Quarterly Investment Research Note – July 15th, 2026

2^nd Quarter 2026 Market Recap Summary

• The S&P 500 produced its strongest quarterly return since 2020, gaining 15.2% during the 2nd quarter after declining in the 1st quarter.¹ As tensions in the Middle East eased, energy prices moderated, helping reduce inflation concerns and improve investor confidence. The market also returned its focus to the significant inflection in the earnings outlook, as the AI investment cycle continues to drive capital expenditures and position companies for stronger long-term profitability.

• Gains were notably broad-based, with strong participation across market capitalizations, investment styles, sectors and geographies.  The S&P SmallCap 600 and S&P MidCap 400 returned +19.70% and +14.47% respectively, while both Growth and Value large-cap stocks rallied for the quarter, returning +16.74% and +13.84%.  MSCI EAFE was up +10.82%, while MSCI Emerging Markets was exceptional, returning +24.05% during the quarter.²

• The Technology sector surged +31.79% during the quarter as the sector continued to report robust earnings and outlooks amid enthusiasm surrounding AI adoption and strong demand for continued buildout.  Strong returns were also found in the Industrials sector, up +14.85%, while the Energy sector lagged, -13.45% after spiking +38% in the 1^st quarter.³

• Earnings optimism remains the key fundamental underpinning for the constructive outlook on equities.  In the US, S&P 500 earnings per share are expected to grow to $342 in 2026, a 26% year-over-year growth rate that rose from the +19% expectation at the end of the 1^st quarter.  For 2027, analysts expect S&P 500 earnings per share to eclipse $403, +17.8% growth from this year.  Due to this earnings outlook, the S&P 500 forward P/E multiple has contracted in 2026 and sits at 20.4x currently, down from 22.3x to start the year.⁴

• The bond market was positive for the quarter, the Bloomberg US Aggregate Bond Index finished +0.67% in total return, but rate volatility persisted among shifting inflation expectations. The benchmark 10-year US Treasury yield hit a closing high of 4.67% in May and settled to 4.44% at the end of the quarter^.5,6

• The Federal Reserve held rates steady in June during the first meeting for new Chair, Kevin Warsh.  The early read on the new Chair is a preference for less communication from the Fed, signaled by a much shorter statement and notably sparse forward guidance in his speaking engagements. The updated economic projections reflected higher inflation expectations and a higher expected path for interest rates than earlier in the year, reinforcing the Fed’s commitment to returning inflation to 2%.  The Fed Funds Futures market is pricing in a hike in the 2^nd half of this year.

• Economic growth remains soft but positive.  Real GDP grew at a 1.6% annualized rate in the 1^st quarter, down from the 2.0% in the advance estimate but an improvement from 0.5% growth in the 4^th quarter of 2025.  Consumer spending slowed to +1.4% while AI-driven investment surged.  Analysts expect +1.8% full-year 2026 growth, down from +2.1% in 2025.  AI spending remains the key driver, but the consumer is fading somewhat under inflationary pressures and the energy shock from the Iran war.⁷ 

• Economic data remained mixed during the quarter. The labor market proved more resilient than expected with unemployment held at 4.3% and job growth surprised to the upside.  However, inflation reaccelerated due primarily to higher energy prices, with CPI hitting 4.2% in May.⁸

2^nd Quarter 2026 Market Recap

The 2^nd quarter marked a notable shift in investor focus. After a 1^st quarter dominated by geopolitical tensions and inflation concerns, attention returned to the single most important driver of long-term stock returns: corporate earnings.  Despite already elevated expectations, earnings have continued to exceed forecasts.

The chart above tells the story that can easily get lost amid the day-to-day market noise: US companies are experiencing a meaningful acceleration in profitability, led by the companies benefiting from the continued investment in AI.  Importantly though, the opportunity set extends well beyond the handful of mega-cap companies that dominate the headlines.  The race to deploy AI capabilities has sparked a wave of capital spending across industries, benefiting not only the companies supplying the chips, memory, energy, and digital infrastructure that power the AI ecosystem, but also businesses across non-technology sectors that stand to realize meaningful productivity gains as AI adoption accelerates.  The current generational investment cycle is translating into a significant uptick in the market’s earnings power, providing a fundamental underpinning for the continued strength of global markets.

The S&P 500 returned +15.20% during the 2^nd quarter, rebounding from the 1^st quarter’s drawdown, hitting multiple all-time highs and posting a +10.21% YTD return through 6/30/26.  Although Technology stocks led, there was strong breadth.  The average S&P 500 stock in the index was up +11.39% for the quarter and is outperforming the market-cap weighted index for the year.  Small-caps were a massive area of strength, with the Russell 2000 index up +21.49% in the quarter.⁹

Outside of the US, International stocks resumed their strong run from 2025 after the 1^st quarter 2026 weakness.  The MSCI EAFE and MSCI Emerging Markets were up +10.82% and +24.05%, respectively for the quarter.  The de-escalation of Middle East tensions was a clear driver of returns as well as Technology-heavy international markets: the MSCI Taiwan IMI and MSCI Korea IMI indexes were up +48.16% and +76.35% during the 2^nd quarter.  European and Japanese markets were solid contributors to developed market returns.¹⁰ 

Growth stocks outperformed Value during the second quarter, across all market capitalizations, the Russell 3000 Growth Index returned +17.05%, compared to +13.99% for the Russell 3000 Value Index.  However, Value remained the leader through the first half of 2026, returning +16.53% versus +5.88% for Growth.¹¹

Sector performance also reflected a broadening of market leadership. Information Technology led all sectors with a gain of +31.79%, supported by continued investment in AI infrastructure and strong earnings from semiconductor and hardware companies.  Industrials (+14.85%) also posted outsized gains as investors continue to see the growing demand for electrical equipment, power infrastructure, and equipment needed to support the AI buildout.  Financials (+9.01%), Consumer Discretionary (+9.27%), Communication Services (+8.32%), and Real Estate (+8.52%) also delivered strong returns, highlighting that market strength extended well beyond the headlines.¹²

Energy was the lone notable laggard, declining -13.45% during the quarter after gaining more than +38% in the first quarter.  While oil prices remained elevated amid ongoing geopolitical tensions, investors rotated away from the sector following its earlier outperformance.  Utilities (-0.53%) and Consumer Staples (+0.33%) also trailed as investors favored more growth-oriented sectors amid improving earnings expectations and stronger risk appetite.¹³

At the end of the 1^st quarter, we posed two questions that we think help to define the durability of the AI investment cycle as it relates to the market as a whole, and continue to monitor these at the midpoint of the year:

1. Will the unprecedented capital investment across hyperscalers, data centers, and AI infrastructure ultimately generate attractive returns?

The 2^nd quarter provided progress towards answering this.  Capital spending did not slow down, it further accelerated; with the largest hyperscalers continuing to commit hundreds of billions toward AI infrastructure.  That spending, however, has come at the expense of near-term free cash flow.  Rather than penalizing this investment, investors have largely accepted lower free cash flow today in exchange for confidence that AI will become a foundational technology tomorrow.

Perhaps more importantly, market leadership has broadened beyond those hyperscalers.  Investors increasingly shifted their focus to the companies supplying the AI ecosystem, including semiconductors, networking equipment, memory, power generation infrastructure companies, and data centers, i.e. the “picks and shovels” of AI.  Unlike the hyperscalers, whose massive capital investments are weighing on near term free cash flow, these companies are realizing immediate benefits through inflecting revenue growth, earnings, and full backlogs.  As a result, they became some of the market’s strongest performers during the 2^nd quarter.

It’s still too early to know whether all of this AI spending will ultimately generate attractive long-term returns, but even if part of today’s demand proves cyclical, the companies supplying the AI ecosystem are benefiting from it greatly and that is being reflected in the market’s overall earnings picture.

2. Will the proliferation of AI ultimately commoditize the technology ecosystem and erode durable competitive advantages?

As capabilities become more widespread, the risk remains that differentiation narrows and excess capacity weighs on the profitability of the market.  In the 1^st quarter, we asked whether AI could ultimately undermine its own economics.  While this question remains largely unanswered, the 2^nd quarter demonstrated that investors are becoming increasingly selective in identifying the likely winners and losers.

While AI has the potential to drive significant productivity gains, it also raises the possibility that value accrues unevenly and that AI-driven services become commoditized.  Additionally, companies with proprietary data, differentiated products, strong distribution, and entrenched customer bases appear better positioned to defend their competitive advantages.

Taken together, the 2^nd quarter was a continuation of the evolution in the AI narrative.  Markets remain enthusiastic about the long-term opportunity and investor focus is moving towards measurable earnings, cash flows, and identifying where value is actually being created, not just hypothesized, across the AI ecosystem. 

For equity portfolios at the halfway market of 2026, the first six months have reinforced two core principles of our investment philosophy: diversification and patience.

The 1st quarter was a reminder that volatility is a normal part of investing in equities. Markets had to digest geopolitical conflict, rising interest rates, and rapidly changing expectations around AI, particularly in the software industry.  Yet despite the pullback, corporate earnings continued to provide the foundation for long-term returns. The inclusion of Value stocks, small- and mid-cap stocks, and International equities alongside the core of US large-caps have contributed positively to portfolios after an extended period of relative underperformance.

We believe these shifts reinforce the importance of maintaining exposure across investment styles, sectors, and geographies.  Investors who remained diversified and stayed focused on fundamentals were rewarded.

In the Fixed Income markets, interest rates remained volatile during the 2^nd quarter, with the 10-year US Treasury yield reaching a closing high of 4.67% in May.  On the long end, the 30-year Treasury yield rose to a high of 5.18%.  Despite this volatility, the bond market was able to deliver a modestly positive return, as the Bloomberg US Aggregate Bond Index gained 0.67% for the quarter.  Fixed-income markets continued to wrestle with persistent inflation readings and uncertainty surrounding the ongoing conflict in the Middle East.^14,15

Credit markets were also positive, as the incremental spread widening in the 1^st quarter reversed.  Investment-grade Corporates, as measured by the Markit iBoxx Liquid Investment Grade Index, was up +1.35% while High Yield, represented by the Bloomberg US High Yield Corporate Bond Index, returned +2.47%.  Municipals were also a notable strong sector of the bond market, posting a +2.50% return during the quarter.  Globally, Emerging Markets debt was a strong niche sector of fixed income in spite of a strengthening US dollar.  The Morningstar Emerging Markets Bond Index was up +3.10% during the quarter.¹⁶ 

The bond market is re-pricing the interest rate outlook in light of stickier, if not accelerating, inflation and shifting expectations for monetary policy.  Treasury yields have moved higher across the curve, reflecting this changing outlook.  For investors, the higher interest rate environment that has existed since 2022 provides an important margin of safety against today’s inflationary pressures.  With significantly higher starting yields, fixed income portfolios are better positioned to absorb increases in interest rates, as the higher coupon income helps offset price declines over time.  “Bond math” is working in investors’ favor again in a way it wasn’t during the ultra-low-rate environment of the prior decade.

The Economy, Inflation, and the Fed

The US economy remains in a relatively healthy position as we enter the 2^nd half of 2026, and growth remains intact but the inputs have been changing.  1^st quarter GDP was revised down to +1.6%.  Consumer spending has slowed from the strong pace of recent years as higher prices and borrowing costs weigh on household budgets, but the AI-fueled capital expenditure cycle continues to support overall economic activity.  Inflation has reaccelerated, leading the Fed to maintain a restrictive policy stance, while additional rate hikes have moved back into the realm of possibility should inflation fail to improve.¹⁷    

The labor market has also proven more resilient than many expected.  Payroll growth strengthened during the 2^nd quarter with a series of surprisingly strong payroll numbers.  The unemployment rate remained at 4.3%, and labor force participation was steady.  Hiring has become more selective and wage growth has moderated, but employment conditions remain supportive of continued economic expansion.¹⁸

The greatest change during the quarter was the outlook for Federal Reserve policy.  After making meaningful progress toward the Federal Reserve’s 2% inflation target over the past two years, inflation reaccelerated as higher energy prices following the conflict in the Middle East filtered through the economy.  While core inflation remained more contained than headline inflation, the data during the second quarter suggested inflationary pressures were proving more persistent than expected.  Although June’s CPI report came in softer than anticipated, the Federal Reserve is likely to remain patient, looking for additional data to prove that inflation is resuming its path toward target.

The Federal Reserve is maintaining a cautious stance.  At its June meeting, the first under new Chairman Kevin Warsh, policymakers left interest rates unchanged while emphasizing that inflation remains the Fed’s primary concern.  Although it is too early to draw firm conclusions about Chairman Warsh’s leadership, the June meeting suggested a greater willingness to tolerate restrictive monetary policy until inflation is clearly moving back toward the Fed’s 2% target.  Markets have responded by pushing back expectations for future rate cuts and increasingly pricing in a higher-for-longer interest rate environment.

Overall, the economy continues to move toward a more sustainable pace rather than showing signs of a meaningful contraction.  Inflation remains the primary macro challenge, but the combination of positive economic growth, a healthy labor market, and solid corporate fundamentals continues to provide a constructive backdrop for investors.

As always, we remain focused on navigating these environments with a disciplined, long-term approach.  We will continue to follow up with timely communication as markets evolve throughout the year.  Please reach out at any time with questions or to discuss your portfolio. 

Footnotes:

1. Morningstar Direct data
2. Morningstar Direct data
3. Morningstar Direct data
4. Bloomberg data
5. Morningstar Direct data
6. US Treasury
7. Bloomberg data
8. Bloomberg data
9. Morningstar Direct data
10. Morningstar Direct data
11. Morningstar Direct data
12. Morningstar Direct data
13. Morningstar Direct data
14. US Treasury
15. Morningstar Direct data
16. Morningstar Direct data
17. Bloomberg data
18. Bloomberg data            

The views expressed herein are those of John Nagle on July 15^th, 2026 and are subject to change at any time based on market or other conditions, as are statements of financial market trends, which are based on current market conditions. This market commentary is a publication of Kavar Capital Partners (KCP) and is provided as a service to clients and friends of KCP solely for their own use and information. The information provided is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal or tax advice. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s investment portfolio. All investment strategies have the potential for profit or loss and past performance does not ensure future results. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. The charts and graphs presented do not represent the performance of KCP or any of its advisory clients. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results.  There can be no assurances that a client’s portfolio will match or outperform any particular benchmark. KCP makes no warranties with regard to the information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, the information. The information is subject to change and, although based on information that KCP considers reliable, it is not guaranteed as to accuracy or completeness. This information may become outdated and KCP is not obligated to update any information or opinions contained herein. Articles herein may not necessarily reflect the investment position or the strategies of KCP. KCP is registered as an investment adviser and only transacts business in states where it is properly registered or is excluded or exempted from registration requirements. Registration as an investment adviser does not constitute an endorsement of the firm by securities regulators nor does it indicate that the adviser has attained a particular level of skill or ability.