Second Quarter Review
Over the past three months we saw the price of oil continue the rise that began in the first quarter, hitting a peak of $114.58 per barrel of West Texas Intermediate crude on April 7. The increase was a notable component of stronger inflation readings as the contribution to overall price increases from the rise in oil were significant, particularly when it is considered that over the past several years energy prices had actually declined in multiple months, pulling the overall rate of inflation lower.
As the rate of inflation rose to a year-over-year (YOY) rate of growth reaching 4.25% in May the outlook for monetary policy shifted from the prospect of potential cuts in the Fed Funds rate to the possibility that rate hikes might be more likely in the second half of the year.
Adding further impetus to this scenario was a labor market that demonstrated a high level of consistency in its firmness and consumers that remained resilient. Regarding the labor market, the unemployment rate remained steady at 4.3% across all three reporting periods during the quarter, the most recent Job Openings and Labor Turnover Survey (JOLTS) report showed an increase in the number of job openings, and jobless claims have remained highly consistent at very modest levels.
Consumer resilience has been evidenced by retail sales that most recently generated a higher than forecast outcome even when taking into account the higher gas prices that consumed a larger portion of consumers’ spending capacity. The strength in consumer spending was aided by larger tax refunds that flowed out of the One Big Beautiful Bill Act (OBBBA) passed last year, as well as a reduction in the personal savings rate which currently registers 3.0%.
Combining all of these various pieces together is anticipated to result in a real gross domestic product (GDP) growth rate of 2.5% for the period.
Second Half Outlook
The second half of the year is anticipated to show continued growth, albeit at a slower pace than that realized in the first half. Currently the Bloomberg survey of economists is looking for third quarter real GDP growth of 1.6% and a modestly higher level of 1.8% in the fourth quarter.
There are numerous indicators that support the outlook for continued growth in the U.S. economy. These include the monthly surveys conducted by the Institute for Supply Management (ISM) which are maintaining readings that indicate an environment of positive economic activity. These surveys cover both the manufacturing and service sectors of the economy. In addition, the Citi Surprise Index is pointing to underlying firmness in the economy as its current reading indicates economic data releases are, in aggregate, exceeding consensus forecast levels. And as we have discussed in previous commentaries the massive capital expenditure being undertaken by the largest hyperscalers will continue to permeate through the economy, creating momentum for numerous sectors and industries.
Labor markets are anticipated to remain stable throughout the remainder of the year as the oft-discussed decline in employment anticipated to occur as a by-product of AI implementation has yet to appear. Stated more precisely, unemployment is expected to show little to no change.
With the decline in oil prices the rate of inflation is anticipated to moderate but remain meaningfully higher than the Federal Reserve’s stated target rate of 2.0%. Services will remain the dominant component in terms of contributors to the changes in overall price levels.
Also forecast to moderate over the course of the next two quarters is the level of consumer spending. With the benefit of increased tax refunds of personal savings, the purchasing power for the consumer will weaken. This is compounded by the fact that unless wage growth increases and/or inflation moderates the consumer is now seeing a rate of price increases in excess of wage growth. One factor that could offset potential stagnation of consumer spending is the continuation of the wealth effect that has been provided by rising equity markets.
Asset Allocation
The Macro Backdrop: Growth Moderating, Not Deteriorating
The U.S. economy enters the second half from a position of resilience. Real GDP growth was 2.1% YOY for Q1 2026, an estimated 2.50% for Q2 2026. Our outlook calls for a deceleration to below 1.8% in the second half, as the tailwinds from fiscal stimulus fade and consumers — having absorbed a combination of tariff-related price pressures and elevated pump prices — shift toward rebuilding savings.
This is a slowdown, not a contraction, and the distinction matters for
portfolio positioning.
After a decline of 4.2% in Q1 2026, U.S. equities, as measured by the Russell 1000, rebounded sharply, delivering a +15.1% return in Q2. On a first-half basis, the Russell 1000 returned approximately +10.3% through June 30. We remain constructive on U.S. equities for the second half, but with caution. The earnings bar is high, momentum is extended, and an increasing supply of equities — through both secondary offerings and the IPO pipeline — creates the conditions for minor drawdowns. These will be viewed as opportunities rather than inflection points to shift our allocation stance.
International equities offer an improving risk/reward profile entering the second half. The oil shock headwinds that weighed on energy-importing economies earlier in the year are diminishing as crude prices retrace. Overseas central banks that raised rates to combat inflation are increasingly pausing, providing a more supportive monetary backdrop for international equity markets.
Bond Markets: Source of Income and Stability
The rise in U.S. rates during the first half reflects the market’s view that higher yields are required in the face of sticky inflation and a Fed that has pivoted from easing rates to raising them. Despite the partial retracement in oil prices, the 10-year yield at 4.47% has only eased modestly from its highs and may not fully reflect the risk of a future Fed tightening move. Despite the downward pressure that higher rates exert on bond prices, coupon income will keep total bond returns positive, as was the case in the first half. Fixed income serves a primary and essential role in portfolios — supplying income and providing a stabilizing counterweight to ongoing equity market volatility. Our view that increasing the weight to bonds ahead of potential further Fed tightening would be premature.
The second half of 2026 calls for disciplined optimism. Growth is moderating but not deteriorating. Inflation is sticky but not re-accelerating. The Fed is on hold but not easing. In this environment, a neutral rate posture, anchored in quality growth equities, selective international exposure, and income-generating fixed income is the appropriate framework. The themes that will determine whether this base case holds are well-defined: energy prices, labor market dynamics, the durability of AI investment, and the geopolitical backdrop.
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