The Broadening of the 2026 Stock Market Rally: A Sector Rotation Opportunity?

The 2025 stock market rally, driven by AI adoption and macroeconomic tailwinds, has left a clear imprint on sector valuations and performance. As we approach 2026, the question of whether this rally will broaden-and how investors might position for it-hinges on understanding valuation shifts and strategic sector rotation.

The 2025 Landscape: AI-Driven Outperformance and Valuation Divergence

The Communication Services and Information Technology sectors led the 2025 charge, with Communication Services surging 33% and Information Technology up 24.4%. These gains were fueled by AI-driven GDP growth and infrastructure spending, as highlighted by Schwab's "Outperform" rating for Communication Services. Health Care and Industrials also outperformed, with Health Care posting a 13.2% return and Industrials gaining 18.7%.

However, valuation metrics tell a nuanced story. For Health Care, the median EV/EBITDA multiple fell to 11.5x in 2025 from 14.5x in 2024, reflecting a correction in optimism while still supporting strong earnings growth. Communication Services, meanwhile, traded at a range of 6.54–6.62x EV/EBITDA in early 2026, a modest premium to its historical 6–7x range, suggesting undervaluation relative to its critical role in AI infrastructure.

Rotation Signals: From Overvalued Tech to Undervalued Defensives

The 2026 outlook, as outlined by Schwab and other analysts, points to a rotation away from narrative-driven sectors like Consumer Discretionary and toward more resilient industries. Consumer Discretionary, rated "Underperform" by Schwab, faces a P/E ratio of 29.46 as of January 2026-well above its 5-year average of 27.12 and 25-year average of 20.1. This overvaluation, coupled with challenges in consumer spending and housing, positions the sector as a potential underperformer in a K-shaped recovery.

In contrast, Health Care and Industrials offer compelling value. Health Care's EV/EBITDA multiple of 12.77x in Q3 2025 (up from 11.5x in 2025) reflects investor confidence in its defensive characteristics and earnings resilience. Industrials, with an EV/EBITDA of 16.70 as of July 2025, appear undervalued relative to their growth potential in AI-driven infrastructure and lower interest rate environments.

Strategic Rotation: Balancing Growth and Value

The case for rotation is further strengthened by macroeconomic dynamics. Declining energy costs and interest rates have broadened market participation, but volatility remains due to tariffs and inflation risks. Schwab's "Outperform" ratings for Communication Services, Industrials, and Health Care underscore their alignment with structural trends like AI adoption and infrastructure modernization.

For investors, this suggests a dual strategy:
1. Reducing exposure to overvalued growth sectors (e.g., Consumer Discretionary) to mitigate downside risk in a potential 2026 market correction according to Schwab analysis.
2. Overweighting sectors with favorable valuations and structural tailwinds, such as Health Care (defensive earnings, innovation in medtech) and Industrials (AI infrastructure, rate-sensitive demand) as noted in industry reports.

Risks and Considerations

While the case for rotation is compelling, risks persist. The sustainability of AI-driven capital expenditures and circular financing models remains uncertain. Additionally, sector rotation in a K-shaped recovery may be uneven, with some subsectors (e.g., medtech within Health Care) outperforming broader indices. Investors must also monitor regional disparities and regulatory shifts, particularly in AI and healthcare policy.

Conclusion

The 2026 stock market rally is poised to broaden, but success will depend on tactical sector rotation. By shifting allocations from overvalued discretionary sectors to undervalued, AI-aligned industries like Health Care and Industrials, investors can capitalize on valuation divergences and structural growth themes. As Schwab and other analysts emphasize, diversifying beyond narrative-driven narratives will be key to navigating the macroeconomic uncertainties ahead.