The second quarter of 2026 delivered one of the best equity rallies in recent memory — and one we needed, given what the first quarter brought. As the war with Iran got underway, risk assets fell sharply, leaving major indices in negative territory by the end of the first quarter.
Then, as oil prices fell from their peak following the June agreement to partially reopen the Strait of Hormuz, and as extraordinary corporate earnings came in well ahead of expectations, markets staged a powerful advance. The war itself remains unresolved. The earnings strength deserves some context, however: the 28.6% year-over-year S&P 500 earnings growth in Q1 was heavily concentrated in mega-cap technology. The “Magnificent 7” — Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, and Tesla — grew earnings approximately 45.7% year-over-year, driven by massive AI infrastructure and datacenter spending.4 Excluding this group, earnings growth for the other 493 S&P 500 companies was closer to 11%.4 The AI buildout was, in no uncertain terms, the primary engine of corporate earnings strength in the first half. This concentration in earnings is also part of the reason for the Great Rotation we discuss below — the companies doing most of the earning were not the ones doing most of the returning. Fixed income navigated a more complex path — the oil spike and resulting inflation pressured duration-sensitive bonds — but credit-oriented and tax-exempt instruments performed well. As we enter the second half, we remain constructive on risk assets while watching inflation, the ongoing conflict, and the new Fed leadership closely.
Q2 Equities
The equity recovery in Q2 was powerful and broad. The S&P 500 (represented by SPY) gained 15.1% for the quarter, its best result since Q2 2020. That said, SPY was not even the top domestic performer. Small cap stocks (IWM, the iShares Russell 2000 ETF, which tracks approximately 2,000 smaller U.S. companies) surged 21.4%, benefiting from renewed investor confidence in the domestic growth outlook. Outside the U.S., emerging markets (EEM, the iShares MSCI Emerging Markets ETF, which tracks developing economies including South Korea, Taiwan, India, China, and Brazil) returned 21.1%, driven by the AI and semiconductor cycle in South Korea and Taiwan. Developed international markets (EFA, the iShares MSCI EAFE ETF, which tracks Europe, Australasia, and the Far East) returned 8.6%. Nine of eleven S&P 500 sectors finished the quarter higher.4
One important nuance within the emerging markets story is China. MSCI China fell 6.6% in Q2 and 14.9% year-to-date, as China continued to face domestic economic headwinds distinct from the AI-driven strength elsewhere in the region. The strong EM results were driven primarily by the AI and semiconductor cycle in South Korea and Taiwan, though broad-based gains across India and other emerging markets also contributed.12
H1 2026 Equities
The full first half picture is striking. Four of the five major markets we track outperformed SPY for the first half: EEM led at +25.7%, followed by IWM at +22.6% and ACWX (iShares ACWI ex-U.S. ETF, which tracks global stocks outside the United States) at +14.7%. SPY returned +10.1%. The lone exception was EFA at +9.9%, finishing just below large cap domestic for the half-year.1 Our equity allocations are structured broadly in line with global market capitalizations, and we are currently neutral on geography — a positioning that participated meaningfully in the broad advance.
The most important storyline beneath the headline numbers is the dramatic rotation from growth to value. IWD (the iShares Russell 1000 Value ETF, which tracks large cap value stocks) returned +16.6% year-to-date, while IWF (the iShares Russell 1000 Growth ETF, which tracks large cap growth stocks) returned only +4.5% — a gap of more than 12 percentage points.1 Many are calling this “The Great Rotation.” The chart below tells the story: IWF dropped to approximately -12.5% at its worst during the Iran conflict, while IWD barely went negative throughout the entire period. The divergence accelerated in June, with IWF falling 2.8% for the month while IWD gained 2.2%.1 Economically sensitive sectors — industrials, financials, energy — drove value’s outperformance.
Small cap stocks tend to appreciate more than large caps in strong market environments, due to their higher operating leverage and sensitivity to domestic economic conditions. This pattern held clearly in H1 2026. That said, small cap stocks have meaningfully underperformed large cap stocks over the past decade — IWM’s 10-year annualized return of 11.4% compares to 15.3% for SPY over the same period.11 This is one important reason we prefer to express our smaller company exposure through private equity rather than public small cap stocks. We discuss this in the Positioning section below.
The S&P 500 entered 2026 at approximately 22x forward earnings and now trades at approximately 20x, despite being up roughly 10% year-to-date.12 Earnings growth has outpaced price appreciation, compressing the multiple — a generally healthy dynamic. The risk, as always, is that if earnings disappoint and multiples contract simultaneously, we could see a meaningful correction.
Q2 Fixed Income
Fixed income in Q2 was a story of credit outperforming duration. AGG (the iShares Core U.S. Bond ETF, which tracks investment-grade U.S. bonds including Treasuries, mortgage-backed securities, and corporate bonds) returned +0.7% for the quarter — a modest positive that masks a turbulent mid-quarter path. AGG fell approximately 0.9% in May as the oil spike pushed inflation fears to a peak, before recovering as energy prices normalized. MUB (the iShares National Muni Bond ETF, which tracks investment-grade tax-exempt bonds issued by U.S. states and municipalities) was the quarter’s best performer at +2.2%. HYG (the iShares High Yield Corporate Bond ETF) returned +2.1% as credit spreads tightened. FLOT (the iShares Floating Rate Bond ETF, whose interest payments reset with market rates rather than paying a fixed coupon) returned a steady +1.3%.1
The 10-year Treasury rose from 4.3% on March 31 to a peak of 4.7% in May before settling at 4.5% by June 30 — all while the Fed kept rates on hold at 3.5%–3.75%.5 That move in the long end reflected the market’s own assessment of inflation risk and long-run fiscal concerns, not a change in policy. New Fed Chairman Kevin Warsh’s first FOMC meeting on June 16-17 reinforced a hawkish signal: nine of the 19 policymakers projected a rate hike by year-end, with markets pricing approximately a 49% probability of a September increase.7
H1 2026 Fixed Income
Looking at the full first half, FLOT was the top fixed income performer at +2.1%, despite finishing third in Q2. The reason is visible in the chart below: when the Iran conflict and inflation shock hit in late February and March, HYG fell to approximately -1.3% at its worst and MUB to approximately -0.8%, while FLOT barely dipped below zero. That stability in Q1 gave FLOT a head start that held through the half, despite strong recoveries in credit and municipals in Q2.1
Looking ahead, we find municipal bonds particularly attractive at current levels. Tax equivalent yields — the pre-tax return a taxable bond would need to generate to match a muni’s after-tax income — are running at historically elevated levels, as we detail in the Positioning section.15 We are actively allocating clients to municipal bonds as part of our H2 positioning.
Macro Environment
- U.S.–Iran conflict: Operation Epic Fury began February 28, closing the Strait of Hormuz (through which approximately one-fifth of the world’s oil supply passes) and spiking WTI crude to approximately $113 on April 7. A ceasefire April 7 and a June MOU reopening shipping lanes allowed WTI to fall to $69.5 by June 30 — essentially a round trip from the pre-war price of approximately $67. Retail gas prices at $3.8 per gallon at quarter-end remain above the pre-war level of $2.9, which could lift consumer sentiment as they continue to normalize7,12
- Inflation and the new Fed: May CPI reached 4.2% and Core PCE rose to 3.4%, primarily driven by the energy spike.5,6 New Fed Chairman Kevin Warsh replaced Jerome Powell in May 2026. At his first FOMC meeting, nine of 19 policymakers projected a rate hike by year-end. His stated commitment — “This Committee will deliver price stability” — signals a different posture than his predecessor. Warsh has also reduced forward guidance, meaning investors will need to operate with less Fed telegraphing going forward7
- Earnings: 85% of S&P 500 companies beat Q1 estimates (five-year average: 78%), with 28.6% year-over-year earnings growth — the strongest since 2021.2,3 NVIDIA reported revenues of $81.6 billion, up 85% year-over-year.2 The Philadelphia Semiconductor Index gained 87.8% in Q2, its best quarter since its 1994 inception4
- Employment: May nonfarm payrolls came in at +172k versus an estimate of +88k. Unemployment held at 4.3% — the labor market remains a genuine positive5
- Tariffs: The Supreme Court ruled existing tariffs illegal on February 20. The administration responded by imposing a new 15% tariff under a different statutory authority. Trade policy uncertainty persists7
- Agriculture and fertilizer risk: The Strait of Hormuz is not only an oil chokepoint — up to 30% of globally traded fertilizer transits it, including urea and ammonia from Qatar, Saudi Arabia, and Iran, which collectively account for approximately 36% of global urea exports and 29% of global ammonia exports.14 Unlike oil, there are no strategic fertilizer reserves, and Gulf fertilizer exports cannot easily be rerouted when the Strait is closed — supplies are physically trapped behind the chokepoint.14 The World Bank’s fertilizer price index rose more than 12% in Q1 2026, hitting its highest level since October 2022, and urea prices are projected to rise nearly 60% for the full year before easing in 2027 — but only if Middle East exports recover.14 If the Strait does not fully reopen, or if production facilities damaged in the conflict do not resume normal output, the impact on fertilizer availability could carry into the 2026–2027 growing season, with lagged effects on food production and consumer food prices well into 2027
- Commodities: Bloomberg Commodity Index fell 8.1% in Q2, driven primarily by the oil reversal. Copper fell 2.7% in Q2 but remains +10.3% year-to-date12
- SpaceX IPO: The largest IPO in history — $86 billion raised at a valuation of approximately $1.75 trillion, with shares trading 19% above the $135 offer price on the first day of trading, June 12th.12,13 OpenAI and Anthropic have reportedly filed IPO paperwork, with each expected to list at valuations above $1 trillion.13 We discuss the implications in the Positioning section
The most significant macro event of the half-year was the Iran conflict. Its economic impact — an energy price shock, inflation spike, and equity market correction followed by a powerful recovery — played out over the course of a few months. The Strait of Hormuz closure was a near-worst-case supply disruption scenario. The fact that markets recovered so fully speaks to the strength of the underlying earnings and economic backdrop.
The Federal Reserve transition is worth watching closely. Under Jerome Powell, markets grew accustomed to detailed forward guidance and transparent communication. Chairman Warsh has signaled a different approach — less forward guidance, a clear inflation-fighting priority, and a willingness to hike if needed. This is not necessarily a negative, but it does mean more uncertainty in the near-term rate environment than investors have been accustomed to.
As noted earlier, our equity allocations are structured broadly in line with global market capitalizations and we are currently neutral on geography. One deliberate exception is our exclusion of U.S. small cap public stocks in favor of private equity, the rationale for which we discuss below.
The most dynamic and fastest-growing companies today increasingly choose to stay private, avoiding the regulatory burden and short-term earnings pressure that accompanies public listing. The number of U.S. publicly listed companies peaked at approximately 7,300 in 1996 and has since fallen to approximately 4,300. Since 2000, the number of U.S. PE-backed companies has grown from approximately 1,900 to more than 11,500. Private equity now represents more than 85% of companies with revenues above $100 million.8,9,10 The SpaceX IPO — the company staying private for 24 years before going public — is the clearest illustration of this pattern. Reports that OpenAI and Anthropic have since filed IPO paperwork suggest the next wave is coming. Each of these companies was built and grew its enterprise value entirely in private hands.12
In fixed income, as discussed above, we find municipal bonds particularly attractive at current tax equivalent yield levels and are actively allocating clients there. Municipal bonds carry meaningful duration — longer than shorter-term instruments — but we believe the tax-exempt income available at current rate levels more than compensates for that interest rate exposure. The Bloomberg Municipal Bond Index yield-to-worst stood at approximately 3.6% as of mid-June, which translates to a tax-equivalent yield of approximately 6.1% for investors in the top federal bracket (37% rate plus 3.8% net investment income tax) — compared to an after-tax yield of roughly 2.6% on a 10-year Treasury at the same rate.15 Nuveen’s Q2 2026 municipal market update puts the broad muni index tax-equivalent yield at 6.4% versus 4.6% for the Bloomberg U.S. Aggregate Bond Index.15
In alternatives, we continue to invest in private credit and private equity. We are also increasing our allocation to real assets — specifically real estate and infrastructure — expressed through semi-liquid structures such as interval funds, tender offer funds, and private REITs. We do not allocate to publicly traded REITs. Despite holding real estate as an underlying asset, public REITs trade like equities and carry equity-like volatility — historically comparable to or exceeding that of large cap stocks and approaching small cap levels — which defeats the purpose of adding real estate as a diversifier.15 The semi-liquid structures we favor provide access to the same underlying assets with the inflation protection, income generation, and portfolio diversification we are seeking — without the daily mark-to-market volatility of public markets. As with all of our alternative allocations, these structures require the same diligence around liquidity mechanics and investor composition that we discussed in our recent article on semi-liquid funds.
As always, please reach out with any questions about how our current positioning applies to your specific portfolio.