Quarterly Market Update

Market summary: Asset returns broaden as markets digest geopolitical headlines

Third Quarter 2026

Markets bounced back in Q2 2026 after a shaky first quarter, as geopolitical fears subsided and oil prices fell from their peaks. Artificial intelligence (AI)-related capital expenditures fueled corporate earnings growth, while an improving labor market helped alleviate concerns of an economic slowdown. 

Optimism over the opening of the Strait of Hormuz helped oil prices fall toward pre-Iran conflict levels.

Asset returns broadened in the second quarter of 2026. Equities gained overall, including smaller U.S. companies, which have trailed their larger counterparts in recent years. Bonds provided positive performance across fixed income markets despite interest-rate volatility and a more hawkish tone from the U.S. Federal Reserve. Commodities declined in Q2 after peaking geopolitical risk subsided, and gold fell sharply, giving back some of its strong gain in 2025.

Valuations remain historically high: Markets still appear predisposed to potential bouts of volatility as geopolitical and monetary policy uncertainty, inflation persistence, and elevated asset valuations warrant continued emphasis on portfolio diversification. Elevated risky-asset valuations—particularly for U.S. and emerging-market stocks tied to AI—may not be a near-term impediment, but they provide little cushion amid a medium-term backdrop of policy, economic, and geopolitical risks. 

The U.S. economy demonstrated mid-cycle dynamics with solid economic activity, including early signs of recovery in the labor market. While domestic activity in China remained subdued, cyclical momentum in most developed-market economies stayed intact even amid elevated energy prices and supply-chain disruptions.

Global industrial activity remained in expansion, overcoming geopolitical uncertainty and rising energy costs. New orders rose relative to inventories in the U.S., other developed economies, and emerging markets, reflecting economic resilience. While the headwinds associated with input price pressures and supply chain disruption have not entirely dissipated, this positive effect suggests that global economies can weather such challenges.

Corporate earnings continued to broaden globally in the second quarter, with tech-concentrated emerging economies and the U.S. leading the way. An optimistic earnings outlook underpinned by improving profit margins provided a supportive backdrop for the global business cycle.

As for the U.S., positive earnings trends moved beyond large cap stocks, with forward earnings expectations for small cap companies keeping pace with their mega-cap counterparts.

Labor market rebounds on strong demand, tight supply: The first half of 2026 exhibited tightening labor conditions as payroll growth started to expand and unemployment claims remained low. The combination of a growing demand for labor and a slowing supply of workers from tighter immigration policy and aging demographics has kept the unemployment rate subdued, reinforcing the midcycle expansion.

Inflation fears inject a hawkish tone: The Fed came into 2026 expecting to continue cutting rates amid soft labor markets and falling inflation. Persistent inflation, a recovering labor market, and a hawkish tone from the new Fed chair shifted market expectations to rate hikes.

AART’s estimate of neutral fed funds, the policy rate that supports stable inflation, suggests the Fed may need to raise rates to tamp down inflation. However, the outlook for policy is highly uncertain, as the new Fed chair may allow demand-driven inflationary pressures to pass, especially if he expects the supply-side to eventually deliver disinflationary impulses.

Consumer inflation rose in Q2 after the conflict in Iran triggered shipping disruptions and a spike in energy costs. Higher oil prices also passed through into core inflation, which excludes the more volatile food and energy components. After exhibiting a steady multiyear decline, shelter and service costs are exhibiting signs of reacceleration, adding to tariff- and Iran-conflict-related inflation in core goods.

Our inflation outlook is above market expectations and remains well above the Fed’s 2% target.

See our interactive presentation for an in-depth analysis

Asset markets: Strong earnings despite volatility

The second quarter of 2026 saw a strong rebound in U.S. information technology and growth stocks, while energy and utilities underperformed. International equity outperformance was broad-based over the quarter, with EM Asia leading gains globally. Emerging markets also led the performance in fixed income, where more credit-sensitive assets outperformed Treasuries. Meanwhile, gold and commodities gave back gains over the quarter, although the latter remained in positive territory so far in 2026.

​Equities: By equity style, growth stocks (+17.1%) led the way in Q2, driven mostly by information technology. Small caps (21.5%), large caps (15.2%) and mid caps (13.8%) each posted double-digit gains.

​Globally, emerging markets, particularly emerging Asia (+30.2%), led the way for the quarter and year-to-date, amid hopes that AI-related capital spending would continue despite global tensions. Conversely, Canada (+6%), partly due to its energy and natural resources focus, lagged the global advance.

​Signs of technology and AI-focused concentrations rose in the U.S. Europe, and emerging markets for the quarter, drawing comparisons to the high-flying markets in the late 1990s/early 2000s, another period of rising market concentration.

​Meanwhile, markets continued to reward AI-related capital investment, incentivizing several notable hyperscalers to ramp up financing.

Fixed income: Emerging markets also led performance in fixed income, where more credit-sensitive assets outperformed U.S. Treasuries. Yields were slightly higher across major fixed income categories with tighter credit spreads helping provide an offset.
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Credit spreads in the Bloomberg U.S. Aggregate Bond Index, emerging-market, and high-yield sectors ended the quarter in the lowest quartile of their historical range, providing limited compensation for taking on credit risk.​

Overall, yields for most fixed income categories stood at or above their 50th percentile, suggesting bond valuations are roughly in line with long-term averages and provide solid income within a balanced portfolio.

Commodities: Commodities (-8.1%) gave back some of their year-to-date gains in Q2, as global energy markets began to price in a gradual normalization of oil flows and reduced Middle East supply disruptions.​

​Late in the quarter, easing tensions between the U.S. and Iran alleviated fears of a global energy shortage. However, geopolitical risks continue, with oil not fully back to 2025 levels, when markets viewed oil supply as ample.

​Gold (-14.1%) and other precious metal prices also fell due to a more hawkish than expected Fed.

Outlook: The fundamental backdrop is supported by positive earnings momentum, improving labor dynamics, easing credit conditions, and accommodative policy.

Equity market corrections are common, especially after periods of strong performance. Looking ahead, we believe maintaining a well-diversified portfolio and focusing on long-term objectives remains critical for investors.​