Investment Overview: 2nd Quarter 2026

The economy

The global economy remained resilient during the second quarter despite higher energy prices, geopolitical conflict, and ongoing trade uncertainty. Growth expectations were revised modestly lower as the conflict in the Middle East disrupted energy markets and supply chains, but moderate global expansion remains the base-case expectation. Continued investment in artificial intelligence, infrastructure, defense, and energy projects helped support activity across many major economies.

In the United States, growth moderated but remained positive. Consumer spending continued to expand, though at a slower pace as higher gasoline prices and inflation reduced purchasing power. At the same time, business investment remained a significant source of strength, with AI-related capital expenditures, manufacturing expansion, reshoring initiatives, and infrastructure spending helping offset softer household demand.

The labor market continued to cool gradually without showing signs of meaningful deterioration. Payroll growth remained positive, unemployment held near historically low levels, and job openings moved closer to the number of unemployed workers, suggesting a labor market that has normalized after several years of tight conditions. Wage growth also moderated, helping reduce inflation pressures while continuing to support household incomes.

Inflation re-emerged as one of the quarter’s primary concerns. Higher energy prices following disruptions in the Middle East pushed headline inflation higher, while services inflation remained somewhat sticky. Encouragingly, shelter inflation continued to moderate and broader inflation pressures remained more contained than during the inflation surge of 2022. Markets responded by reducing expectations for near-term Federal Reserve rate cuts as policymakers balanced inflation concerns against moderating economic growth.

Manufacturing activity showed encouraging signs of improvement throughout the quarter. New orders, production activity, and business confidence strengthened as companies expanded investments in data centers, semiconductor production, electrical infrastructure, and domestic manufacturing capacity. Reshoring initiatives and AI-related investment continue to provide important support for the industrial sector, while improving order backlogs suggest manufacturing momentum has strengthened after a prolonged period of weakness.

Trade policy and geopolitical developments remained key sources of uncertainty. Businesses continued to navigate evolving tariff policies and shifting supply chains, while the conflict involving Iran fueled concerns about energy supplies and global shipping routes. As the quarter progressed, however, markets grew more confident that a broader energy crisis would be avoided, helping stabilize sentiment and support a strong rebound in global equity markets.

Despite economic and geopolitical headwinds, corporate America continued to report impressive profitability. Earnings growth remained robust, supported by healthy margins, ongoing productivity improvements, and continued investment in technology. Business confidence improved over the course of the quarter, reflecting optimism that economic growth can continue even amid a more challenging operating environment.

Looking ahead, the outlook remains constructive but increasingly balanced. Economic growth continues, labor markets remain healthy, manufacturing activity is improving, and corporate profits remain strong. At the same time, inflation has moved higher, trade policy remains uncertain, and geopolitical tensions continue to pose risks. While volatility is likely to persist, the most likely outcome remains moderate economic expansion through the second half of 2026 rather than a material slowdown or recession.

Fixed income

Fixed income markets recorded modest gains in the second quarter despite rising interest rates. U.S. Treasury yields rose during the quarter as investors reassessed the likelihood of Federal Reserve easing. Investment-grade and high-yield corporate bonds generally held up well. Credit spreads widened modestly early in the quarter but remained historically tight overall.

The Bloomberg U.S. Aggregate Index finished the quarter up 0.67% and a healthy 3.79% over the last 12 months. The 10-year Treasury finished the quarter at 4.47%, up from 4.32% at prior-quarter end. The yield curve flattened as shorter-term rates increased more than the long end. The 2-year Treasury finished the quarter at 4.18%, up from 3.80% at the start. 

Kevin Warsh assumed the Federal Reserve chairmanship on May 22. He previously served as a Federal Reserve Governor from 2006 to 2011 and was a key participant in the Fed’s response to the 2008 Global Financial Crisis.

Under Chairman Warsh, the Fed kept rates unchanged at its June meeting. The Fed Funds Target Rate range currently stands at 3.50%–3.75%. Of particular note, Warsh’s first policy decision statement removed language that had previously suggested a bias toward future rate cuts and emphasized the Fed’s commitment to restoring inflation to the 2% target. The Fed’s more “hawkish” tone led to a flatter yield curve as short-term yields rose faster than long-term yields.

As we move into the third quarter, we emphasize that current yields remain attractive and offer compelling risk-adjusted return potential and diversification benefits. Nevertheless, interest-rate volatility is likely to stay elevated until inflation shows a clearer path back toward the Fed’s 2% objective. Market expectations have turned decidedly more hawkish than those expressed last quarter. Interest rate futures markets currently imply roughly even odds of a rate hike by year end with virtually no chance of a rate decrease.

Treasury yields of selected maturities for recent time periods are displayed below (data from Bloomberg).

Total return numbers for various fixed income indices over the past quarter and 12 months are below (data from Bloomberg).

Equities

Stock markets rebounded sharply in the second quarter as exceptional earnings growth carried markets higher despite continued geopolitical uncertainties. Semiconductor companies had historic gains in the quarter, leading the tech-heavy NASDAQ Composite to a gain of over 21%, enjoying its best quarter since 2020. The S&P 500 gained over 15%, also posting its best quarter in six years. Market breadth has improved beyond technology, as the Dow Jones Industrial Average finished the quarter at a record close of 52,319, capping its best first half of a year since 2021, while the small-cap Russell 2000 Index had its best first half of a year in over three decades.

Earnings growth has been robust and remained the key driver of stock price gains. For the first quarter, the S&P 500 saw earnings growth of over 25%, as any adverse effects of higher energy prices and other macro uncertainties did not filter into corporate earnings reports. In fact, estimates for second quarter earnings call for another quarter of above 20% growth, which would mark the seventh consecutive quarter of double-digit growth for the index. Both revenue growth and margin expansion have contributed to the impressive earnings growth.

Overall, the second quarter of 2026 saw robust gains after a challenging first quarter. Growth stocks regained their momentum and easily outpaced value stocks for the quarter. In a sign of broadening participation beyond the “Magnificent Seven” companies, smaller capitalization stocks and emerging market equities were the best performers for the quarter. Looking back further, nearly all major market indices have posted very strong 12-month returns of greater than 20%.

International stocks continue to post impressive gains. The developed foreign market benchmark rose over 11% for the quarter, while the emerging market benchmark gained over 44% over the past 12 months. Tailwinds over these periods have included currency benefits from a weaker dollar and heightened infrastructure spending abroad against a backdrop of relatively less demanding international valuations.

The strength in markets has not been a smooth ride. Over a quarter of trading days so far this year have seen the market move up or down greater than one percent. With the market trading at above average valuations, sustained earnings growth will be key to maintaining upward momentum.  Concerns of stubbornly high inflation pushing rates higher and any signs of a slowdown in the artificial intelligence buildout will be closely monitored, and volatility may well remain elevated.

Returns from this point forward will likely be decided by the ability of companies to continue to meet elevated expectations. The ability of corporate America to manage through the uncertainties of the past several years has been remarkable. Given the potential for quickly changing narratives and the prospects for volatility, a well-diversified equity portfolio remains a prudent approach.

Below is a table displaying various equity index returns for the past quarter (data from Bloomberg).

Sector returns

Second-quarter sector returns were broadly higher as most areas of the market enjoyed gains. However, only one sector was ahead of the S&P 500 for the quarter, as certain beneficiaries of the AI trade rebounded strongly and led the market for the period.

The Technology sector as a whole regained its spot at the top of the chart, but within the sector there was a wide divergence in industry performance. The Semiconductor Index had a record quarter as it roughly doubled for the period, while the software industry within tech showed “merely” market-like gains.

Many other cyclical growth areas of the market were positive for the quarter as well. Industrials fared well, as the manufacturing sector returned to expansionary conditions led by the massive data center build out. Consumer Discretionary and Financials also gained as consumer spending and credit conditions remain stable for now.

After leading the market in the first quarter, the Energy sector was the biggest laggard this quarter, as the price of crude oil fell after signs of an end to the war in Iran surfaced. The energy sector is still up nearly 20% for the first half of the year.

Consumer Staples and Utilities, traditionally more defensive areas of the market, were flattish for the quarter. Investors tend to shy away from these sectors during periods of strong overall market performance.

As we move into the second half of 2026, hopes of broader stock market participation persist. While concerns about lofty valuations and geopolitical uncertainties remain, corporate America has delivered strong earnings growth driven by both top line performance and improving margins. A diversified portfolio with exposure to cyclical growth as well as more traditionally defensive sectors is likely to remain prudent against a backdrop where the market has seemingly priced in a continuation of strong growth.

The following table details S&P 500 sector total returns for the quarter (data from Bloomberg).