2026 Second Quarter Review & Outlook
The S&P 500 rebounded during the second quarter of 2026 and is now up 10.21% year to date. The rebound was fueled by stronger-than-expected corporate earnings. First-quarter earnings increased 28.8% year over year, led by the technology sector, where earnings grew an impressive 54.8%. These results exceeded analysts’ expectations and helped the market look beyond the geopolitical tensions in the Middle East.
Long-term inflation concerns continue to ease despite ongoing geopolitical uncertainty in the Middle East, increased demand for technology components driven by AI infrastructure investment, and the transition to new Federal Reserve Chair Kevin Warsh. Investors remain focused on the Federal Reserve’s interest rate policy, as periods of rising interest rates have historically created headwinds for equity markets.
At Virtue Asset Management, we do not expect the Federal Reserve to raise interest rates this year and believe technology companies will continue investing aggressively in AI infrastructure. We remain constructive on equities for the balance of 2026, although we expect leadership within the technology sector to continue to evolve.
Performance of AI Hyperscalers (check writers) v AI Equipment Providers (check receivers)
Source: Zerohegdge & Bloomberg
We believe the AI investment cycle is entering its next phase. While artificial intelligence remains the dominant investment theme, we believe the primary beneficiaries of this investment cycle are evolving. During the second quarter, investors increasingly favored the companies supplying the infrastructure needed to build AI: including semiconductor manufacturers, networking providers, and memory companies: over the hyperscalers making the largest capital investments. While Microsoft, Amazon, Alphabet, and Meta continue to invest aggressively in AI infrastructure, much of the near-term economic benefit has accrued to the companies supplying the chips, memory, networking equipment, and other critical components required to build next-generation data centers. We believe this trend is likely to continue as AI infrastructure spending remains robust.
One of the primary concerns for investors during the second half of 2026 is the outlook for interest rates under new Federal Reserve Chair Kevin Warsh. As shown in the chart below, the first year under a new Federal Reserve Chair has historically been accompanied by increased market volatility. Today, the futures market is pricing in a 41% probability of one 25-basis-point interest rate increase by year-end and a 27% probability of two 25-basis-point increases. Additional rate hikes would likely slow economic growth, increase borrowing costs, and moderate the pace of AI infrastructure spending by the hyperscalers.
Source: Strategas
At Virtue Asset Management, we believe additional interest rate increases are unlikely. Instead, if inflation continues to trend lower and Congress enacts regulatory reforms that allow the Federal Reserve to reduce its balance sheet more efficiently, we believe policymakers are more likely to rely on balance sheet normalization than additional rate hikes to manage monetary conditions.
Despite heightened geopolitical uncertainty, Treasury yields have retreated from their recent highs, suggesting investors are becoming increasingly confident that inflation will continue to moderate over the long term. During the peak of the Middle East conflict, the 10-year Treasury yield reached 4.67%, its highest level of the year, before declining to approximately 4.38%. Likewise, the 2-year Treasury yield peaked at 4.24% on June 22 and has since eased to approximately 4.07%.
Although Treasury yields remain above where they began the year, the retreat from recent highs and the flattening of the yield curve suggest investors are looking beyond the geopolitical conflict and elevated AI-related capital spending while maintaining confidence that inflation will continue to moderate over time.
We will continue to closely monitor the Treasury market. A sustained move above 5% on the 10-year Treasury would likely represent a meaningful headwind for equity valuations and would justify a more defensive investment posture.
Corporate earnings remain the foundation of our constructive outlook on equities. Consensus estimates now call for S&P 500 earnings of approximately $339 per share in 2026, an increase of nearly 24% over 2025, followed by another 16% increase in 2027. At current market levels, the S&P 500 trades at approximately 20 times forward earnings, modestly above its long-term average. While these valuations leave less room for disappointment, we believe they remain reasonable if companies continue to deliver the earnings growth currently expected by analysts.
One of the most encouraging developments this quarter has been analysts’ willingness to raise earnings expectations rather than lower them. During the second quarter, consensus earnings estimates increased 3.4%, compared with an average decline of 2.0% over the past five years. This meaningful departure from the normal pattern reflects growing confidence in the strength of corporate America.
Technology continues to lead earnings growth, but an important distinction has emerged. Without semiconductor companies, expected earnings growth for the technology sector would decline from 63.2% to just 25.7%. This illustrates that much of today’s earnings momentum is being driven by the companies supplying the chips, memory, networking equipment, and other infrastructure powering artificial intelligence rather than by the companies making the largest AI investments.
| Index | 2026 YTD Return |
|---|---|
| S&P 500 | 10.21% |
| S&P 500 Growth | 11.77% |
| S&P 500 Value | 7.88% |
| S&P Mid Cap 400 | 17.39% |
| S&P Small Cap | 23.97% |
| MSCI EAFE | 9.44% |
| MSCI Emerging Markets | 25.67% |
| MSCI China | -14.50% |
| MSCI India | -8.62% |
| Bloomberg US Agg Bond | 0.62% |
| TIPS Bond | 1.23% |
| iShares iBoxx $ High Yield Corp Bd | 1.69% |
In response to this changing landscape, we recently adjusted client portfolios to increase our exposure to companies benefiting most directly from AI infrastructure spending: including businesses providing semiconductors, networking equipment, memory, and other critical technologies: while reducing exposure to select companies funding much of that investment. While we have increased our participation in this powerful earnings trend, we remain disciplined in managing downside risk. Our objective continues to be to participate in long-term market appreciation while maintaining protection should equity markets experience a meaningful correction.
Looking ahead, we believe corporate earnings will remain the single most important driver of equity returns. The greatest risk to this outlook would be a significant slowdown in AI infrastructure spending by the largest technology companies. At present, however, we believe these companies have little choice but to continue investing aggressively. AI has become central to protecting their competitive positions while strengthening demand for their cloud computing businesses, making continued investment economically attractive.
While we recognize that markets rarely move in a straight line, we believe the combination of continued AI infrastructure investment and rising corporate earnings should provide a favorable backdrop for equities through 2027. Even if earnings growth falls meaningfully short of current expectations, we believe positive earnings growth should continue to support long-term equity returns.
We continue to recommend maintaining 12 to 24 months of anticipated spending needs in cash or high-quality short-term bonds. Maintaining adequate liquidity allows long-term investment portfolios to remain invested through inevitable periods of market volatility without forcing the sale of quality investments at unfavorable prices.
Disclosures
Virtue Asset Management is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
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