By Sean Neethling, Head of Investments at Morningstar

Global diversification continues to pay off for investors with several of our overweight equity positions, Korea, China, Japan and Latin America, performing well. Gains reflect subdued prior expectations about their outlook and company or broad economic outcomes that surpassed this low bar.

High expectations on the other hand tend to be harder to beat so it’s natural for investors to review the stellar run in US IT stocks and ask if that can continue. Most of the rally in US equities has come from a re-rating of US IT focused on AI superscalars, strongly supported by blow away earnings results from select majors including Nvidia and more recently Cisco. While other sectors have also risen, it’s US IT that has been the key driver of the overall market because of its scale.

Morningstar’s recent review of the US IT sector explored in depth the key drivers of the industry growth, profitability and whether there is still value. Taking the long view, it is clear that the re-rating – investors paying more per unit of sales, cashflows or earnings – has supercharged returns over the past 5-10 years. Looking forward, the big players in software, hardware, semiconductors and IT services still have a great outlook in terms of the strategic advantages (using Morningstar “MOAT” definitions of competitive strengths) that can support faster growth and higher profitability than peers and other industries.

It’s just that uncertainty levels are also very high, in many cases, as AI quickens the pace of change and poses direct threats to several business models. Looked at this way, we find the overall reward for risk not attractive for US IT, given full valuations, fast pace of change and high levels of uncertainty. We see better prospects in another fast-growing sector with dominant franchises – healthcare – as well as communication services and smaller companies that can benefit from lower interest rates and corporate tax rates.

We have also just completed a review of the US Dollar, at a time when there are growing question marks over the US Dollar’s status as a safe-haven currency. Uncertainty about the Fed’s capacity to keep inflation low, if it becomes more sensitive to political aims, has added a new risk for investors to weigh up.

Another growing risk is the escalating amount of debt, expansionary fiscal policy and no clear plan to achieve a balanced budget as yet. On the positive side, overall debt levels are not excessive when you consider households and businesses. Thus far no other currency can match the Dollar in terms of scale and ease of use for global trade and finance. It’s also true that big pools of capital looking for a low cost, liquid and low risk home have few alternatives to US government bonds. So in our view the US Dollar is not at risk of losing its status as the dominant reserve currency, despite some deterioration in its fundamentals. Of more immediate concern today is the high level of US Dollar which tilts the balance in favour of other currencies. We prefer the Yen as a safe haven and see more upside in emerging market currencies.

So ultimately investors must consider what is priced in, as well as what is most likely to occur. On this basis we see less upside for US IT and the US Dollar and more upside for US Healthcare, US Communication and US smaller companies.