The second quarter of 2026 was a sharp reversal from the first quarter. Risk assets staged a powerful rally after a 1st quarter decline of 5% in the S & P 500. After a negative first quarter highlighted by conflict in the Middle East, the S & P 500 rallied 15.2% over the second quarter, setting a record close on June 1st before a late June pullback in technology trimming gains.
The macro picture inverted during the middle of the quarter. Oil collapsed nearly 40% from its conflict peak as a U.S.-Iran ceasefire framework took hold and the Strait of Hormuz began to reopen, pulling Brent from around $100/barrel back toward $70 at the end of June. Inflation finally caught up with the energy shock. Headline PCE reached 4.1% and the Fed’s preferred core PCE gauge hit 3.4%, the highest in over two years. Much of the pressure was energy-driven and likely peaking as oil fell, but the data framed the quarter’s most consequential development as rate hikes instead of rate cuts are now being priced into market expectations.
The market fell about -9.2% from the high in the first quarter to the bottom in April from the Iran war and fear of inflation. Once the market concluded there was no significant risk from Iran, there was a round trip in risk assets. The S & P 500 returned 10.5% in April, its best month since 2020, then added another 5.3% in May, closing the month at successive record highs. The rally carried into early June, when the index set a record close of 7,609. By the time the quarter ended (even after a choppy June), the S & P 500 had gained 15.2% for the three months and is now up 10.2% for the year.
Source: Morningstar Direct. Data as of 6/30/2026.
Equities have reached record highs despite inflation that has accelerated to a three-year high, a Federal Reserve that is being interpreted as more hawkish, and a war that remains unresolved. But markets are looking ahead, and the rally was in large part a bet that the worst of the energy shock was behind us and that corporate earnings can continue to grow. That bet may prove correct but there are many unsettled questions about the direction of rates, inflation and geopolitical conflicts.
One feature of the quarter was the broadening out of the equity rally from a top-heavy market. For most of the past two years, the complaint about US equities has been that handful of mega-cap technology names were doing most of the work. That remained largely true though May. But in the final weeks of the quarter, participation broadened. The qual-weighted S & P 500 outperformed the capitalization-weighted index- as did value and small-cap stocks. The Russell 2000 index gained 3.7% in June and is now up 22.6% in the first half of the year. Value stocks (Russell 1000 Value Index) outgained their growth counterparts by nearly 500 basis points in June – bringing their year-to-date return to 16.3%. A market that broadens as it climbs is a healthier market than one that narrows.
The rotation extended into foreign equities. Emerging markets led the way with the MSCI EM Index gaining roughly 24% for the second quarter, as the same memory and semiconductor demand driving Korea and Taiwan rewarded the markets most exposed to it. Developed International equities had solid absolute returns but failed to keep pace with other equity markets. The broad MSCI Index rose about 10.8%, while European stocks gained nearly 11% for the quarter, slightly dampening foreign equity returns when converted back to dollar terms.
Fixed income had its own version of the quarter’s round trip. The Federal Reserve made no change to the policy rate-the June meeting marked a fourth consecutive hold at 3.5% to 3.75%. The two-year Treasury yield, anchored by the front end, finished the quarter at near 4.14%, while the ten-year settled at 4.44%. The thirty-year told the more dramatic, spiking to 5.18% in mid-May (its highest in two decades) before easing back toward 4.91% at the end of June. The broad Bloomberg U.S. Aggregate Bond Index returned a modest .67% for the quarter. Credit stayed calm during the quarter with high yield bonds gaining 2.5% in the quarter as spreads held near multi-year highs.
The single variable that has shaped the past two quarters is the conflict in the middle East. We entered April with the conflict in its worst phase, the Strait of Hormuz effectively closed since late February, and the global oil market pricing in sustained supply disruption. Now there is a signed ceasefire framework, a partially reopened strait, and crude oil trading closer to its pre-war levels.
A loosely held ceasefire took effect in early April. Through the middle of the quarter, a Pakistan-mediated framework gradually took shape, culminating in a memorandum of understanding announced in mid-June and signed by President Trump and Iranian President Masoud Pexeshkian. The agreement was designed to end the conflict within sixty days and to restore free commercial passage through the Strait of Hormuz.
The market’s response was swift and up. Brent crude, which had peaked at $118 per barrel in late April, fell about 26% in May back into the mid-80’s. Oil prices fell further in June as the ceasefire Framework took hold. By the end of the quarter, Brent was trading near $73, the lowest level since late February and roughly back to where prices sat before the war started. (Chart).
Source: Bloomberg LP. Data as of 6/30/2026.
The conflict in the Middle East is far from a settled manner. The truce is fragile and actively contested. In the final days of the quarter, Iran struck a commercial vessel in the strait with a drone, and the U.S. launched retaliatory strikes. The oil market has priced a return to normalcy, but the physical oil market is far from it today. That gap is a risk worth watching closely because much of the disinflation story of the second half rests on it.
The inflation data released during the quarter told the story of the energy shock working through the system with its usual lag. By the time the conflict’s supply disruption was working through the inflation readings, the conflict itself was already de-escalating. Headline PCE accelerated to 4.1% year-over-year in May, the highest reading since April 2023, with the May PPI rising 6.5% year-over-year, the steepest since late 2022. The Federal Reserve’s preferred gauge, the core personal consumption expenditures index, reach 3.4% year-over-year, the highest since October 2023. Falling oil prices should provide some reprieve to prices in the coming months; however, we are closely watching core inflation, and any sustained move higher would be worrisome for markets. (Chart)
Source: U.S. Bureau of Economic Analysis. Data as of 5/30/2026.
The acceleration in inflation has been an energy story so far. Energy accounted for more than 60% of the monthly increase in consumer prices, and the energy component of the CPI index was up more than 23% from last year. Strip out energy and picture far calmer. This is consistent with the view we expressed in our first quarter commentary, that the 2026 inflation event is fundamentally a supply-driven energy shock rather than a repeat of the broad, demand-driven inflation of 2022. The distinction matters because supply shocks tend to reverse when the supply returns. With oil having round-tripped back to pre-war levels by late June, the near-term peak in inflation is likely behind us, and the early evidence supports that; consumer sentiment, which had collapsed to a record low of 44.8 in May, recovered to 49.5 by the end of June, and long-run inflation expectations eased meaningfully.
New Fed Chair Kevin Warsh’s First meeting as chair was held June 16-17. The committee held the federal funds rate steady at 3.5% to 3.75% by a unanimous vote, the fourth consecutive hold. But almost everything around that decision changed. It removed much of the forward guidance and easing bias that had characterized the FOMC’s communications for the better part of two years and renewed its commitment to deliver price stability.
The dollar rallied to a post-liberation Day high, reversing some of its 2025 decline. Meanwhile, gold sold off and the front end of the Treasury curve firmed. By the end of the quarter, markets had moved to price a meaningful probability of a rate hike by October and a strong likelihood of one by December – a complete reversal of the easing narrative that was present at the start of the year.
The key driver of the rally in the second quarter was artificial intelligence, much like it has been over the last few years. The amount of capital being invested by the hyperscalers is difficult to overstate. Over the course of the spring, the largest technology platform companies raised their capital expenditure guidance, and the combined planned spend over the next 12 months is now nearly 850 billion. These are real revenues, real profits and in most cases capital spending funded out of free cash flow rather than debt. However, significant equity and debt issuance during the second quarter markets a divergence from internal cash flows funding the CAPEX.
Source: Bloomberg LP. Data as of 6/30/2026.
The Magnificent Seven now represents nearly one-third of the entire S & P 500, a historic level of concentration. The forward price-to-earnings multiple on the index sits near 21X and that premium is overwhelmingly a function of these few stocks.
U.S. Equity markets stumbled twice in June. A disappointing capital-spending signal from Broadcom triggered a technology selloff in early June and a second round of selling hit in the final weeks of the quarter around Micron’s earnings. For all the recent volatility in technology, the broad market held up nicely because something was working beneath the mega-cap surface. The equally weighted index, small caps, and other unloved sectors began to carry their eight in the final weeks of June. The beginning of a genuine broadening is exactly what a durable bull market requires. The last quarter and year to date performance of these other sectors is a welcome development.
Returns were again solid outside the United State in the second quarter. Emerging-market equities were the standout, led specifically by South Korea. Korean equities rose more than 38% in April-its best month since the 1998 financial crisis-and added another 35% in May propelled by Samsung and SK Hynix. The is helped propel the emerging-markets index to a 24.1% return in the quarter and for the year. Japan had a similar story, with its equity markets reaching record highs on the same technology tailwinds, while developed European markets posted solid gains as well.
The bond market was much more muted in the second quarter than the equity market. The 30-year Treasury Yield spiked to 5.18%, its highest level in 19 years, before easing back below 5% by the end of June. The move on the front-end of the curve, which tends to move with Fed funds rate expectations, moved slightly higher as it prices in a rate hike instead of cuts. By the end of June, the 10-year Treasury yield stood at 4.44%, the two-year near 4.14%and thirty-year near 4.91%, leaving the curve modestly upward-sloping after spending much of the 2022-2024 period inverted. However, it is worth noting that in early February the spread between the two-year and 10-year hit a record high of 74 basis points-but it has since more than halved to 30 basis points by quarter end.
Credit markets, by contrast remained calm. High-yield spreads ended the quarter at 275 points and corporate bonds spreads near 75 basis points, both close to multi-year lows. The credit market does not show any stress in the markets. When spreads are this tight, investors are being paid very little to take on credit risk. However, the all-in yields for corporate bonds above 5% offer nice current income. We continue to favor high quality within credit and extending duration at current levels.
Alternatives can provide powerful long-term portfolio benefits and non-correlated returns to traditional stock and bond holdings and improve risk-adjusted returns of balanced portfolios. Given the current volatility in public equity markets, alternative investments have delivered good relative returns with low volatility just as we would have expected.
We favor private real estate investment allocations to multi-family, industrial, and self-storage, and selected grocery-anchored centers. We expect equity like long-term returns from these investments with built in inflation protection and tax efficient income generation. Our real estate investments will also benefit significantly as the Fed cuts interest rates. We also favor private equity but have sold our remaining private credit investments as they no longer offer good risk/reward characteristics. We believe alternatives tend to follow public markets and offer meaningful upside. We will continue to add alternatives to our diversified balanced portfolios and expect solid returns.
Conclusion
The markets and economy have remained resilient so far in 2026 despite numerous things to worry about. Markets sit near record highs, after having recovered losses in the first quarter. It has done so while inflation reaches a three-year high, the Federal Reserve pivoted from rate cuts to projecting rate hikes, and a war shut off the key transportation route for many energy commodities. The markets have moved through all of it.
Our base case remains positive, with real GDP growth and supportive consumer spending and ongoing investment in infrastructure, energy and Artificial Intelligence all expected to enhance productivity.
Despite volatility, equity market fundamentals remain strong. Market leadership has broadened away from mega-cap technology stocks to smaller and more value orientated companies, providing crucial breadth for the market. Most importantly, corporate earnings expectations continue to expand in 2026.
Credit fundamentals remain sound. Attractive starting yields have resulted in fixed income returns increasingly driven by income rather than prices appreciation.
This is a moment to stay disciplined. We remain vigilant to the changing geopolitical landscape. We continue to maintain diversified portfolios, balancing risk and opportunities, and positioning to benefit from long-term secular trends while staying alert to evolving macro and policy risks.
We sincerely thank you for your confidence and trust in us. Please do not hesitate to reach out to us if you have any questions or wish to discuss how all this relates to your specific financial situation in more depth.