July 2026 edition

Déjà vu and a market of dichotomies

In a bit of déjà vu, after falling 4.3% in the first quarter of this year – identical to 1Q of 2025 – the S&P 500 rebounded with a similarly strong, and even better, second quarter (14.9% vs. 10.9% last year).

In fact, the S&P 500 just posted its strongest quarter since 2020. Even so, it wasn’t the top performer. Emerging markets (+24%) and small caps (+20%) led the way.

One could almost swap “tariff shock” for “oil shock” as the catalyst for the initial drawdown, followed by the easing of those pressures to explain the rebound. Beyond that parallel, other forces were at work, most notably a profits boom and the broadening impact of AI across markets and the economy.

By our measure, tech has driven ~70% of global equity returns year-to-date (YTD). At the same time, tech spending as a share of U.S. GDP is near 5%, surpassing levels seen during the 1990s technology boom.

A market of dichotomies – The first half challenged conventional wisdom

#1. Despite the Magnificent (Mag) 7 down YTD, S&P 500 and tech up strong

    Why: Leadership broadened (9 of 11 sectors up YTD), and semiconductors surged >80%

#2. Small caps outperform despite higher rates and a hawkish Federal Reserve (Fed) shift

    Why: Starting points mattered. Small caps hit 20+ year relative price and valuation lows late last year, small-cap tech is +50% in 2026, and rotation from mega cap stocks. Each of the top five S&P 500 names (>$2T) exceeds the S&P 600 market cap (~$1.8T). Even a modest shift can drive outsized moves.

#3. Oil round trip – Jumping to ~$120, then back to ~$70

    Why: China cut crude imports by 3-4M barrels per day, alongside higher OPEC+ supply, greater pipeline flows bypassing the Strait of Hormuz, and the release of tankers that had been stuck in the Strait.

#4. Gold falls despite the Iran conflict

    Why: Starting levels (most extended above 200-day moving average since 1980s), rising real rates, and a stronger U.S. dollar outweighed safe-haven demand.

#5. Jobs accelerate amid uncertainty

    Why: The tax bill is now in place, following depressed hiring tied to tariff uncertainty and multiple government shutdowns. Companies are battle-tested and adapting quickly.

On deck for the 2nd half

Our key themes entering 2026 remain largely intact:

• Economy: Growth in the low 2% range, supported by a resilient consumer, productivity gains, and continued AI/tech spending.
• Equities: The bull market still deserves the benefit of the doubt. The path ahead may be bumpier, but earnings remain the key driver.
• Fixed income: Risk/reward has improved with higher yields. We expect the Fed to remain on hold, supported in part by easing energy pressures.

Looking ahead, the focus will shift to the midterms, the transition to a new Fed chair and the path of rates, and the ongoing evolution of AI and its impact on profitability.

Evaluating the weight of the evidence

History points to a choppier path higher

• Strong quarters tend to have follow-through – Since 1950, after 10%+ gains, markets were higher six months later 85% of the time with an average gain of 8%.
• Midterm years tend to see a choppier environment into late summer/early fall before a relief rally into year end.
• Markets have only seen one pullback this year exceeding 5% versus a long-term average of three per year.

Fundamentals – Earnings remain the north star

• We are in an earnings boom, with estimates rising across large, mid, small caps, and emerging markets.
• S&P 500 forward earnings estimates have been revised higher by 19% since the beginning of the year, which is the strongest since at least 2000, led by the tech sector.

Despite strong returns, valuations have reset

• S&P 500 forward price-to-earnings (P/E) down ~8% YTD; Currently ~20x, near lower end of recent range.
• The equal weighted S&P 500, small caps, and mid caps are closer to their 20-year averages.
• Tech valuations have compressed; Mag 7 P/E at low-end of range

Market signals – Trend intact, leadership broadening

• The primary uptrend remains intact and has broadened.
• After a ~47% surge from the late-March lows, tech has paused while leadership has rotated for the sixth time of this bull market to prior laggards.
• We view this as a healthy development as capital is shifting within the market rather than leaving it.
• Sentiment is mixed – signs of increased speculation (margin debt, leveraged ETFs), but surveys remain more balanced.

Key risks

• Sticky inflation and/or a sharp increase in rates would likely pressure markets.
• Midterm-related volatility and headline risk likely increase.

As in the first half, unexpected “curveballs” remain likely.

Tactical positioning

From a global asset allocation perspective, we maintain our equity bias, with a continued core preference for U.S. large caps and growth.

As outlined in our annual outlook, U.S. small caps were expected to serve as a key hedge to any rotation away from mega cap growth names – a theme that is playing out. Given lower starting valuations alongside improving earnings and relative price trends, we continue to see upside potential.

Within international markets, we favor emerging markets, where relative earnings momentum and price trends remain stronger, though elevated tech concentration remains a key risk. By contrast, we downgraded international developed markets in early June as relative economic, earnings, and price trends have deteriorated.

We also downgraded gold again, after doing so near the January highs. Unlike prior years, diversification benefits have been more limited in 2026 – gold has only been positive on 26% of days when both stocks and bonds declined, and technical trends have broken down.

In fixed income, we see an improved risk/reward with higher yields and continue to expect the Fed to remain on hold, in contrast to market expectations for rate hikes.

Bottom line

On balance, the weight of the evidence suggests the primary uptrend remains intact. The path forward may be bumpier, but underlying fundamentals support staying aligned with the primary trend and viewing pullbacks as opportunities.

As always, we will continue to follow the weight of the evidence, keep an open mind, and update you as our views evolve.