The second quarter of 2026 marked a sharp turnaround for markets. Major equity indices, including the S&P 500, Nasdaq and Russell 2000, delivered their strongest quarterly gains since 2020, driven by continued enthusiasm for artificial intelligence (AI), easing geopolitical concerns and shifting expectations for monetary policy.
Three drivers behind the market rebound
Three themes helped fuel the recovery.
First, AI remained a major source of market leadership. Strong corporate earnings and continued investment reinforced confidence that AI will remain an important driver of economic and market growth.
Second, signs that there could be diplomatic progress in the Middle East helped calm investor concerns. The temporary resumption of shipping through the Strait of Hormuz eased pressure on energy markets and improved risk sentiment.
Third, investors began adjusting to a new Federal Reserve Chair. Kevin Warsh's focus on controlling inflation prompted markets to reassess the timing and pace of future interest rate cuts.
Perhaps most encouraging was the broadening of market participation. Small-cap stocks and emerging markets joined large-cap technology companies in driving returns, creating a healthier market backdrop than one reliant on a narrow group of leaders. Fixed income returns were also positive across major segments, although gains were more modest as Treasury yields moved higher.
A new Fed and a resilient economy
Markets are still evaluating what a Warsh-led Federal Reserve means for policy, but the early message has been clear: restoring inflation credibility remains a priority.
Recent inflation data have been encouraging, supporting the view that price pressures may gradually moderate. Our current outlook calls for inflation to remain elevated but gradually easing over the coming months, with economic growth holding above 2% and unemployment settling near 4.3%
We expect the Federal Reserve to remain on hold as policymakers assess incoming economic data, with the potential for interest rate cuts to resume in 2027. The greatest source of uncertainty continues to be developments in the Middle East. A lasting resolution could accelerate the decline in inflation and provide an additional boost to global growth.
Energy and artificial intelligence remain key themes
Higher oil prices remain a risk but one that appears manageable under current conditions. The U.S. economy is less energy-intensive than in previous decades, benefits from being a net energy exporter and has been supported by healthy consumer finances. However, a prolonged disruption to energy supplies or further escalation in regional tensions could alter the economic outlook.
At the same time, we remain constructive on the AI investment cycle and do not believe it represents a speculative bubble. While investors should monitor rising debt levels used to finance AI infrastructure, capital spending continues to translate into meaningful earnings growth. Importantly, the impact of AI-related investment is extending beyond tech and semiconductor companies, creating potential opportunities for investors in industrials, infrastructure, power and real estate. As AI evolves toward robotics, autonomous vehicles and AI-powered manufacturing, the opportunity set is becoming increasingly broad.
Positioning for the second half of 2026
Our outlook remains modestly positive. Strong earnings growth, broadening market leadership, continued AI investment, supportive fiscal policy, and improving labor market conditions provide reasons for optimism.
At the same time, investors should remain mindful of risks, including renewed geopolitical tensions, inflation that remains above target and stretched valuations in certain segments of the market.
We continue to maintain a modest overweight to equities and a modest underweight to fixed income. Within fixed income, we favor higher-quality sectors and a short-to-intermediate duration focus given ongoing uncertainty around inflation and the timing of future Fed rate cuts. Within equities, diversification remains important. We continue to see opportunities not only in U.S. large-cap stocks, but also in small- and mid-cap companies, international equities and emerging markets as market leadership broadens.
The bottom line
The first half of 2026 demonstrated the importance of diversification and staying invested. Despite geopolitical conflict, inflation pressures and changing monetary policy expectations, markets proved resilient. While volatility may continue, maintaining diversification across both equities and fixed income, while remaining focused on long-term objectives, remains the foundation of successful investing.
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