The second quarter of 2026 (Q2) was eventful, as they all seem to be lately. The stock market rallied off first-quarter lows enough that major indexes had their best quarter in recent years. This impressive performance came from mixed market conditions, more inflation and a new Fed Chair, the on-again-off-again peace process with Iran, and shifts within the expanding AI investment story.
Here's a summary of how major market indexes have performed during Q2 and this year, respectively.
- US Large Cap Stocks: up 15.1% and 10.1%
- US Small Cap Stocks: up 21.4% and 22.6%
- US Core Bonds: up 0.7% and 0.7%
- Developed Foreign Markets: up 8.6 and 9.9%
- Emerging Markets: up 21.1 and 25.7%
While US stocks displayed strong performance at the index level during Q2, most of that happened during April and May. There are always a number of reasons why, but the primary reason for the snap-back following Q1 losses was the initial ceasefire memorandum of understanding between the US and Iran announced in early April. That news helped oil prices to fall from well over $100 per barrel for the US benchmark during Q1 to around $70 as Q2 ended (although shipping through the Strait of Hormuz remains ostensibly under Iranian control and isn’t back to normal). Falling oil prices plus generally positive economic news buoyed the stock market through May. Unfortunately, multiple subsequent ceasefire deals suffered various setbacks even following a deal signing at Versailles.
While major indexes like the S&P 500 and NASDAQ performed well for Q2 as a whole, large performance variations occurred within the indexes themselves, especially later in the quarter. Most of the impact came from the largest companies like Microsoft, Broadcom, Amazon, Tesla, Meta, and Apple, which were each down over 10% during June alone. Combined, those companies make up around 16% of the value of the S&P 500 and mega-caps in total comprise about 40% of the index, so their performance carries more weight. This poor performance mostly had to do with evolving sentiment around AI’s potential impacts on the software industry and a shift in interest from hyperscalers to chip makers. Other companies performed well in June, including Micron Technology (AI-related, computer memory and data storage), which rose 20% and was added to the list of trillion-dollar stocks. Non-AI stocks like JPMorgan Chase, Intel, and Johnson & Johnson also performed well, each up at least 10%. But those companies have a smaller weighting in the S&P 500, so the index ultimately lost about a percent during June while still performing well overall.
Elsewhere in the stock market, typical foreign developed and emerging market indexes performed well in Q2 after also slowing materially in June. The reasons were mostly the same as for US markets, but changing investor enthusiasm around AI and semiconductors caused more volatility in some foreign markets. The main stock index in South Korea for example, the KOSPI, rose over 60% for the quarter but suffered multiple daily swings of 5%-10% during June. South Korea and Taiwan, another country that performed well during Q2 for similar reasons, are together worth about half of the typical emerging markets index. China is worth about 20% of the index and fell about 11% for the quarter, but its relatively low weighting helped obscure the country’s poor performance.
The bond market also reacted to these dynamics during Q2, but the primary drivers of its modest performance were rising inflation and the anticipated response from new Fed leadership. So-called headline inflation jumped to a 3.8% annual rate in April and 4.2% in May. The headline numbers include energy prices which rose substantially after the Iran War began. Most energy prices have fallen since and should remain low assuming the global flow of oil gets back to normal. June inflation numbers won’t be out until later this month, but forecasters are expecting a decline to something in the high-3% range. If that trend continues, lower inflation would be positive for markets if it helps the Fed avoid raising its interest rate benchmark. Investors had been anticipating that Kevin Warsh, the new Fed Chair, might push his committee to lower interest rates, but he threw cold water on that thinking during his first press conference in May and investors rapidly changed their outlook. As of this writing, the bond market is pricing in one or two rate increases this year. These changing expectations helped the yield on the 10yr Treasury, a key benchmark, rise to nearly 4.7% from around 4.3% at the beginning of Q2. That declined to about 4.5% during the last part of the quarter and helped the price of the typical bond index remain slightly positive during June’s stock market volatility.
Ultimately, Q2 provided solid performance for investors who owned more stocks than bonds. There were surges of volatility and a lot of movement within the indexes, but traditional asset allocation and diversification helped smooth this out. Looking ahead, AI continues to drive overall market performance, and some areas seem overvalued, but potential remains. According to Bespoke Investment Group, institutional research clients (like yours truly) think we’re about four innings deep if AI growth was a baseball game. Plus, corporate profits are up across a variety of non-AI sectors, and the economy is doing well, at least on average. We should continue to expect risk and volatility coming from the political sphere, but that’s nothing new. That said, frothy markets provide opportunities to rebalance and perhaps also to “realize” some gain for real-world expenses like funding your retirement distributions, gifting to charity and family, and so forth. As always, let me know how your needs have changed and if you have any questions.
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