Halftime

In the spirit of the World Cup, a halftime break feels appropriate for the title of this brief overview of markets and the domestic economy. After a sluggish start to the year, equity markets rallied strongly in the second quarter, with the S&P 500 posting its largest quarterly gain since 2020. The leadership over the first six months has been broad with the Industrials sector leading the advance, followed closely by the Technology and Energy sectors. A variety of factors conspired to ignite investor optimism including a (now-defunct) cease-fire in the Middle East; moderating inflation expectations; stable employment; strong consumer spending statistics; and the continuation of historic levels of spending on Artificial Intelligence. The alluring possibility of an enduring productivity cycle resulting from widespread adoption of Artificial Intelligence and anticipated cost savings has investors contemplating strengthening economic growth with modest inflation pressure. S&P 500 earnings projections were revised higher by 3.4% during the second quarter resulting in an estimated full-year EPS growth rate of approximately 17% for 2026.

Fixed Income markets posted modest positive returns as the inflation spike resulting from the conflict with Iran had a disproportionately negative impact on bonds. While interest rates have risen, the yield curve has flattened, suggesting the market views the drivers of higher near-term rates to be transitory. In addition, credit spreads have remained exceptionally tight, indicating the market is quite comfortable with the investment backdrop despite the headline volatility. That confidence will be tested over the next several months as the conflict in the Middle East has resumed and oil prices are rallying. Corporate bond issuance totaled $1.52 trillion through June, representing a 28% year-over-year increase. Remarkably, credit spreads have tightened despite the increase in supply. The outlook for inflation is increasingly a point of contention with a new Chair of the Federal Reserve firmly stating his intention to return inflation to the Fed’s long-term target. While the U.S. is relatively insulated from the energy price spike, the ongoing inflationary shock will negatively impact real incomes and consumer spending.

Looking forward, global economic growth has slowed but appears stable despite the exogenous impact of the war in the Middle East. While the impacts are increasingly understood, the duration of the conflict is the key variable that handcuffs central banks from providing monetary accommodation if growth weakens further. However, with a successful resolution, inflation likely resumes its previous trend, allowing the Federal Reserve to continue its rate cuts late in the year. Most Economists project that the boost to domestic consumer incomes from tax refunds is sufficient to offset the impact of $100/bbl oil for all of 2026. Assuming the conflict is resolved, most commodity strategists expect crude oil prices to return to around $70/barrel by the end of 2027. Unsurprisingly, markets
will be very sensitive to monthly inflation readings over the course of the next several months. Visibility to a normalization of energy flows throughout the Middle East should give monetary policymakers confidence to ‘look through’ near-term inflation readings and improve the likelihood of rate cuts over the next twelve months. In the near-term, as companies report their earnings results, their outlook for organic revenue growth and profitability will be the focal points. While the starting point of valuations for both equity and fixed income asset classes is elevated relative to historical norm, most strategists continue to expect a favorable backdrop for risk assets over the next several quarters.

As markets head ‘back to the pitch’ for the second half, expectations seem reasonable while uncertainty certainly remains elevated. It should be an entertaining close to what has been a profitable start to the year!

​Now is as good a time as ever to schedule time with your Waterfront Advisor to review your financial circumstances and update your plan as you navigate the second half of 2026.

-Matt Hekman (Portfolio Manager, WE & WB)


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