Is It Time to Underweight Tech in 2026?

The U.S. stock market's relentless focus on technology stocks has created a structural imbalance that investors may no longer afford to ignore. As 2026 approaches, the dominance of the "Magnificent Seven" tech giants-accounting for 45.2% of the S&P 500's market capitalization-has sparked a critical debate: Is it time to rebalance portfolios away from overvalued tech and AI stocks? According to strategic shifts from influential firms like Morningstar and its veteran strategist Ed Yardeni, the answer appears increasingly affirmative. Their 2026 outlook emphasizes sector rotation toward healthcare, small-cap equities, and international markets, driven by relative valuations and a recalibration of risk-adjusted return expectations.

The Overvaluation Conundrum in Tech

The case for underweighting technology begins with its valuation. The Magnificent Seven's outsized influence has inflated the S&P 500's price-to-earnings ratio to levels that many analysts deem unsustainable. As Yardeni notes, this concentration has created a "bubble-like" scenario where growth expectations are front-loaded, leaving little room for error according to Morningstar's analysis. Morningstar's analysis underscores that the information technology sector's projected annual returns have contracted to 3.6%, lagging behind healthcare's 7.6%-a stark divergence that reflects diverging fundamentals and investor sentiment as data shows. This gap highlights the growing appeal of sectors where valuations align more closely with earnings potential.

Strategic Shifts: Healthcare and Small Caps in Focus

Morningstar's 2026 strategy explicitly calls for overweights in healthcare and financials, alongside a return to market-weight exposure for technology and communications services. The firm's rationale hinges on healthcare's undervaluation relative to its peers. With aging demographics and innovation in biotechnology, the sector offers a compelling mix of defensive qualities and growth potential. Meanwhile, small-cap stocks-historically trading at discounts to large-cap counterparts-present an attractive entry point for long-term investors seeking diversification and value according to Morningstar's analysis. Yardeni's decision to abandon his 15-year preference for tech stocks marks a pivotal shift, signaling that even the most bullish strategists are recalibrating their allocations as reported.

International Markets: A Case for Rebalancing

The firm's recommendations extend beyond domestic sectors. Morningstar's focus on international markets, particularly emerging economies like Brazil and Latin America, reflects a broader thesis: global equity markets have overcorrected for macroeconomic risks, creating opportunities for patient capital. These regions, where valuations remain depressed relative to fundamentals, offer a stark contrast to the U.S. tech sector's stretched multiples. By allocating to international equities, investors can hedge against domestic overconcentration while tapping into growth stories insulated from the U.S. market's volatility according to Morningstar's analysis.

The Case for Immediate Action

The urgency to rebalance portfolios stems from the narrowing window of opportunity. As tech stocks trade at premium valuations, their margin for error shrinks, while sectors like healthcare and small caps offer more attractive risk-reward profiles. Morningstar's framework-grounded in relative valuation and expected returns-provides a clear roadmap: underweight overvalued sectors, overweight undervalued ones, and diversify geographically to mitigate systemic risks. For investors, the message is unambiguous: delaying action risks locking in gains from a sector that may soon face profit-taking and valuation compression.

In conclusion, the strategic shifts proposed by Morningstar and Yardeni are not merely tactical adjustments but a fundamental rethinking of portfolio construction in a post-"Magnificent Seven" era. By prioritizing relative valuations and sector rotation, investors can position themselves to capitalize on more balanced, sustainable returns in 2026 and beyond.