Q2 2026 Market Update

Q2 2026 was a solid rebound from the Q1 declines. A quarter that began under the shadow of war, an energy shock, and recession fears ended with U.S. equities posting their strongest three months since 2020, erasing the first quarter decline entirely. Another useful reminder that the cost of trying to sidestep volatility is usually the recovery that follows it.

Beneath the surface, a good chunk of money moved into a narrow group of companies tied to artificial intelligence, increasing the market’s weighting to the AI industry. In addition, the Federal Reserve under the new leadership of Chair Kevin Warsh has shifted from interest rate cuts to more likely increases in an attempt to fight inflation. And the conflict in the Middle East continues to drag on with little long-term clarity. We want to walk you through each of these: what happened, why it matters, and how we are thinking about the second half.

Because several of the most important developments happened after the quarter ended, this letter carries the market and policy story through July 31, while all performance figures are reported as of June 30.

Q2 MARKET PERFORMANCE

The S&P 500 returned approximately 15.2% for the second quarter, erasing the first quarter decline and leaving the index up roughly 10.2% for the first half of the year. The index crossed 7,600 for the first time during the quarter.

More diversified world equities, represented by the All Country World Index (ACWI), gained roughly 13.4% for the quarter as international valuations attracted capital and the dollar remained soft through much of the period. The equal-weight version of the S&P 500 (which gives smaller companies the same representation as the largest names in the index) gained approximately 11.0%. The Aggregate Bond Index delivered a modestly positive return, with rising Treasury yields creating a headwind late in the quarter.

Below is a summary of key total index performance across multiple time horizons as of 6/30/2026:

THREE STORIES SHAPING THE QUARTER

Beneath the Index: One Market, or Two?

The headline index return conceals the sharpest rotation of capital between sectors that we have seen in years. Some outsized capital and margin has moved into a narrow theme revolving around spending on artificial intelligence infrastructure; principally computer chip manufacturers and the businesses supplying them with networking equipment and power. That buying was funded by large selling elsewhere. Business software companies were the single largest source of those funds, and share prices in parts of that industry fell to their lowest valuations in a decade or more on two arguments: that AI will eventually replace what those businesses do, and simply that investors want more exposure to high-momentum names connected to the AI buildout.

In some respects this is a healthy development. The market is no longer led as narrowly by the largest technology companies as it was from 2023 through 2025. The seven largest companies now account for 33.4% of the index rather than the nearly 40% they approached at their peak.

But the market has traded that concentration for something else, and we think the something else is less well understood. The divide now runs between the large technology companies spending enormous cash flows to fund the AI buildout and the companies receiving those cash flows to do the building. The risk is no longer sitting on the surface in the form of index concentration. It is buried inside the same companies that dominate the index, and it takes the form of their continuing to spend nearly all of their profits on infrastructure.

Consider what that spending touches. A handful of the largest cloud platforms are building data centers on an enormous scale, using close to all of their profits to do it. That single decision fuels the growth of the companies selling the chips that fill those buildings, the machinery that moves the dirt and puts them up, the commodities that become the pipe and wire inside them, and the power generation required to run them. This is good for a time. But eventually supply and demand find an equilibrium, and then what?

Contrary to some, we believe there is a limit on this demand over the short term. When that limit is reached and spending slows, the question becomes what the knock-on effect will be, both on the companies that have come to rely on that spending and on economic growth more broadly. That question, and some straightforward supply and demand arithmetic, is what has kept us from getting overly excited about certain areas of this earnings growth and about the market generally. We believe there is more cyclicality baked into today’s earnings and today’s market leadership than most investors recognize.

Our read: When this tide finally goes out, we expect real disconnects to appear between prices and business results. That is not a prediction about timing, and we are not positioned as though we know the date. It is the reason we would rather own businesses whose earnings do not depend on a single spending cycle continuing.

Of course, anytime we see this much capital move and this much divide, we also see opportunities. This is why the rotation interests us more than it worries us. When strong, profitable businesses are sold simply because investors have somewhere more exciting to put their money, patient owners get the chance to buy very good companies at fair prices. That is where we have been looking.

Fundamentals: The Strongest Earnings Quarter in Five Years

Corporate profits came in far ahead of an already raised bar. With roughly 61% of the companies in the index having reported, combined second quarter earnings growth stands at approximately 47.4% compared with a year earlier, the highest since 2021, against an expectation of 18.8% at the start of the quarter. Of the companies that have reported, 86% beat expectations, also the highest share since 2021. Revenue grew roughly 12.3%, a second consecutive quarter of double-digit growth, with all eleven sectors of the market growing and eight of them

posting double-digit profit growth. Expectations for the full year have moved up substantially from the 18% to 19% we cited in April, and now point toward roughly 29% profit growth for 2026.

Read the headline carefully: That 47.4% figure is inflated by two unusually large one-time accounting gains at two of the biggest companies in the index. Setting those two aside, growth was approximately 28.8%. Still exceptional, and still a seventh consecutive quarter of double-digit growth, but a meaningfully different number. Energy company profits grew more than 130%, but that is a comparison against pre-war oil prices a year ago, and it reverses on its own if the Strait of Hormuz returns to normal. We are planning around roughly 29%, not 47%, and we are not assuming energy profits continue at anything like this rate.

We think that distinction is worth putting in front of you rather than simply passing along the larger number. The difference between a headline figure and the figure we actually plan around is where a great deal of investment risk lives. What remains after the adjustment is still the most encouraging feature of this market: broad, durable profit growth across the whole map of industries, not just at the top of the index. Growing company profits are ultimately what justifies market values and drives portfolio returns over time.

The reason we remain measured rather than completely celebratory is that the strength of this profit picture is already reflected in market prices. We are not buying earnings at a discount. That means the margin for error is thinner than we would like, and the burden falls on the economy and corporate America to keep delivering. So far they have.

Valuations: The Cushion Has Been Spent

In April we described the equity risk premium (fancy way of saying profit yield on stocks vs. bond yields) as thin but positive, and the market as priced for adequacy rather than with a margin of safety. That cushion has now been spent.

The equity risk premium is simply the extra return that stocks offer over safe government bonds. Think of it the way you would think about buying a rental property. If a building generates 4.5% a year after expenses, and a government bond pays 4.67% with no tenants, no roof to replace, and no risk of a vacancy, then the building has to be worth owning for some reason other than its yield. That is roughly where the broad stock market sits today. In April, the building was still paying you a little more than the bond. It no longer is.

The mechanism here is simple arithmetic, and it is not a problem with company profits. Profits improved. Share prices improved faster, while the return available on safe bonds rose at the same time. That squeezes the gap between the two from both ends.

One note on method, because we would rather show you how we measure something than present a single number as settled. There is a second common way to calculate this, using a rolling twelve-month estimate of future profits that blends in 2027. On that basis the earnings yield is closer to 5.1% and stocks still hold a small edge over

bonds, roughly four tenths of a percentage point. Both approaches are defensible. Both point in the same direction and show roughly the same amount of narrowing in a single quarter.

The practical implication is the one that matters for your portfolio. None of this is bad in and of itself. But it does place real pressure on businesses to grow their earnings and to earn a solid return on the capital they invest, because the market is no longer offering investors much cushion for the possibility that they fall short. A year ago, and even in April, an investor in the broad index could argue that a modest premium over bonds plus growing profits justified the price. That increase in what investors are willing to pay has now already happened. From here, returns on the broad index have to be delivered by continued higher than normal profit growth, not by investors paying still higher multiples for the same earnings.

That brings us back to the divide described earlier, because this is where the two issues meet. A large and growing share of the index is now either deploying capital into the AI buildout or receiving capital from it. If that capital fails to pay off, the effect on long-term valuations at the index level would be meaningful, and it would not be confined to one sector. The market’s current price therefore rests, to some degree, on a systemic reliance on the AI buildout not merely working, but working in a way that delivers a high return on invested capital for a long period.

We want to be precise about that question, because it is an easy one to get wrong. The question is not whether AI matters. We think it plainly does, and we expect it to matter enormously. The question is whether the extraordinary sums being spent to build it will earn a good return on that capital, and for how long. Those are two different questions, and only the second one determines what the index is worth today. We are not predicting a decline, and we want to be careful not to overstate the point: periods where stocks and bonds offered similar yields persisted for years in the late 1990s while markets rose. But this is the clearest way we can explain why diversification need and structuring portfolios in alignment to plan outcomes is so important rather than alignment with only a market index.

The Same Question, Asked Two Ways

Diving deeper into these thoughts. A premium of roughly zero for the market overall turns out to be an average of two very different things. The more useful division is not the giant companies against everyone else. It is between the companies that receive AI infrastructure spending and the companies that pay for it. The large cloud computing platforms are the payers, and that spending reduces their own reported profits. Chip manufacturers are where that spending arrives as revenue. Those chip companies now account for a record 19.7% of the total value of the S&P 500, compared with roughly 5% in June 2020, grew their profits by about 133% in the second quarter, and are earning record profit margins above 50%.

We want to be careful about how much weight this carries. Margin debt is a condition, not a signal, and it is published several weeks late. High leverage has persisted for long stretches without incident, and it has occasionally risen further from levels that already looked extreme. We are not presenting this as a timing indicator, because it is not one. What it tells us is how much force could be added temporarily to a decline if one arrives.

THE MACRO SCENE

The Iran Conflict: Reopened, Then Closed Again

The most important development of the quarter looked, briefly, like a resolution. On June 17 the United States and Iran signed an agreement providing for an end to hostilities, a sixty-day reopening of the Strait of Hormuz free of transit tolls, Iranian clearance of naval mines within thirty days, a lifting of the naval blockade imposed in April, sanctions relief, and a sixty-day window for nuclear negotiations. The blockade was lifted on June 18 and 19, the strait reopened, commercial shipping traffic surged, and international monitors lowered their threat assessment for the waterway for the first time since the conflict began.

It did not hold. A second and more serious round of attacks on vessels began on July 7, three ships were hit, and traffic collapsed again. In mid July there were reports that Iran had asked Yemen’s Houthi forces to prepare to close the Bab el-Mandeb strait, the other major shipping route in the region, and Saudi Arabia announced a defense alliance to protect shipping lanes. On July 31 a drone struck a U.S.-owned liquefied natural gas vessel at Egypt’s Damietta port, the first attack on Egyptian soil in this conflict and the first affecting the Suez corridor. As of this writing the strait is still in limbo without a clear path of opening locked down just yet.

Brent crude oil trades near $86 per barrel, roughly 19% above where it traded before the conflict began. Europe remains where the economic damage is most acute, and the risk of industrial recession persists in Germany, Italy, and Belgium.

Our approach here is unchanged. We do not make concentrated bets on the price of oil or on how a geopolitical conflict resolves, because the range of possible outcomes is wide, the timing is unknowable, and the penalty for being wrong in either direction is severe.

The Federal Reserve: From "No Cuts" to "Possible Increases"

The single most consequential development of the quarter was not the profit results or the market rally. It was the change in what investors expect from the Federal Reserve. In April we reported that markets had moved from expecting two quarter-point rate cuts this year to expecting none. The debate now is whether the next move is upward.

At its late July meeting, the Fed held its benchmark interest rate at 3.50% to 3.75% on a nine-to-three vote. Three members dissented in favor of a quarter-point increase, an unusually wide split for a committee that typically prefers consensus. Futures markets currently put the odds of an increase in September near 63%, down from roughly 80% before the meeting but still making an increase the expected outcome rather than a remote possibility. Core PCE inflation, the measure the Fed watches most closely, is running at 3.3% compared with a year earlier, well above the Fed’s 2% target, and the consumer price index is running near 4.2%. Under new Chair Kevin Warsh, the Fed has offered less guidance about its intentions than at any point in recent years.

For our purposes, the inflation number matters less than what it implies about interest rates. When the return available on safe bonds rises, the present value of every future dollar of profit we own falls, and the bar that any new investment has to clear rises with it. Said another way…higher rates attract money away from stocks and into bonds. The higher they go, the more investors might choose safer bonds compared to equities. We know this and manage accordingly relative to the plans. This is a key reason we view valuation of equities as slightly stretched with a small margin of safety. A backdrop of higher low risk rates that may increase will eventually pull money away from equities making proper balance long term key.

Growth, the Consumer, and the Labor Market

First quarter economic growth came in at 2.1%, a solid result that reflected the economy’s resilience through the energy shock. Unlike decades past, our larger service base economy has greatly helped our resiliency against energy shocks as compared to an industrial centric economy. Second quarter growth came in at 1.5%, below the 1.8% that had been expected. Growth of 1.5% alongside core inflation of 3.3% is the mild version of stagflation we described in April, meaning inflation running higher than economic growth, and it is now visible in published data rather than only in forecasts. It is not a contraction, and we do not view a full stagflationary spiral as the most likely outcome, but we do view it as a real risk that portfolios should be positioned to manage.

Consumer spending drives roughly 70% of U.S. economic activity, which makes the job market one of the most important things we watch. The picture remains the low hire, low fire pattern we described in April: layoffs remain low by historical standards, which is genuinely reassuring, but new hiring has slowed meaningfully. That combination can be a sign of stability, or it can be the precursor to a more significant slowdown if business confidence keeps eroding. The renewed energy disruption adds another weight here, particularly for lower-income households that spend a larger share of their budgets on transportation and food, and it has not helped the uneven economy we have written about in prior updates.

The Deficit — Still on Our Radar

The U.S. federal budget picture has not improved. With required spending and interest on the national debt consuming a growing share of tax receipts, the underlying math of federal finance is unchanged, and the continued need to borrow is part of why longer-term Treasury yields have moved higher. Higher yields on government bonds directly reduce the premium that stocks offer over them, which is how a government budget problem becomes a portfolio consideration.

We do not expect a debt crisis in the near term, as many levers exist to defer the reckoning. Case and point ; we mentioned in April that the Banks could absorb any needed purchases of treasuries if the government simply changed the rules allowing the USA to keep running a large debt. Without getting technical..the government finalized rule changes allowing banks more room to deploy capital into treasury purchases which is exactly what we expected and proves we have a good amount of room to keep financing our debt internally. This said, we continue to believe that portfolios built to last over ten- and twenty-year horizons must account for the possibility that U.S. Treasuries and the U.S. dollar face more pressure over time than they have over the past four decades.

Diversification, including international equity exposure and assets with genuine pricing power, remains an important part of how we think about this.

FINDING OPPORTUNITY WITHIN THE ROTATION

The opportunity available to us entering the second half looks different from the one we described in April. The second quarter rally consumed much of the discount that Q1’s decline had created across the market as a whole. But the movement of money beneath the surface created something more useful to us than a broad discount: a set of specific opportunities in strong businesses (and select areas) that were sold not because anything went wrong with them, but because investors wanted their money somewhere more exciting.

When capital moves this quickly on the basis of a narrative, prices often detach from business fundamentals, and the businesses left behind are frequently the ones with the most durable earnings. We are looking for the same characteristics we always look for: strong free cash flow, durable competitive positions, manageable debt, and the ability to navigate more than one economic environment. The current environment is opening up some real opportunities we are actively pursuing in client accounts. So while we might sound pessimistic in some areas we are getting excited in others! Since each strategy and acoounts vary in objectives it is difficult to accurately cover the nuance of action in this writing but suffice to say we are making some adjustments to add balance while also capturing what we believe could be some longer term outsized opportunities. In general the moves have a common theme:

Maintaining and moving up into higher quality balance sheets of companies that have been hit hard

Adding a counterbalance against the crowded momentum driven trades

Thoughtful positioning in fixed income for plans requiring more income and risk management.

CLOSING THOUGHTS

Q2 was a quarter that rewarded staying invested. Valuations have continued be elevated while concentration and systemic connection to the AI narrative has increased. The Federal Reserve is moving in a direction few expected at the start of the year. And the conflict in the Middle East has proven far more durable than most observers assumed in the spring. None of this changes our approach. Periods of elevated uncertainty have a way of making the present feel uniquely dangerous and the future feel uniquely unknowable. We want to offer a gentle counterpoint to that feeling. The world has always been uncertain, and markets have always had to absorb shocks: geopolitical, economic, technological, and human. What has separated successful long-term investors from unsuccessful ones is rarely the ability to predict which shock comes next. It is the discipline to stay invested in quality, the patience to wait for genuine opportunity, and the humility to know that no one can forecast the future with precision. We continue to remain balanced in alignment with objectives and are genuinely more excited about current opportunities than anytime in recent past!

As always, please don’t hesitate to reach out if you have questions about your specific situation.

With sincere gratitude,

Evergreen Wealth Management