Technology: Sector Bounces Back After a Sluggish Q1

Following a strong performance throughout 2024, the technology sector experienced a collapse in the first quarter of 2025 before rebounding in the second. While we recently thought the sector was undervalued, we now see it as nearly fairly valued. After reeling early in the quarter from tariff rhetoric and trade policy changes, tech shares generally rebounded as the quarter progressed. Results for software companies have typically remained solid, which has helped support share performance.

The Morningstar US Technology Index is up 14.8% on a trailing 12-month basis, compared with the US equity market up 15.1%. Over the past quarter, the wider market was up 22.9% while tech was up 37.6%.

Technology Kicked Off 2025 in Ugly Fashion

The median US technology stock is fairly valued, with little margin of safety. We see software, semis, and hardware as fairly valued, with none skewing much in terms of being over- or undervalued.

We See Increasing Investment Opportunities Throughout the Tech Sector

Overall, tech was the strongest in the quarter, rebounding from a weak first quarter, when it was the second-worst-performing sector. Over the last 12 months, tech’s performance has been below average, coming in just below the broader market. Our confidence in secular tailwinds, such as cloud computing, artificial intelligence, and the long-term expansion of semiconductor demand, remains unchanged.

We still see targeted investment opportunities. Generative AI remains the most prominent theme. Software firms are developing and incorporating next-gen AI capabilities into their solutions, while cloud providers are introducing new services and increasing capacity. Meanwhile, some semiconductor firms, such as Nvidia, are seeing surging demand for AI and data center chip applications. We see attractive value within the AI theme as hard to find.

We See Rapid Adoption of Gen AI Occurring Already

We believe generative AI will support revenue growth across the sector over the next five years as consumption shifts from pilot programs to broader adoption. Growth has indeed been explosive for the public cloud vendors. We anticipate that the largest gen AI use cases over the next several years will be in customer service and software development. The cloud service providers have clearly invested ahead of growth but continue to butt up against capacity constraints every quarter. We therefore think that cloud provider capital expenditure levels will plateau but remain elevated going forward.

AI Services Drove Surging Capex by Cloud Providers in 2024 and 2025

Top Technology Sector Picks

NXP Semiconductors

• Fair Value Estimate: $280.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

Wide-moat NXP NXPI is one of our top picks in the analog and mixed-signal chip space. As automotive and industrial demand improves from cyclical and tariff softness, we anticipate that NXP will benefit from a recovery, and we’re starting to see early optimism of such a recovery. We’re especially fond of the firm’s outsize exposure to the automotive end market, where it obtains nearly 50% of its revenue. We believe the company will also gain market share in electrification and safety automotive products, including radar and battery management systems. NXP’s auto business is well tied to the secular tailwinds around rising chip content per vehicle.

Atlassian

• Fair Value Estimate: $250.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High

Atlassian TEAM is a leading provider of project management and collaboration solutions for software developers, and it continues to do well with expansion into service management. The company is emerging from a model transition to be primarily cloud-based, which was inevitable and leaves the company better able to innovate and compete with larger peers. Atlassian’s broad portfolio helps establish a large base across clients of all sizes and lets it integrate AI throughout its burgeoning portfolio. The company is also investing in a salesforce to have more of a direct presence, which should further support topline growth efforts.

Microsoft

• Fair Value Estimate: $505.00
• Morningstar Rating: ★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Medium

Microsoft MSFT is one of our top picks in the technology sector. The company dominates several markets, such as with Office in productivity software and Windows for PC operating systems, while establishing itself as one of two leaders in public cloud. We think the proliferation of hybrid cloud environments will continue to strengthen Microsoft’s position with Azure. Furthermore, an investment in OpenAI has propelled Microsoft into a leadership position in generative AI, driving acceleration in Azure growth over recent quarters. Our growth estimates are centered around Azure, Microsoft 365 E5 migration, traction with the Power Platform for long-term value creation, and proliferation of AI.