2026 Stock Market Outlook Key Takeaways
- US stock market trading at 4% discount to composite of our valuations
- Fair value increases resulted in growth stocks trading at a discount
- Small-cap stocks remain especially attractive
- Buckle up, expect more volatility ahead—key risks to monitor
As of Dec. 31, 2025, the US equity market was trading at a 4% discount to a composite of our fair value estimates of the over 700 stocks we cover that trade on US exchanges. While the Morningstar US Market Index rose 2.43% during the fourth quarter, a composite of the fair valuations of those stocks under our coverage rose even faster.
As mega-cap stocks continue to increase their share of the total market, their valuations increasingly skew market valuation. For example, excluding Nvidia NVDA from our market valuation would increase our price/fair value estimate metric to 0.98. In addition, excluding Alphabet GOOGL and Broadcom AVGO would yield a price/fair value estimate metric of 1.00, equal to the composite of our fair values.
As we enter 2026, we anticipate further volatility. Artificial intelligence stocks require even stronger growth to support lofty valuations. Yet, our base-case forecast for AI growth over the next five years is below that of many AI market prognosticators and participants, such as CEO Jensen Huang at Nvidia. If their vision for AI were to come to fruition, we still see further AI upside ahead.
In addition, a new chair will take the reins at the Fed in May, and trade and tariff negotiations will likely resume this spring. Our economics team foresees economic growth slowing over the first half and higher-than-expected inflation as the impact from tariffs continues to push prices higher. Political rhetoric will ramp up as we approach midterm elections, and geopolitical risk will test investors’ resolve.
Source: Morningstar. Data as of Dec. 31, 2025.
US Stock Market Trading at a Discount
Over the past quarter, Morningstar’s price/fair value metric dropped to a 4% discount as our fair value increases outpaced the market.
As detailed in our November and December stock market outlooks, we made significant fair value increases on a number of mega-cap stocks under coverage. For example, during the fourth quarter, our intrinsic valuation for Alphabet rose by $2.5 trillion, Nvidia by $1.2 trillion, Broadcom by $740 billion, and Apple AAPL by $440 billion. In all, we increased valuations across our coverage by approximately $7 trillion. This total increase represents approximately 8% of the total market capitalization of our coverage that trades on US exchanges.
By capitalization, small-cap stocks remain very attractive, trading at a 15% discount to our fair value estimate. Mid-cap stocks trade just below our fair value estimates, while large-cap stocks trade at a 4% discount.
By style, following significant increases in our fair values on a number of growth stocks, that style is now at a 10% discount. Value stocks also remain attractive, trading at a 5% discount, whereas core stocks are trading at fair value.
Source: Morningstar. Data as of Dec. 31, 2025.
Where We See Value by Sector
The greatest valuation change by sector over the past quarter occurred in technology, bringing the sector to an 11% discount, from fairly valued last quarter. Similarly, fair value estimate increases in the communication sector raised our bar, resulting in a 9% discount for the sector.
Source: Morningstar. Data as of Dec. 31, 2025.
Undervalued Sectors
Real Estate
Real estate remains the most undervalued sector at a 12% discount. While we prefer to avoid urban office space, real estate with defensive characteristics appears compelling. Areas including retail (Federal Realty FRT), healthcare (HealthPeak DOC), wireless towers (Crown Castle CCI), and apartment (AvalonBay AVB) REITs each have attractive undervalued stocks.
Technology
As we revised our assumptions to incorporate the view that the AI buildout boom will last longer and require greater capital than we originally contemplated, many stocks appear undervalued to us. Yet, it’s not only AI where we see value (Nvidia and Broadcom). Many traditional technology sectors, such as software stocks including Salesforce CRM and ServiceNow NOW, offer attractive opportunities for long-term investors.
Energy
Energy continues to languish as oil prices have drifted lower, yet we think the market is overly pessimistic. Following the change in leadership in Venezuela, we think positive market sentiment will provide a tailwind for oilfield services stocks. SLB SLB and Baker Hughes BKR both surged and moved into 3-star range yet still trade at discounts to fair value. US domestic oil producers such as 4-star rated Devon DVN remain at deep discounts.
Communications
Alphabet and Meta Platforms META dominate the communications sector, as their stocks account for 72% of the sector. Following its 70% run over the past year, Alphabet has moved into 3-star range. However, our analysts still see value in 4-star rated Meta at a 24% discount to our fair value. Traditional communications such as Verizon VZ are also attractive at a 23% discount and 6.8% dividend yield.
Overvalued Sectors
Consumer Defensive
Consumer defensive stocks remain overvalued, though the excess is concentrated in 1-star-rated Walmart WMT and Costco COST, leaving many others attractive; many of the food stocks (Kraft Heinz KHC and Mondelez MDLZ) are significantly undervalued, though.
Financials
Banks benefit from a steepening yield curve and low default rates as the economy avoids recession, but we think the market is overextrapolating too much growth, too far into the future. Each of JPMorgan JPM, Wells Fargo WFC, and Citigroup C are rated 2 stars.
Industrials
Industrial stocks that support the AI buildout boom have done well but, at their high valuations, are at risk of selling off if the growth in data centers slows. We see better value in stocks tied to the agricultural sector. Low agricultural commodity prices have temporarily reduced demand for new ag equipment, but as the cycle recovers, we think Deere DE and CNH Industrial CNH are both well positioned.
Volatility Ahead—Key Risks to Monitor
Early 2025 proved to be a volatile period for the markets. The emergence of DeepSeek battered overextended AI stocks before the broader market sold off even further following President Donald Trump’s early April tariffs. Yet, the market does what it often does and acted like a pendulum—in this case, swinging too far to the downside. As such, we revised our market outlook to overweight on April 7, 2025.
Soon thereafter, Trump suspended those tariffs, and the market realized that DeepSeek was not a threat to the AI buildout boom. For the remainder of the year, while there were a few hiccups here and there, the trend was generally up and to the right and brief bouts of volatility were modest.
We suspect that, over the course of 2026, there will be multiple bouts of volatility, as there are a number of key risks that could play out. These include:
- AI stocks require even greater growth to support high valuations
- New chair will take the reins at the Fed
- Resumption of trade and tariff negotiations
- Slowing rate of economic growth
- Hotter-than-expected inflation
- Impending midterm elections
- Weakening fundamentals in private credit markets
- Chinese economy weaker than expected/deceleration accelerating
- Japanese government bonds suffering losses as yields rise, and yen weakening
So that begs the question, how can investors position themselves to take advantage of volatility?
Based on our overall valuations, we think investors should market-weight equities within their portfolio at their targeted allocation. Within this allocation, investors can create a barbell-shaped portfolio in order to retain the further upside potential we see in technology and AI stocks, yet balance these positions with high-quality value stocks to account for potential elevated volatility in 2026.
Within this portfolio, if the market runs too hot and too far above our fair values, investors have the ability to take profit to the upside, lock in gains, and then reallocate the proceeds into undervalued value stocks.
If the market sells off, we’d expect value stocks to hold their value better and could be sold. The proceeds could be used to increase positions in those technology and AI stocks that will have sold off into undervalued territory.
