The Comeback Quarter

We’ve passed the midpoint for 2026; the first half was eventful. We started the year with the expectation of easing monetary conditions (two to three rate cuts per the consensus), a significant rotation out of U.S. mega cap and Mag 7 themes into more diversified areas of the stock market. War broke out, oil skyrocketed, inflation fears resurfaced, but the U.S. stock market shook off concerns, with AI-related stocks leading the way. Let’s do a quick review of past, present and possible future.

The second quarter was the “comeback quarter.” We went from stagflation concerns to record highs.

We entered the second quarter, the Strait was closed, oil was above $100 a barrel and odds of recession ticked up. The market’s sensitivity to the war faded, oil dropped about 30% and equites had one of the best quarters since 2010. Recall the S&P 500’s year-to-date return at the end of the first quarter was -4.43%. U.S. large caps were up over 15% in the second quarter. As of filming, we are still over 10% year-to-date for the S&P 500.

The rally was earnings driven, not multiple driven, and this is important — valuations were a mild concern — earnings growth far exceeded expectations, revenue grew and margins expanded. Simply put: The gains were real because the profits were real.

Moving to the present …

The ceasefire is over, attacks are escalating and uncertainty is growing. The latter explains the moderate “risk-off” response we’ve seen recently in the S&P 500. Oil prices have moved up, but not as much as some feared. We appear to be back in a range-bound world until the market finds something to anchor to. We’ve seen this movie before.

Earnings reports commence this week with some key companies reporting the market will likely focus on earnings barring a major prolonged escalation in the Middle East. You may say, "but Chuck, didn’t you state last month the prospect of higher rates from the Fed is the one thing that could rattle the market?" True, but the expectations for a rate hike before year-end are likely already built in … that might be why we experienced a pullback in June.

Looking forward …

Chart 1, 2:40— Probably the safest bet is some degree of continued uncertainty. The second quarter may turn out to be the highlight for the year. Here’s what we are watching for the second half:

1. The War: Events are so fluid that sometimes a slide is stale before the ink dries. As of filming, the ceasefire is over. As I mentioned, responses from U.S. stocks and oil prices have been moderate so far.
2. Inflation and the Fed: Expectations are for a rate increase before year-end. Inflation is proving sticky, Warsh is reshaping the Fed and there is heightened debate within the Fed regarding monetary policy for the remainder of 2026. For now, the market appears to have digested the new expectations.
3. Earnings: Barring a significant escalation, earnings should be the primary focus. Inflationary pressures largely missed first quarter earnings. Will we hear from companies that they experienced cost pressures in the second quarter? Focus on earnings and the durability of the AI narrative will be key.
4. Breadth: The broadening we witnessed in the second quarter was encouraging. Keep an eye on leadership and whether it narrows or if the party remains more inclusive.