Key Takeaways
- Big-tech stocks are sputtering after driving the market’s returns for the last few years.
- Investors are rotating into other areas, with sectors like healthcare, basic materials, and financials outperforming, along with some international markets.
- Some market rotations turn out to be head fakes, and strategists are divided on whether this one will last.
- Investors can set themselves up for success by staying focused on attractive valuations.
The big rally in the stock market may have stalled, but there’s been lots of churn under the surface. The Morningstar US Market Index has slipped into the red this year, falling 0.25% since the beginning of January. Technology stocks, which were far and away the largest contributor to the big bull market in 2023 and 2024, have been the biggest drag on stock returns in 2025.
Meanwhile, sectors like financial services, basic materials, and healthcare are seeing new investor interest. Non-US markets such as China, the UK, and Germany have also staged significant rallies. “Overall, there’s this subtle transition in leadership,” says Michael Arone, chief investment strategist at State Street Global Advisors.
It’s unclear whether these trends will stick. Markets are struggling to find focus amid uncertainties about the future. Federal Reserve interest rate cuts are not guaranteed this year, inflation remains sticky, and the impact of President Trump’s economic policy proposals (like tariffs) remains unknown. Additionally, more than once, big tech has stumbled only to roar back to life a few months later. At the same time, the expansion of earnings growth is leading some strategists to say that previously underloved areas of the market could continue to shine.
What Does a Market Rotation Look Like?
During a rotation, investors shift from stocks that have been key to a dominant trend into other parts of the market that have been on the sidelines. This often involves moving out of groups of stocks that have acquired expensive valuations thanks to a big rally and into cheaper stocks which have been left behind. Rotations can happen among stock sectors and industries, market capitalizations, or investment styles (such as growth vs. value).
There’s plenty of evidence that a shift is underway. US technology stocks returned more than 36% in 2024 but are down almost 5% so far in 2025. The three heaviest-weighted stocks in the Morningstar US Technology Index (Apple APPL, Microsoft MSFT, and Nvidia NVDA) are all in the red for the year (with Nvidia down more than 10%).
On the other hand, basic materials constituted the worst-performing sector in 2024—the only sector to end the year with a loss. But so far in 2025, these stocks have returned 4.55%. Healthcare stocks are also soaring after returning just 2.7% in 2024 (the second-worst performance of any sector), even after accounting for major losses from UnitedHealth Group UNH.
Investors also appear to be shifting toward value. The Morningstar US Value Index lagged the Morningstar US Growth Index by a significant margin in 2024. This year, value stocks are climbing while growth stocks flounder, dragged down by losses in big tech.
Some elements of the shift are less cut and dry. Certain cyclical sectors, like financials, are outperforming, while others in the category, like consumer cyclicals, are struggling. And both large- and small-cap stocks have posted losses this year. That muddy picture shows idiosyncratic factors like consumer confidence, inflation worries, and geopolitics are also weighing on the market.
Investors Search for Undervalued Opportunities
Morningstar chief research and investment officer Dan Kemp sees the rotation in terms of valuations. “The starting point for us at Morningstar is always the price/fair value ratio,” he explains. That’s the ratio between the market price of a stock and Morningstar’s assessment of that stock’s true value. A price/fair value ratio above 1 means the stock looks overvalued and expensive, while a ratio below 1 means it looks cheaper. The greater the distance from 1, the greater the premium or discount.
Kemp points out that as the mega-cap tech sector has become increasingly overvalued, there are early signs that investors are turning toward areas of global markets that are trading at more attractive prices.
The Morningstar China Index is up 16.00% this year, compared with a 0.25% loss for the US Market Index. Kemp points out that UK stocks have also performed well, even though many are concentrated in “old economy” stocks like banks, energy, and pharmaceutical companies.
Kemp also points to global defense stocks, which have rallied this year. The Morningstar Global Aerospace and Defense Index is up more than 9% since the beginning of January.
Strategists Point to Cyclicals
In the absence of reliable returns from big tech these past few months, some strategists advise investors to look to cyclical areas of the market as economic growth remains solid, the job market holds up, and inflation remains only slightly elevated. Cyclical stocks tend to be closely tied to the performance of the economy.
In a recent note to clients, Morgan Stanley Wealth Management CIO Lisa Shalett suggested investors “consider adding cyclicals like financials, energy, domestic manufacturers and consumer services to US stock positions.”
Over the past week, however, a spate of weak consumer sentiment data has been accompanied by a surge in defensive sectors, like healthcare and consumer defensive stocks. Scott Wren, senior global market strategist at the Wells Fargo Investment Institute, says he expects that boost to be “temporary.” While defensive stocks may continue outperforming if investors remain nervous about economic growth, the fundamental outlook remains solid. He expects to see the US economy improve in the second half of the year, which would be a constructive environment for cyclicals.
Against that backdrop, Wren also points to financials, industrials, energy and communication services. “Those are the sectors we particularly like right now,” he says. “Given our forward outlook, we’re going to look for spots to recommend that clients put cash to work.”
Is This Rotation Another Head Fake?
Investors have been here before. Late last summer, mega-cap technology stocks stumbled, while value stocks and small caps took the lead. But it wasn’t long before the growth trade roared back amid ongoing enthusiasm for artificial intelligence, evidence of a resilient economy, and investor hopes for interest rate cuts.
“Everyone wants to jump on the rotation bandwagon,” says Adam Turnquist, chief technical strategist at LPL Financial. “We have these relief rallies, but they only last a month, maybe six weeks. And then it goes right back to large-cap leadership and the growth trade.” He says that with just a small fraction of the stocks in the S&P 500 hitting new highs recently, he’s not seeing signs of a durable shift away from the growth stocks that have powered the market for the past few years. And he’s not anticipating a soft landing for the economy, which would help value stocks outperform their growth counterparts. “The trend of growth outperformance has not changed in the longer term; same for US versus international.”
Other strategists see more evidence that the rotation could last. While there have been “a number of head fakes” over the past year and a half, Arone says the market may be seeing a more durable shift. He points to the narrowing earnings gap between the Magnificent Seven and the rest of the market as evidence.
“Technology and the Mag Seven in particular outperformed so dramatically because that’s where all the earnings growth was,” he says. “Now you’re seeing that broaden to a much greater number of stocks, companies, sectors, and industries … that is healthy.” Whether that gap continues to close in the months ahead will be the key determinant for whether the rotation can continue, Arone says.
Look for Attractive Valuations
For Kemp, whether the rotation starts now or in a few months (or whether it’s already happening) doesn’t matter. He thinks investors should focus on quality stocks at attractive prices rather than try to time the exact moment the market begins to shift.
He says focusing on attractively priced areas yields a higher expected return than popular, overvalued trades. The valuation gaps are where opportunities lie. “Whether that turn has happened now, or whether it happens at some point in the future … if you’re buying good quality undervalued stocks … then you’ve got a higher expected return,” Kemp says. “The odds are in your favor.”
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
