By: Darren W. King | Wealth Management
Markets quickly dispelled concern of a lasting Iran affair in the second quarter, and instead, a massive rally in semiconductor shares unfolded as AI capital spending continued to move higher. The S&P 500 rallied from down 4% to roughly up 10% for the year. The S&P 500 concluded the half year up10.19% and up 15% for the second quarter alone. The technology-heavy NASDAQ ended the second quarter up 13.14%, while the DOW Jones Industrial average ended the second quarter up 9.75%. The Russell 2000 Small Cap Index finished the quarter gaining 21.57%. International developed market equities, as measured by the Morgan Stanley Capital International Europe, Australasia, and Far East Index (MSCIEAFE), closed the second quarter up 11.08%. The MSCI Emerging Markets Share Price Index closed June up 24.14% and has been the best returning asset class thus far in 2026. Money flow into small-cap, and international markets coincided with investor diversification into lower valuation investments as investors have used Mag 7 companies as a source of cash in 2026. After years of outperformance, the average return for mag 7 stocks thus far in 2026 has been down almost 3%. These “hyperscaler” companies collectively have spent heavily on AI data center buildout which has impacted free cash flow available to return to shareholders. Debate centers on how quickly these AI investments will help the bottom line for these 7 megacap, market leading companies.
The first half of 2026, especially during the second quarter rally, witnessed the AI “pick and shovel” trade gain momentum as beneficiaries of the AI buildout led the market higher. Semiconductor stocks, industrial and construction companies, and energy companies reacting to commodity price increases, posted strong returns. S&P500 sector results through June: Industrials 20.15%, Technology 19.75%, Energy 19.65%, Materials 11.97%, Real Estate 11.52%, S&P 500 10.18%, Consumer Staples 8.03%, Utilities 7.69%, Health Care 3.48%, Communication Services .80%, Consumer Discretionary -.77% and Financials -1.31%. For the second quarter, a very concentrated AI capex beneficiary trade was the story with the Philadelphia semiconductor Index up 115% in the second quarter alone while health care, consumer stocks, and financial stocks lagged. Earnings growth rates for the technology sector are up a staggering 63% year-over-year with cumulative semiconductor earnings approximately two-thirds of that growth.
Earnings growth exceeding expectations was the story in the second quarter. The AI boom and higher earnings for energy stocks propelled equity gains in the second quarter. The forward 12-month P/E ratio for the S&P 500 is 20.4X, slightly higher than the five-year average P/E of about 19.X but still down from 21.5X earnings at the end of 2025. Currently, the market is estimating 24.1%earnings growth on 10.8% revenue growth in 2026. Profitability remains high for S&P constituents, with net profit margins currently at 14.2%, compared to 5-yearaverage profit margins at 11%; the highest profit margins since 2008. Average equity strategists’ bottom-up price targets for the S&P 500 in 2026 are at 8947, currently 13% higher than current trading levels. AI data center initiatives have been a major source of the recent move by many Wall Street equity strategists to move S&P 500 targets higher over the past several months. In the second quarter alone, consensus EPS growth was revised up 7.7 percentage points; the highest amount since 2Q2021. The backdrop for equities in 2026 remains supportive for continued gains with admittedly some fluff in valuations for the data center trade. We see a continued broadening of equity returns out of technology and into other areas of the market that have not participated as dramatically in the equity rally. Even after a stellar year for international stock returns in 2025, the Current forward P/E multiples for the MSCI EAFE is currently 15.7X earnings while the MSCI Emerging Markets Index trades at 12.2X earnings, much less richly valued than domestic markets and illustrates why investors are beginning to diversify out of domestic markets that are trading closer to 20X forward earnings.
As expected, the Federal Reserve held rates steady at 3.75% to 3.5% at new Fedchairman Kevin Warsh’s first meeting. The most significant change in outlook was a change in forward outlook as 9 of 18 fed chairs indicated a vote to increase the fed funds rate by at least one rate hike by year-end 2026. The rate cutting cycle that began in 2025 appears to be on an indefinite pause as inflation has moved closer to 4% than the 2% inflation target. The Fed now forecasts full year 2026 GDP growth to be 2.2%, revised down from 2.4% in January. The median year-end unemployment forecast for 2026 was moved down .1% to 4.3%. Core PCE inflation, the Fed’s preferred inflation gauge, was revised higher to 3.6% in 2026 (previously 2.7%). For now, economic growth is solid but markets are closely monitoring a quick resolution to the Iran conflict and a swift positive reversal in rising inflation numbers primarily from higher energy costs.
The 10-year treasury yield rose by 30 basis points in the first half of 2026, starting the year at 4.17% and ending the second quarter at 4.47%, while the 30-year treasury ended the second quarter up 10 basis points to end the quarter at 4.95%. Longest duration bonds underperformed shorter duration issues as yields increased uniformly across all maturities in the first half of the year and took into account the anticipation for less Fed action in the short-term. Long treasuries were down .21% in 2026, while intermediate treasuries were up .21%. In a risk-on trade, higher credit quality underperformed the lowest credit quality issues. Aaa rated bonds within the Barclays U.S. Aggregate Index were up .53% in the first half of 2026, while Baa rated bonds were up .98% during the same period.
The Bloomberg Dollar Spot Index finished June with the dollar having strengthened 1.55%compared to our trading partners as investors rushed to the safety of the dollar at the start of the Iran conflict. However, the dollar has still weakened 7.6% from January of 2025 as international capital market flows have incrementally diversified away from an US severe overweight position. Light crude oil futures are up 27% over the first half of the year. Thankfully, West Texas crude peaked in May at around $100/ barrel and has fallen to $68/ barrel following the truce in Iran. 30-year mortgage rates rose from 6.25% at the end of 2025 to 6.55% by the end of the second quarter, while 30-year treasury yields rose 10 basis points to 4.94% from 4.84% at the end of 2025.
According to the Bureau of Labor Statistics, the June jobs report showed 57,000 jobs added during the month. Much slower jobs growth from prior years but still positive. While 2025 was one of the weakest years for hiring since 2009, employers have largely refrained from layoffs. Over the past 12 months, the economy has grown by an average of 36,000 new jobs per month compared to monthly jobs growth over the past 5 years greater than 200,000 new jobs added per month. The June jobs number reported unemployment at 4.2%, a slight improvement from the end of 2025. The labor force participation rate slipped in March to 61.5%, the lowest rate since 2021. For June, average hourly earnings rose 3.5% over the past year, while recent inflation numbers have been around 4%. In short, the June jobs number indicated stabilization but inflation numbers higher than annual wage growth is worrisome for consumer spending.
Annualized retail sales, through May of 2026, were up 6.9% over the past year, compared to the consumer price index’s measure of inflation up 4.2.%. Excluding gasoline station sales, which were up 26.5% over the past year, retail sales were still up a healthy 5.4%, as tax refund checks continued to propel spending. In fact, total retail spending across a broad range of categories, such as clothing and accessories, sporting goods, and online and department store sales were up 7.5% on average. Spending on necessities, such as healthcare, grocery stores, and restaurants were up much more modestly in the 2% to 3% range. With consumer spending two-thirds of our economy, retail sales in the first half of 2026 surpassed all expectations. In short, the consumer remains resilient, but current retail spending clearly shows inflation once again entering the picture.
We remain constructive on equity prospects for the year, especially after the latest positive uptick in earnings growth in 2026. Corporate tax cuts, accelerated depreciation incentives for capital expenditures, continued AI server spending, and historically high profit margins should drive further gains despite slightly elevated equity valuation levels domestically. We continue to favor cyclical sectors overdefensive stocks and advise the continued diversification into a larger international, small cap, and value allocation. We continue to focus on equities that benefit from AI technological advances, continued deregulation within financials, and value in the health care sector. We continue to deemphasize consumer sectors with the expected continued pullback in discretionary spending levels. With earnings growth rates in 2026 somewhere in the 25% range; we see equity returns moving lockstep with continued earnings momentum.
Within the fixed income markets, interest rate, Fed policy, and market traders see the Fed on hold in the near term until signs emerge that the current bout of inflation that has presented itself from the Iran conflict abates. Our outlook is for interest rates to move lower following the Iran energy inflationary scare. For reference, the 10-year treasury yielded 3.94% at February month-end and is now trading at 4.54% on July 7. With bond maturities and reinvestment, we are extending duration and buying longer-dated maturities to take advantage of this run up in yields while it holds. If the economy falters with a cost weary consumer; the Fed has ample room to move rates lower from current semi-restrictive Fed fund levels at 3.65%. Bond allocations would provide a hedge to any equity market weakness should a slowing economy unfold.
Click here to read the Q2 2026 Market Summary.
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Data Sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Dept. of Commerce (GDP, retail sales, housing); Institute for Supply Management (manufacturing/services). Factset (S&P 500 statistics); Performance: based on data reported in Bloomberg (indexes, oil spot prices, foreign exchange); News items are based on reports from multiple commonly available international news sources (i.e. wire services) and are independently verified when necessary with secondary sources, such as government agencies, corporate press releases, or trade organizations. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied upon as financial advice. Forecasts are based on current conditions, subject to change, and may not come to pass. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.
