Technology: Stocks Give Back Some 2025 Strength During the First Quarter

After bottoming in April 2025, the technology sector rebounded throughout 2025. Around the end of the year, tech stocks hit a wall and began to roll over, as strength in semiconductors and hardware could no longer carry weakness from the software industry. As a result, tech was the third-weakest sector in the first quarter. Over the last 12 months, tech’s performance has skewed above average, making it the third-best-performing sector, topping the overall market by over 600 basis points. Our confidence in secular tailwinds, such as cloud computing, artificial intelligence, and the long-term expansion of semiconductor demand, remains unchanged. After months of poor performance, we see software as offering the most upside.

Generative AI remains the largest theme within the sector. Software firms are developing and incorporating next-generation AI capabilities into their solutions, while cloud providers are introducing new services and scaling capacity, and some semiconductor firms, like Nvidia, are enjoying surging demand for AI and data center chips. We see pockets of attractive value within the AI theme as semiconductors lost some ground early in 2026. Volatility has definitely been a hallmark of recent trading activity around this theme.

The Morningstar US Technology Index is up 22% on a trailing 12-month basis, compared with the US equity market’s 16% rise. For the quarter, the US equity market was down 3.5%, while tech was down 6.9%.

The median US technology stock is undervalued, with an attractive margin of safety. Overall, we see hardware and semis as slightly undervalued, and software as undervalued, given the fears surrounding AI. We believe we are in the early stages of AI adoption.

Given rapid advancements in AI, we systematically reviewed the moat ratings of 132 software and services firms to assess this emerging threat. As a result, we downgraded the moat ratings for 40 companies and raised our uncertainty ratings for 27. The most heavily affected areas were enterprise software and IT services, as we think there is not enough clarity to maintain our original moat ratings. We note that AI is not obviously threatening software models immediately. In some cases, we are unsure about the excess returns beyond 10 years, while in others, we believe there may be more serious moat erosion.

Top Sector Picks

Broadcom

• Fair Value Estimate: $500.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

Broadcom AVGO is one of our top picks in semis, with a robust AI growth opportunity via its custom AI compute chips, or XPUs. We expect phenomenal growth in these chips in the medium term, including a tripling of revenues in fiscal 2026 and doubling in fiscal 2027. To us, the market is overly bearish on the long-term growth of these AI chips and bearish on their impact on margins, where we see them as operating margin-accretive

Microsoft

• Fair Value Estimate: $600.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Medium

Wide-moat Microsoft MSFT is one of our top software picks. The company dominates several of its served markets, such as with Office in productivity software and Windows for PC operating systems, and it has established itself as one of two clear leaders in public cloud. We think the proliferation of hybrid cloud environments will continue to strengthen Microsoft’s position with Azure. Further, the firm’s investment in OpenAI has catapulted Microsoft into a leadership position in generative AI, which has driven an acceleration of Azure growth in recent quarters. Our growth estimates are centered around Azure, Microsoft 365 E5 migration, traction with the Power Platform for long-term value creation, and the proliferation of AI.

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 semis. As automotive and industrial demand improve from cyclical and tariff softness, we anticipate that NXP will benefit from a recovery. We like NXP’s outsized exposure to autos, which accounts for nearly 50% of its revenue. NXP is well-diversified in the automotive market, with a broad portfolio of processors, microcontrollers, and analog parts. The firm should gain share in electrification and safety automotive products, too, such as radar and battery management systems. Overall, NXP’s auto business is well tied to the secular tailwinds around rising chip content per vehicle