Q2 2026: Reflecting on the Investment Markets

“We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.” The Declaration of Independence, July 4, 1776.

• Equity markets rallied sharply in the second quarter, recovering losses incurred in the first quarter and pushing year-to-date returns for the S&P 500 Index above 10%.
• Bond investors faced a difficult second quarter as rising interest rates produced negative price returns for duration-sensitive bond portfolios.
• The interest rate narrative has experienced a 180-degree shift, moving from “two rate cuts expected” at the end of 2025 to “one or two hikes possible” following the June FOMC meeting.

Economic Review and Outlook

Index return data provided by Bloomberg. This information is provided for illustrative purposes only.
Index performance does not reflect fees or expenses that investors typically pay to buy or sell securities.
It is not possible to invest directly in an index.

The second quarter opened with the U.S. economy showing considerably more underlying resilience than first-quarter headlines had suggested. The second estimate of GDP for the first quarter of 2026 was revised to 2.0% annualized. This was a material improvement from the downwardly revised 0.7% for the fourth quarter of 2025, and well above the near-zero reading that had briefly been feared when the Iran conflict erupted in late February. The recovery in output growth reflected the strength of capital investment related to artificial intelligence (AI) and the continued resilience of upper-income consumer spending, even as lower-income households remained under sustained pressure from elevated energy costs and stubbornly persistent goods price inflation.

The June 15 peace framework announcement and the formal reopening of the Strait of Hormuz on June 18 have started to reverse some of the effects of the energy shock. Falling energy prices may provide a disinflationary tailwind heading into the second half of 2026. Whether that tailwind proves durable, or whether earlier price increases have already become embedded in core inflation, will be watched closely as we move into the second half.

On May 22, Kevin Warsh was sworn in as the 17th Chair of the U.S. Federal Reserve (Fed). The market’s first extended read of his positions on monetary policy came at the June 16–17 FOMC meeting. What investors received was not the accommodative pivot some had anticipated when Warsh was nominated for the post. The decision to hold the federal funds rate at 3.50%–3.75% for the fourth consecutive meeting was universally expected. What was not anticipated was the hawkish reconfiguration of the “dot plot.” Nine of 18 FOMC officials indicated they expected at least one interest rate hike before year-end, with six projecting multiple increases. Warsh himself declined to submit a rate forecast, breaking with recent precedent.

The broader significance of Warsh’s debut extends well beyond a single meeting. The announcement of task forces to overhaul the Fed’s communications architecture and operational practices signals a structural reorganization of how the central bank engages with markets. The elimination of forward guidance means that each upcoming data release will carry more market-moving weight than it has in recent years. Fed funds futures quickly responded to Warsh’s first meeting as FOMC Chair with a complete inversion of the market’s starting point for 2026. Investors had entered the year expecting two rate cuts and now, six months later, they are pricing one or two hikes by year’s end.

Stock Market Review and Outlook

Index return data provided by Bloomberg. This information is provided for illustrative purposes only.
Index performance does not reflect fees or expenses that investors typically pay to buy or sell securities.
It is not possible to invest directly in an index.

Equity markets rallied strongly in the second quarter, buoyed by a geopolitical relief rally based on the hopes that the U.S.-Iran conflict was concluding, as well as an exceptionally strong earnings season. The S&P 500 powered to a gain of 15.2% for the quarter, recovering all of the first quarter’s losses and pushing year-to-date returns to 10.2%. Equity market performance has meaningfully broadened thus far in 2026, expanding from the AI-focused large-cap growth companies. U.S. small-caps and emerging markets were the biggest beneficiaries, with the Russell 2000 Index surging forward 21.6% and the MSCI Emerging Markets Index up 24.1% in the second quarter. The market’s year-to-date performance, despite an energy shock of historic proportions, a leadership transition at the Fed, the largest initial public offering (IPO) in history, and an intra-year correction of roughly 7%, reflects the depth of underlying corporate earnings momentum and the market’s ongoing confidence in the AI investment supercycle.

The sector leadership patterns that characterized the first quarter reversed sharply in the following three months. After a difficult first quarter, technology stocks resumed their upward trajectory in the second quarter, reflecting better-than-expected earnings. Technology and growth-oriented stocks reclaimed the leadership mantle from energy, dividend and defensive stocks that had dominated January through March. The Information Technology sector was up 31.8% in the second quarter, easily outpacing Industrials, the next-best-performing sector, which was up 13.3%. Energy stocks, which had been the top-performing S&P 500 sector in the first quarter, gave back a meaningful portion of those gains as crude oil retreated from its war-premium highs following the ceasefire and the hopes for a peace deal. Regarding the relative laggards over the second quarter, the Energy sector dropped -13.5%, Utilities fell -0.5%, Materials gained 2.0%, and Consumer Staples rose 0.3%.

International developed markets dramatically outperformed U.S. stocks in 2025, at least in part owing to dollar weakness and increased levels of defense spending by European nations. International markets saw that advantage narrow sharply in the first half of 2026. The June 15 peace framework and the Strait of Hormuz reopening provided a partial recovery for European energy-intensive sectors, but the structural damage to corporate margins and consumer confidence from months of elevated energy costs will take time to reverse fully.

Currency dynamics added a further layer of complexity. The broad-based depreciation of the U.S. dollar against foreign currencies in 2025 served as a powerful tailwind for international equity returns for dollar-based investors, and this dollar weakness persisted through much of the first quarter. However, a more hawkish June FOMC meeting produced a sharp reversal, with the dollar strengthening based on the anticipation of higher-for-longer interest rates in the U.S. Despite this and other near-term factors that appear to have turned less favorable, what will likely remain intact are the structural case for international diversification based on attractive relative valuations between U.S. and international markets, the expected continuation of the European defense and energy security spending themes, and the potential for dollar depreciation over a multi-year horizon.

Bond Market Review and Outlook

Index return data provided by Bloomberg. This information is provided for illustrative purposes only.
Index performance does not reflect fees or expenses that investors typically pay to buy or sell securities.
It is not possible to invest directly in an index.

Fixed income markets in the second quarter were characterized by elevated yield volatility and the emergence of a new set of structural risks under the leadership of new Fed Chair Kevin Warsh. The 10-year Treasury yield began the second quarter at approximately 4.30%, which was already elevated after a first-quarter surge in rates during the early phases of the Iran war, and then proceeded through a series of dramatic intra-quarter moves before ultimately ending the quarter at 4.47%. The 10-year yield peaked at 4.67% in mid-May before retreating on hopes of a peace deal in the Middle East. The cumulative effect of these moves was, on balance, negative for duration-sensitive bond portfolios.

The Bloomberg US Aggregate Bond Index has found itself swimming against the strong current of rising interest rates in the first half of 2026. Despite the challenging rate environment and still-tight credit spreads, the higher starting yields resulted in coupon income largely offsetting price declines. As a result, the Bloomberg U.S Aggregate Bond Index was up 0.7% in the second quarter.

Credit markets demonstrated more resilience over the period. Investment-grade spreads, which had entered 2026 at historically tight levels, widened modestly during the height of the March–April volatility before recovering in May and June in response to strong corporate earnings. As yields remain elevated, bond investors should consider retaining this advantage going forward, with the higher yields giving bonds a far stronger foundation for future returns than they have had in years.

Portfolio Implications

The second quarter of 2026 was defined by reversals of some of the geopolitical and market conditions that ended the preceding quarter. The Iran war energy shock transformed into a relief rally after a ceasefire was struck on April 7. Deescalation built steadily through May, and a formal peace framework was announced on June 15. A blowout first-quarter earnings season, the historic IPO of SpaceX stock and a broadening of AI-driven revenue gains across enterprise technology contributed to market momentum. The quarter ended with Fed Chair Kevin Warsh’s first FOMC meeting (held on June 17) producing a hawkish surprise, with the dot plot signaling possible rate hikes before year-end and a new “regime change” philosophy at the central bank.

There is a wide range of possible outcomes as we move into the second half of 2026, and there’s always the possibility of additional macroeconomic and geopolitical shocks emerging that we have yet to contemplate. While we can’t accurately forecast the scope and duration of the war with Iran, how AI will evolve, or the future path of interest rates, we can prepare for an uncertain future by building resilience into the portfolio construction process.

• The concentration of equity market performance in a handful of large-cap technology growth stocks known as the “Magnificent Seven” has been a powerful tailwind driving the positive performance of U.S. large-cap indices like the S&P 500. But this sort of market concentration has, to a significant extent, turned portfolios that have been built around a market-cap-weighted index of large U.S. companies into a bet on the fortunes of these seven companies. And, as investors experienced in the first half of 2026, when these seven stocks underperform, this narrow focus can be a double-edged sword. The current backdrop may lead investors to evaluate diversification beyond U.S. mega-cap growth stocks. Two areas that stand out as particularly timely are U.S. small- and mid-cap stocks, and international equities, with emerging markets offering the potential for an attractive combination of valuation and structural tailwinds.
  
  The common thread across small-/mid-cap and international/emerging market equities is that each offers a way to reduce portfolio dependence on a narrow set of technology stocks tied to the AI-theme. These asset classes allow investors to reallocate exposure towards market segments priced more reasonably. The structural case for emerging markets has already benefited investors in the first half of 2026. Thus far, two key drivers of the positive performance have been a weakening dollar and access to AI supply-chain exposure outside of the Magnificent Seven through companies based in Taiwan and South Korea.
  
  This is not an argument for abandoning U.S. large-cap growth, as these companies continue to generate a disproportionate share of corporate profits and cash flow. A wider investment scope allows investors to diversify their equity allocations across regions, styles and sectors, and also reduce concentration risk while maintaining participation in broad secular growth themes.
  
  
• Today’s fixed income environment of elevated bond yields and a positively sloped yield curve present an opportunity for bond investors that did not exist for much of the 15 years following the 2008 global financial crisis. High starting yields mean that bonds are now offering meaningful income return rather than serving simply as a tool for dampening volatility. The positively sloped yield curve means investors are being compensated for extending duration rather than being penalized for it.
  
  For taxable investors, the broader opportunity set of fixed income municipal bonds may offer an attractive combination of elevated tax-equivalent yields, strong underlying credit quality and potentially attractive value relative to historically tight credit spreads. Specific positioning, such as how far to extend duration, the use of municipal bonds and balancing credit quality versus yield, should reflect each investor’s individual tax situation, liquidity needs and risk tolerance.
  
  
• As companies are often choosing to stay private for longer, a larger share of the value creation for many fast-growing companies has begun to accrue to investors in private markets, rather than after they become publicly traded. This trend has been driven by several factors:
  • The increasing abundance of private capital available at scale means founders no longer need public markets to fund expansion.
  • The threshold for IPO readiness has risen substantially, which has narrowed the number of companies that are good candidates to go public at any given time.
  • Staying private longer allows companies to delay quarterly earnings scrutiny and the burden of the compliance overhead faced by public companies.
  • A deepening secondary market has given early-stage investors an additional avenue to liquidity that reduces the urgency to follow the IPO route.

Conclusion

Thus far in 2026, markets have offered a reminder that the events likely to cause investors the most anxiety—such as the next inflation report, FOMC statement or geopolitical headline—are all beyond their control. Instead, investors should focus on the things that are under their control, such as effectively managing their asset allocation, building a process to control their behavior, and dealing with the impact of costs and taxes. These are the factors that, over time, tend to have a much greater influence on long-term investment success than any market call or reaction to current events.

July 4, 2026 is the 250th anniversary of the signing of the Declaration of Independence, which itself might be viewed as a risk management document. Its authors believed that no single entity should hold unchecked power, that the legitimacy of a government flows directly from broad participation by the governed, and that an enterprise built to endure must be designed for an unknown future rather than one that is merely hoped for.

These beliefs are remarkably similar to the convictions that inform modern portfolio management. The founders distributed power across various branches of the federal government and across all the states, so that a single failure would not topple the whole. Similarly, disciplined investors distribute capital across asset classes, geographies and time, so that a single shock will not impair the whole plan. The Constitution’s framers wrote in mechanisms for self-correction that included regular elections, the power to amend the founding documents, and judicial review of laws.

Modern investors diversify portfolios, follow a regular plan of rebalancing and adhere to a process of regular portfolio review to update the plan as their circumstances change. Both systems rest somewhat on humility about the future. They recognize that no forecast is certain, that the world we inhabit will change in unseen ways, and that resilience matters more than forecasting future events. Both are, ultimately, exercises in patience and a belief that broad participation, prudent structure and steady commitment will compound over time into something far greater than any single actor could achieve alone.

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