Key takeaways
- Three main factors support Russ’ argument for ongoing strength within tech: earnings momentum, current valuations, and a supportive macro environment.
- While concerns are most commonly voiced around valuations, Russ argues that these figures are high but justifiable, specifically among the mega-cap names, given their structurally higher profitability.
Markets have not followed a straight-line, but 2025 is increasingly resembling 2023 and 2024. While there are some key differences, one theme has reasserted itself: tech leadership. In my view, this is likely to continue into 2026.
I last discussed technology companies back in July. At the time, tech was recovering from a difficult start to the year. My view was that tech leadership would reassert itself based on three factors: a supportive macro backdrop, elevated but not unreasonable valuations and earnings momentum. All three factors still support the sector.
If anything, the economic outlook is now more encouraging than back in July. Despite a softening labor market and lingering tariff uncertainty, according to Bloomberg consensus estimates for 2026 growth are back to 1.8%, close to trend. While headwinds remain, fiscal stimulus and a strong investment and capital spending outlook should support growth into next year.
As the economy has recovered so have earnings estimates, with the improvement disproportionately driven by a rebound in technology companies. As was the case last summer, tech companies continue to enjoy the strongest earnings momentum (see Chart 1).
Valuations: High but Justifiable
For many the bear case for tech rests on valuations. Here it is worth differentiating between the household mega-cap names and many of the early growth names in more speculative parts of the market. While valuations are high, for the mega-cap names they are arguably justified by structurally higher profitability.
Today, the S&P 500 technology sector trades at approximately 42x trailing earnings. By comparison, at the peak of the tech bubble in early 2000 the sector traded at more than 67x earnings. While today’s valuations cannot be described as cheap, there is a stronger case that prices are justified.
The return on equity for the tech sector is slightly above 30%. By comparison, the 25-year average is less than 20% and the figure was 17% back in 2000. In other words, not only are stock valuations not comparable to the tech bubble but today’s premium is better justified by the unique business model of many mega-cap tech firms.
All that said, there is one important caveat: the profitability argument does not extend to the smaller companies in the more speculative parts of the sector. Since the spring lows, the best performing tech companies have not been the Mag-7 or mega-cap names. Instead, leadership has shifted towards early-growth stocks and less profitable companies, a theme that has dominated since the summer.
The recent preference for low quality, high beta names has lasted longer than I would have expected. This is the part of the rally that I would fade. Instead, I would focus on the mega-cap names that are still enjoying record high profitability. To my mind, this part of the trade has further to go.
Russ Koesterich, CFA, JD
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