The last few months played out much differently than the beginning of 2026. We started the year out with conflict in the Middle East, rising oil prices, and growing concern that a prolonged closure of the Strait of Hormuz could disrupt the global energy supply. Investors worried that higher energy costs would lead to higher inflation while slowing economic growth. But it appears that by the end of Q2, many of those initial concerns weighing on investors in early 2026 eased up.
A ceasefire framework helped reopen key shipping routes, oil prices fell back toward where they started the year, and the stock market made a fairly quick recovery. The S&P 500 gained about 15% during the quarter and finished the first half of 2026 up roughly 10%.
Movement in The Middle East Helped Shape the Quarter
The conflict in the Middle East remained the biggest story for much of the quarter.
When April began, markets expected the global oil supply disruption to continue indefinitely. But throughout the month, negotiators were able to reach a ceasefire agreement. This agreement was designed to end the fighting and restore commercial shipping through the Strait of Hormuz.
Oil markets responded quickly. Brent crude climbed to nearly $118 per barrel in late April before falling back to about $73 by the end of June, close to where it traded before the conflict began.
Even so, we believe it’s too early to assume the risk has disappeared. A drone strike on a commercial vessel near the end of the quarter led to U.S. military response, reminding investors that the physical oil market is not yet as settled as prices imply.
Inflation Began to Improve
The inflation rate at the beginning of the year was 2.4%. In the Spring, it began increasing as higher energy costs affected gasoline, transportation, and a broader set of goods and services. By May, inflation reached 4.2%, hitting its highest reading in nearly three years.
Because the inflation rate rose rapidly during the early months of 2026, the Federal Reserve changed its tune on monetary policy.
Earlier this year, markets expected the Federal Reserve to begin lowering rates. As inflation accelerated, investors considered whether the Fed might eventually need to raise rates instead. The Federal Reserve ultimately left interest rates unchanged throughout the quarter, choosing, it appears, to wait for more evidence before making its next move.
More recently, however, the inflation outlook has improved. June’s inflation report came in well below expectations as annual inflation fell to 3.5%, helped in part by lower energy prices.
Notably, inflation cooled outside of energy prices. Core inflation, which removes the often-volatile food and energy categories to better measure underlying price trends, fell. Shelter costs (the most stubborn component) experienced their smallest increase in years.
Stocks and bonds both reacted positively to the news.
Important for investors to remember, one month of data doesn’t establish a trend. Federal Reserve officials have made it clear they want to see additional progress before changing policy. Still, recent inflation numbers are moving in the right direction.
The Federal Reserve Begins a New Chapter
Kevin Warsh was confirmed as the new Federal Reserve Chair in May following one of the closest confirmation votes in the institution’s modern history. In an unusual move, his predecessor remained on the Board of Governors and will continue serving the final 17 months of his term.
At its June meeting, the Federal Reserve left interest rates unchanged for the fourth meeting in a row. Still, its inaction can be interpreted as a cautious message. Economic growth forecasts from policymakers have lowered. At the same time, they’ve increased their inflation expectations and made clear that their next move could be an interest rate increase instead of a cut.
Since then, cooler inflation data has eased some of those concerns. Even so, the Federal Reserve still faces a difficult balancing act.
If inflation remains stubbornly high, the Fed may need to keep interest rates elevated for longer. If economic growth continues to slow, policymakers could face more pressure to support the economy by lowering rates instead.
How the new Federal Reserve leadership balances those competing risks will be one of the biggest questions for investors during the second half of the year. At this point, it’s simply too early to know how that story will unfold.
A Healthier Market Rally
One of the most encouraging developments this quarter was where the market gains came from.
For much of the past two years, a small group of mega-cap technology companies has driven most of the stock market’s returns. During the final weeks of the second quarter, that began to change.
Smaller companies and value stocks started to outperform. The Russell 2000 Index, which tracks smaller U.S. companies, gained more than 22% during the first half of the year. International markets also posted strong results, with emerging markets leading the way.
South Korea and Taiwan were among the strongest performers. This was largely because they produce many of the advanced memory chips needed to power artificial intelligence.
A shift in market growth drivers is significant, as markets tend to be healthier when gains come from a broad range of companies rather than just a handful of large stocks. Broader participation often creates a more durable rally, and it is a trend we have been waiting to see.
The AI Investment Boom Continues
Artificial intelligence remained the biggest force behind the market rally.
Technology companies continue investing enormous amounts of money to build the infrastructure needed to support AI. Over the next 12 months alone, the largest technology companies expect to spend roughly $850 billion. That follows about $1 trillion in spending over the past 18 months, with expectations for another $5 trillion over the next five years.
So far, these investments are generating real revenue and real profits. The bigger question is whether this level of spending can continue long enough to justify the cost.
To put the scale into perspective, investment in AI data centers now equals roughly 3% of the entire U.S. GDP. That’s larger than the peak of the internet and telecommunications buildout during the late 1990s. Only the railroad expansion of the late 1800s represented a larger investment relative to the size of the economy.
There is one important difference, however.
Railroad tracks remained productive for decades. AI hardware evolves much more quickly, meaning today’s equipment can become outdated in just a few years. Whether these massive investments ultimately produce the returns investors expect remains to be seen.
Another remarkable aspect of this AI boom is the speed at which companies are committing capital.
According to Sequoia Capital partner David Cahn, roughly $1.5 trillion is expected to be invested in AI infrastructure in 2026. It will need to generate approximately $3 trillion in revenue to produce an acceptable return on investment. He’s described that figure as being conservative, too.
We continue to believe AI will reshape businesses and the broader economy for years to come. At the same time, expectations have become extremely high. Investment cycles of this size slow down eventually, even if no one can predict exactly when. We continue monitoring these trends closely while positioning portfolios for a range of possible outcomes.
Fixed Income Told a More Cautious Story This Quarter
Long-term Treasury yields climbed to their highest levels in nearly two decades during May before easing later in the quarter. Shorter-term interest rates also moved higher as investors reduced expectations for Federal Reserve rate cuts.
Overall, the bond market generated modest positive returns, while credit markets remained relatively calm (which cut both ways).
Investors are currently receiving relatively little additional compensation for taking on extra credit risk. As a result, we continue to favor U.S. government-backed bonds, maintain a neutral maturity profile, and rely on active managers who can take advantage of some of the most attractive bond yields we’ve seen in more than a decade.
What Can We Expect for the Second Half of 2026?
With stocks once again trading at record highs, it’s important to set realistic expectations.
After several years of strong returns, stock valuations are staying above their long-term averages. That doesn’t mean markets can’t continue moving higher. It does suggest, however, that future returns will likely depend more on companies growing their earnings than on investors simply paying higher prices for stocks. It also means periods of volatility are likely to continue as market narratives evolve.
Our own positioning reflects that view. We remain constructive on the market while continuing to emphasize discipline and diversification. Portfolios remain tilted modestly toward smaller companies, with less exposure to the “Magnificent Seven” technology stocks and greater exposure to the broader market participation that emerged late in the quarter.
Our views aren’t a call against technology or artificial intelligence. Both are likely to remain powerful drivers of long-term economic growth. We believe the balance between risk and opportunity has become less attractive in the market’s most crowded areas. A broader, more diversified approach may offer better opportunities going forward.
As we move through the second half of the year, we are watching three developments especially closely:
- Whether inflation continues to move lower
- Whether the ceasefire in the Middle East continues to hold
- Whether the pace of AI investment remains strong or begins to mature
Stay Vigilant as 2026 Continues On
If there’s a lesson in the past two quarters, it is that markets tend to continue surprising investors.
The year began with fears of higher inflation, slowing growth, and geopolitical conflict. Just a few months later, stocks were setting new record highs.
That is exactly why discipline, diversification, and long-term thinking remain so important. Markets continually adjust to new information, and periods of uncertainty are a normal part of investing.
As always, our focus remains on long-term planning, thoughtful portfolio construction, and tax-aware investment strategies. We will continue to monitor these developments closely and make adjustments where appropriate.