Q2 2026 Review: From Shock to Recovery

After a difficult start to the year, equity markets rebounded sharply in the second quarter. One of the central focuses was the U.S.-Iran conflict and the prospect of reopening the Strait of Hormuz. News flow was often volatile, with reports of progress frequently interrupted by renewed tensions or conflicting comments. Despite the uneven path, markets increasingly priced in the view that a resolution would eventually emerge. As the probability of a reopening improved and negotiations advanced toward a memorandum of understanding, commodity prices retreated from their highs, helping ease concerns around both higher inflation and weaker global growth. The global economy proved more resilient than many anticipated.

Economic data generally held up well, particularly in the U.S., where consumer spending continued to expand, labor market conditions showed some signs of improvement, and technology capital expenditure was strong. The combination of resilient demand and easing energy pressures helped shift the balance of risks in a more constructive direction by quarter-end.

Against this backdrop, central banks signaled a bias toward a more restrictive policy posture. One of the more notable monetary policy developments came in the U.S., where Kevin Warsh's inaugural meeting as Chair of the Federal Reserve resulted in higher yields at the short-end of the Treasury curve. While policy rates were left unchanged, markets moved to price additional tightening and adjusted to Warsh's message that forward guidance would play a smaller role in future communications. Outside the U.S., policy paths were more mixed, but most major central banks enter the second half of the year with a more restrictive stance than at the start of 2026. The European Central Bank and Bank of Japan were among central banks delivering rate increases during the quarter.

In terms of financial market performance, equity markets significantly outperformed fixed income markets as investors looked through near-term geopolitical uncertainty and focused on strong earnings fundamentals. Corporate profit growth trended strongly across most major regions, allowing equities to generate outsized returns without a significant increase in valuation multiples.

The AI buildout continued to be a defining market theme. Persistent shortages in semiconductors and memory components, coupled with continued growth in technology investment, drove exceptional performance in AI-linked markets and sectors, including global semiconductors, Korea, emerging markets, and U.S. large-cap technology stocks.

Yet the advance was broader than just remarkable returns in those pockets of the markets. Financials, banks, and small cap equities also posted strong gains, reflecting confidence in the durability of economic and corporate profit growth. Nearly every U.S. large-cap sector outside energy and utilities finished the quarter in positive territory. By the end of the quarter, technology stocks started to experience some pressure, and leadership had begun to rotate from AI beneficiaries.

Despite one of the largest oil supply disruptions in history, oil markets and global growth proved notably resilient. While spot crude prices surged, longer-dated oil prices remained more contained, supported by existing supply buffers and confidence that disruptions would prove temporary. Amid higher headline inflation driven by energy prices, global growth remained firm, aided by reduced tariff uncertainty, accommodative financial conditions, U.S. consumer tax refunds, and continued strength in technology investment.

In the face of the energy shock, many central banks continued to maintain a more restrictive posture. The agreement to reopen the strait reduced market pricing of near-term inflation pressures, but elevated core inflation and the absence of major economic cracks kept expectations for rate hikes tilted upward. This was reinforced at June’s Fed meeting, where new Chair Kevin Warsh expressed a commitment to price stability and indicated that forward guidance will play a smaller role in shaping policy expectations than in the past.

While economic growth remained resilient, corporate earnings growth was particularly exceptional. The gap between U.S. large cap profit growth and economic activity widened to one of its largest levels in decades, a dynamic more commonly seen during recoveries. This cycle has been different, with AI-related profits proving more structural than cyclical in nature. Although many sectors posted gains, the AI ecosystem was the primary driver of above-average earnings growth and the key engine behind the quarter’s outsized equity returns.

The IPO market came back to life with the SpaceX listing and other potential mega offerings (i.e., OpenAI, Anthropic). If these deals come to market, issuance volumes could reach historic levels. While the size may be manageable relative to overall market capitalization, they reflect a broader trend: the high capital needs of next-generation technologies. From equity issuance and debt financing to index concentration and corporate fundamentals, the innovation buildout is reshaping how investors evaluate markets and allocate capital.

The 2-year Treasury yield rose 38 basis points (bps), significantly outpacing the 15-bp increase in the 10-year yield. The 10-year Treasury yield climbed through mid-May, peaking just below 4.7% alongside the peak in oil prices before retreating to under 4.5% by quarter-end as concerns surrounding the U.S.-Iran conflict eased. Beyond the energy shock, economic resilience allowed central banks to maintain a hawkish stance. While the Fed remained on hold, markets shifted from pricing 7 bps of cuts to 38 bps of hikes by year-end.

Investment grade (IG) credit spreads contracted 14 bps to 0.69%, while high yield (HY) spreads tightened 47 bps to 2.70%. IG bonds returned 0.7%, and high yield gained 2.5%. Although U.S. interest rates moved higher, the drag was more than offset by starting yields and spread tightening for bonds with exposure to credit risk. After facing pressure in the first quarter from higher energy prices and AI-related concerns, credit spreads spent most of the second quarter retracing those moves, ending not far from record lows.

Similar to oil futures, equities traded ahead of both the peak in spot oil prices and the formal reopening of the Strait of Hormuz. Global equities gained 15% during the quarter, approximately 1.5 standard deviations above their 30-year average. While U.S.-Iran de-escalation helped, technology stocks led the advance on the back of remarkable semiconductor strength. This led to outsized gains in tech-heavy markets such as Korea (+68%) and contributed to the outperformance of U.S. and emerging markets relative to developed ex-U.S.

Real assets exhibited significant dispersion during the quarter. Global real estate gained 8.5%, followed by a 1.6% return for global listed infrastructure, while natural resources declined 8.5%. All three lagged global equities (15.1%). Natural resources was the clear underperformer after returning 20% in Q1, trading largely sideways before selling off in late May as commodity prices fell 14% from that point through quarter-end. Despite the volatile path, all three real asset categories remain up roughly 10% year-to-date.