For investors, the underlying strength in earnings and economic data supports staying invested—leaning into volatility and maintaining a long-term perspective. It also helps to remember that financial markets reward those who remain invested, diversified, and disciplined, especially when conviction is hardest to sustain.
The economy’s resilience can weather the inflation surge
Despite the shock from rising energy prices and the uncertainty surrounding the Iran conflict—though a recent interim agreement between the U.S. and Iran should help reduce near-term volatility in energy markets—the U.S. economy has remained resilient, supported by tailwinds from AI investment, fiscal stimulus, and solid consumer spending underpinned by a strong labor market. We anticipate a soft patch in economic growth in Q3, followed by a rebound toward year-end as the conflict’s price pressures fade. GDP growth for 2026 is projected at 2.0%, roughly in line with 2025, with stronger momentum likely delayed until 2027.
The extended period of elevated fuel costs and ongoing supply chain disruptions is contributing to higher inflation, reinforcing the tug-of-war between inflation and growth, which we expect to linger into the fall, weighing on discretionary spending and increasing costs for businesses. Hiring has been stronger than expected as labor demand has picked up. Job gains should remain solid in the second half of the year, with hiring becoming more broad-based as businesses ramp up investment to capture available tax incentives. The unemployment rate has remained low and is expected to end the year at 4.2%.
Given the recent uptick in inflation and signs of stabilization in the labor market, we expect the Fed to remain on hold for the rest of 2026. Inflation is likely to peak above 4.0% before easing to around 3.2% by year-end, as moderating energy prices—partly reflecting the interim U.S.-Iran agreement—help relieve price pressures alongside gradual cooling in housing and services. While new Fed Chair Kevin Warsh may favor gradually lower interest rates over time, current economic conditions are unlikely to support further rate cuts until 2027; modest easing next year should move the policy rate closer to a neutral stance. Long-term rates are expected to trend modestly higher over 2026, as elevated inflation expectations, fiscal debt concerns, and the Fed’s pause put upward pressure on yields. The 10-year Treasury yield is projected to end 2026 near 4.3%, as inflation trends lower in the second half of the year.
Tailwinds lift equities despite geopolitical risks
The case for equities in the second half of 2026 is grounded in a resilient economic backdrop. While crosscurrents from geopolitical strain, policy uncertainty, and higher interest rates remain, they are likely to coexist with continued economic growth, solid earnings trends, and ongoing innovation.
At the core of the market’s resilience—and our constructive outlook—is a broadening earnings cycle that continues to improve in quality, supported by AI-related investment, infrastructure spending, and meaningful fiscal stimulus. Margins remain firm, cost discipline is evident, and early productivity gains from technology adoption are materializing across sectors—supporting both revenue growth and margin expansion through improved operating leverage.
As the second half unfolds, investors should expect equity returns to remain positive but more measured, with greater dispersion and outcomes increasingly driven by company-specific fundamentals and earnings execution. In this environment, maintaining a clear focus on long-term objectives and diversified portfolios will be essential to navigating periods of volatility. That includes broadening exposure beyond the narrow leadership that has defined the current bull market, with opportunities in areas such as small caps, emerging markets, and traditional value-oriented sectors.
The strong performance of small caps this year is a reminder that leadership can shift quickly—and often without clear warning. Beneath the surface, market strength has broadened, with improving breadth and earnings revisions supporting a more durable advance beyond the largest companies. Varying sensitivities to interest rates, inflation, and commodity prices underscore how different exposures may respond to evolving economic conditions.
Investing internationally may feel riskier given persistent geopolitical tensions and shifting economic currents. However, earnings momentum has not been confined to the U.S.; emerging markets, in particular, have continued to trend higher despite rising energy prices and volatility. Recent results reinforce this strength, with first-quarter earnings tracking ahead of consensus expectations and full-year growth projected at a robust pace, approaching 50%, while valuations remain relatively undemanding. A forward P/E of roughly 11.8x sits below long-term averages, reinforcing the case for emerging markets as a compelling combination of growth and valuation for investors seeking diversified sources of return.
As we move through the second half of 2026, style leadership is likely to resemble a rotation, with capital continuing to shift between growth and value rather than decisively favoring one. While broad diversification remains critical, dispersion in fundamentals, policy sensitivity, and valuation across sectors is likely to drive outcomes in the months ahead. Sectors tied to real economic activity and AI-driven capital deployment should continue to show positive momentum. Consumer-facing segments may remain more uneven, though still supported by a resilient labor market and the wealth effect. Technology continues to offer powerful structural growth tied to innovation, but elevated expectations and positioning call for greater selectivity.
Bonds offer stability despite rate volatility
Fixed income should continue to serve as a core stabilizer within diversified portfolios, particularly as economic uncertainty and market volatility persist. While the Fed is likely to keep rates on hold, the policy backdrop has become more balanced, with recent commentary suggesting a bias that could shift depending on the path of inflation. While elevated oil prices have filtered through the economy, recent easing in energy markets following the interim U.S.-Iran agreement may help soften inflation pressures over time—reducing the risk that inflation remains persistently sticky.
The transition at the Federal Reserve introduces an additional layer of uncertainty. Markets often test new leadership as policy frameworks evolve, and any perceived shift in the Fed’s reaction function—particularly with less explicit forward guidance—could amplify rate volatility. A sustained move higher in long-term yields, especially beyond recent ranges, would likely tighten financial conditions and present a more meaningful headwind for risk assets.
Overlaying this is the historical pattern of midterm election cycles, which tend to coincide with elevated policy uncertainty and periodic market dislocations. The current year has been relatively subdued in terms of drawdowns compared to historical averages, suggesting that volatility may be deferred rather than avoided. Taken together, these crosscurrents point to a market environment where volatility is not an anomaly, but an expected feature as the year progresses.
Looking ahead, adaptability will matter
The road ahead for the rest of 2026 will likely be defined by the market’s ability to adapt to shifting expectations around growth, monetary policy, and inflation. While uncertainty persists, the underlying foundation—supported by durable earnings growth, healthy margins, and sustained investment—remains intact. Importantly, the quality of this expansion continues to evolve, albeit not without fits and starts, with productivity gains and broader participation likely to complement still-dominant secular growth themes.
In this environment, investment opportunities should broaden, with returns increasingly driven by selectivity and diversification. Technology and AI-related stocks are likely to remain market leaders, but performance may widen, creating a more balanced and complex structure beneath the surface. Elevated expectations and lingering economic risks suggest volatility will remain a defining feature of the landscape.
Investors should stay anchored to their long-term objectives, using periods of volatility as opportunities rather than signals to retreat. The economic expansion remains intact, but navigating it successfully will require staying invested, diversified, and adaptable as the cycle evolves.
