After a months-long valuation compression across the US technology sector, JPMorgan believes the toughest phase may already be behind it, though the era of technology standing alone at the top will not repeat itself.

Strategist Mislav Matejka noted in a September 28 report that valuations for large-cap technology stocks, represented by the so-called "Magnificent 7" (Mag-7), have fallen to their lowest level in a decade. The price-to-earnings premium of hyperscalers relative to the S&P 500 has also compressed to a level more than one standard deviation below the norm, suggesting the de-rating process is largely nearing its end. The report maintained an overweight stance on semiconductors and recommended re-establishing a pair trade of "long semiconductors, short software."

However, JPMorgan made clear that the technology sector is unlikely to return to its previous extreme position of unrivaled strength. The bank argued that the AI capital expenditure cycle will persist, earnings momentum remains solid, and monetization paths are gradually becoming clearer. Together, these factors support technology regaining market attention, but the era in which tech stocks alone drove market returns is over.

Mag-7 and Hyperscalers: Valuation Compression Nearing Its End

The Mag-7 has continued to underperform the broader market this year, with its 12-month forward price-to-earnings ratio relative to the S&P 500 falling to nearly one standard deviation below the average, the cheapest level in a decade. JPMorgan noted as early as March this year that the de-rating process had already gone too far.

The hyperscaler index, which includes Amazon, Google, Microsoft, Meta, and Oracle, has underperformed the S&P 500 by 8% year-to-date. As AI capital expenditures surge, free cash flow at these companies is turning negative. According to Bloomberg data, the combined free cash flow of these five companies is expected to fall from approximately $233.4 billion in 2024 to about $10.6 billion in 2026, before turning negative in 2027. At the same time, debt and equity financing volumes are rising accordingly.

JPMorgan acknowledged that the shift in business models from asset-light to asset-heavy does provide some justification for the valuation compression. However, current relative price-to-earnings ratios have already exceeded one standard deviation below the average, and the compression may have overshot. The bank believes that share price performance for hyperscalers will be supported by earnings growth. Although further valuation compression may erode some gains, it will not offset them entirely.

Another commonly cited concern is monetization capability. LLM token prices have fallen sharply in recent months, but JPMorgan pointed out that explosive growth in consumption has been sufficient to offset the impact of price declines. Overall spending is in fact still rising, and monetization case studies continue to accumulate.

Semiconductors: Earnings Keep Rising, Pair Trade Re-Entry

JPMorgan maintained its overweight stance on the semiconductor sector and recommended re-establishing a pair trade of "long semiconductors, short software."

During the momentum unwind from June to July this year, the Philadelphia Semiconductor Index (SOX) fell as much as 28%, while the Korea Composite Stock Price Index (KOSPI) dropped even more, at 39%, with the latter amplified by concerns over HBM spec downgrades and algorithmic efficiency improvements compressing memory demand. However, JPMorgan called for a return to a bullish stance on semiconductors as early as late July, citing continued earnings strength.

Data confirmed this judgment. Since the relative price of semiconductors versus software peaked in June, 12-month forward earnings per share for semiconductors have continued to be revised upward, gaining 30%. Earnings expectations for the software sector have shown almost no improvement. JPMorgan views this significant divergence between price and earnings as a favorable buying opportunity.

From a fundamental industry perspective, JPMorgan's semiconductor research team emphasized that supply-demand balance is unlikely to be achieved before 2028, and pricing is expected to continue rising through 2027. Recent quarterly commentary from several companies also confirmed that demand is still accelerating. Broadcom management stated that inference demand is accelerating the adoption of custom XPUs. Applied Materials issued guidance that significantly exceeded expectations and described unusually strong visibility spanning eight quarters from its largest customer. Arm Holdings said its cloud/AI royalty mix is growing at twice the rate annually.

Capital expenditure forecasts for hyperscalers also support this judgment. JPMorgan expects combined capital expenditures for hyperscalers to climb from an estimated $950 billion in 2026 to $1.4 trillion in 2027, and reach $3 trillion by 2030, implying a compound annual growth rate of approximately 28% from 2027 to 2030.

Within the semiconductor supply chain, JPMorgan specifically highlighted the semiconductor equipment (SPE) sub-sector and named ASML as a core European play. Although market bets on earnings downgrades have pushed ASML's PEG ratio to a low level, JPMorgan considers this a buying opportunity, with its industry analysts believing the company's fundamentals will ultimately prove resilient.

Software: Valuations at Historic Lows, But Fundamentals Lack Support

The software sector has continued to underperform the broader market since mid-last year, with investors worried that the rise of AI will render its business models and revenue models irrelevant. Currently, valuations for the US AI Vulnerable basket and European stocks at risk from AI disruption have both fallen to near historic lows.

In late June this year, comments from Anthropic CEO Dario Amodei about the need to "slow the frontier of AI development" triggered a single-day rally of 12.2% for software relative to semiconductors, one of the largest single-day gains in history. JPMorgan is skeptical of this, arguing that the AI race is essentially an existential battle with a winner-takes-all dynamic, and a significant slowdown is unlikely.

JPMorgan noted in March this year that given the excessive decline in the software sector, there were short-term trading rebound opportunities, and advised against excessive shorting. However, the bank also emphasized that the profitability of the software sector will continue to be questioned, and the sector may lag other parts of the AI ecosystem for a long time.

Cybersecurity is an exception within the software sector. JPMorgan pointed out that increasingly severe security threats posed by AI models have driven a sharp rebound in cybersecurity company share prices in recent months, and the AI security theme is expected to persist.

Overall Market: Poised to Resume Gains After Oil and Rate Volatility Subsides

JPMorgan believes that once oil price and interest rate volatility stabilize, combined with the fading of unfavorable September seasonality, the overall stock market is expected to resume its upward trend, with strong third-quarter results serving as an important catalyst.

The main disturbances currently facing the market come from two fronts. First, the US 10-year Treasury yield broke through the 5% mark last week for the first time in nearly two decades, driven by multiple factors including rising energy prices, strong PMI sub-components, weak demand at the 5-year Treasury auction, and hawkish comments from Federal Reserve officials. Second, oil prices have risen amid escalating US-Iran tensions. Nevertheless, the S&P 500 and Europe's Stoxx 600 are currently only 1% to 3% below their highs, demonstrating the market's strong ability to absorb volatility.

JPMorgan noted that improvement in the technology sector benefits the overall market, as tech stocks account for 39% and 44% of US and emerging market indices, respectively. However, technology outperformance is not a necessary condition for the market to rise. During the momentum unwind from June to July this year, both KOSPI and SOX fell sharply, yet the overall stock market still stabilized and reached new highs in August, only recently coming under pressure again due to oil price and interest rate volatility.

In terms of sector allocation, JPMorgan maintained an overweight position in semiconductors, an underweight position in software and media, and is bullish on indirect opportunities in Korea and emerging markets benefiting from the improvement in the semiconductor sector.