downturns. “It’s about leveraging market fluctuations and strategically positioning in undervalued sectors while steering clear of the notably overvalued ones,” he advises.
Navigating the ongoing market rotation
Sekera also identifies potential in the energy sector, which has been trading at a discount of about 10% since January. By February 23, this sector made up only 4.63% of the overvalued stocks, making it one of the lowest across the market.
He thinks that the energy sector can be reassuring for investors, particularly given ongoing inflationary pressures, geopolitical tensions like US-Iran relations, and the potential rise in oil prices. “It serves as a strong hedge against geopolitical struggles,” he remarks.
For tech investors, Sekera emphasizes the importance of stability in the face of sharp price shifts. “Endurance through market volatility is crucial.”
Finally, he recommends a balanced portfolio, blending growth stocks—especially those tied to advancements in AI—with value stocks like resilient food and consumer products. This approach could provide a safety net in case of market overheating or downturns.
