GSAM's Investment Committee Releases Its 2nd Quarter 2026 Market Update

July 22, 2026

The second quarter of 2026 was eventful to say the least. Equities had their best quarterly performance in six years, coming off a challenging February and March, a war with Iran surged oil prices, the US dollar strengthened, and inflation remained elevated compared to early-year expectations. As we move toward the second half of the year, investors are likely to balance optimism for continued market strength with a watchful eye towards a new Fed Chairman, potential interest rate hikes and elevated equity valuations. The mid-term elections in November also have the potential to influence markets, but historically these fluctuations are temporary noise until the election dust has settled.

Geopolitical tensions in the Middle East have remained an important backdrop for markets, with flare-ups in the region contributing to volatile energy prices. These energy fluctuations have increased headline inflation, temporarily reversing the progress seen over the past twelve months. Energy prices remain a key factor for inflation and could influence future policy decisions from the Federal Reserve in the second half of the year.

The Personal Consumption Expenditures (PCE) Price Index is the Federal Reserve's preferred measure of inflation. The Fed has a PCE inflation target of 2%, though this measurement hasn’t been at or below 2.0% for more than five years. Following a brief cease-fire with Iran, crude oil prices nearly returned to levels seen prior to the conflict. Oil prices closed the quarter at around $70 per barrel, which is down 42% from the high point for the year at around $120 per barrel. Consumers have shared in a portion of that price-easing at the pump recenly, as gas prices have declined 14% from highs.

The strong labor market has helped consumers battle higher prices at the pump. After a lackluster 2025, in which only 116,000 total jobs were added, the Fed projected 2026 would echo the same sentiment. As a result, the Fed was messaging a plan to cut rates in 2026 to help keep the economy from going into a recession. However, this year’s job growth has exceeded expectations. The US employment picture has strengthened during the first half of 2026, adding on average 92,000 jobs per month. The unemployment rate fell to 4.2% in June, down from 4.5% last November. The recent reading also matches the average for the five years preceding the covid pandemic, indicating we have reached a more normalized labor environment.

Considering the status of higher inflation and a resilient labor market, the Fed voted to keep rates unchanged at a range of 3.5% to 3.75% during their June meeting. This was a unanimous decision and widely expected. However, the outlook for policymakers is murky for the second half of 2026, as half of the Fed policymakers expect higher rates by the end of 2026. Many projections indicate at least one rate hike towards the end of the year. It is important to note that while rates seem elevated, they are not high enough to keep the economy from growing. Elevated real rates tend to coincide with a healthy economy rather than a fragile one.

While economic growth has moderated from the rapid pace of recent years, the economy remains fundamentally healthy; neither overheating nor slipping into recession. Investors have shifted their attention to the quality of corporate earnings, profitability, and cash flows. These are the factors that truly drive stock prices long-term. As a result, equity markets delivered an exceptionally strong second quarter, driven by strong corporate fundamentals and continued exuberance for artificial intelligence. The S&P 500 saw double-digit earnings growth and gained more than 15%. At this current rate, US equities may be on track for the fourth year in a row of double-digit returns, a record unseen since the 1990s. The positive equity performance was broadly based across market caps and sectors as shown in the table below:

The fundamental outlook for equities remains consistent and supportive of growth. Second quarter earnings are projected to increase across every sector of the S&P 500, and profit margins are forecast to reach nearly 14%, a potential record. This growth reflects the ability of companies to maintain pricing power and benefit from ongoing investments in technology and automation. Artificial intelligence remains a key driver of capital spending across the technology, semiconductor, industrial, and infrastructure sectors, providing tailwinds for both earnings growth and long-term productivity. The GSAM Investment Committee believes that within equities, the most significant risk to current prices is a derailing of the AI-investment thesis, and this is a threat we are monitoring. That said, the broad-based growth across sectors, cap size and industries that we have seen over recent quarters is a positive sign that the growth is less concentrated than in recent years, a healthy market signal.

Fixed income markets produced modest but positive returns during the second quarter as interest rates remained relatively stable. Core investment-grade bonds and Treasury securities returned 0.1% during the quarter. Higher-yielding sectors continued to provide the strongest source of return, with high-yield corporate bonds gaining 2.5% during the quarter.

Short-term bonds have outperformed longer-duration bonds year-to-date because they are largely insulated from interest rate fluctuations and continue to benefit from elevated short-term yields. Longer-term bonds, by contrast, are more sensitive to changes in interest rates. While fixed income returns have understandably lagged the impressive gains produced by equities, bonds continue to fulfill their role of providing portfolio diversification, income, and stability amid evolving market conditions.

For fixed income investors, current yields remain attractive by historical standards and provide an important source of stability and diversification should economic growth moderate. However, it is worth noting long-term Treasuries are on pace for one of their weakest decades on record. As a result, it has been beneficial to explore defensive alternatives that maintain a similar low-risk profile. Equity buffer strategies can further enhance portfolio resilience with measured downside protection coupled with upside gains well in excess of traditional bonds. The GSAM Investment Committee has utilized these defensive alternatives to add meaningful risk-adjusted returns to portfolios in recent years, and we continue to appreciate the risk-reward profile that they provide for our clients.

The committee was active in client portfolios during the second quarter with shifts in overall equity allocation. We reduced our long-standing overweight to the health care sector, as the future earnings growth in the sector has deteriorated relative to other sectors, especially as AI commands more of the market. While the weighting of the technology sector within the S&P 500 has reached nearly 38%, we remain more diversified than the passive index. This positioning has proven to be beneficial in periods of downward shocks, such as February and March of this year. We also swapped a long-held active deep-value international strategy for a new core international ETF due to a trend of underperformance. The new strategy should provide more stable returns as well as better tax efficiency. These adjustments represent incremental enhancements rather than significant shifts and are consistent with our disciplined process.

As we enter the second half of 2026, the investment landscape remains constructive, although investors should anticipate periods of increased volatility following such a strong first half of the year and a potentially dynamic mid-term election cycle. Market expectations have risen alongside corporate earnings, leaving less room for disappointment. Even so, the underlying drivers of the current bull market remain intact. Economic growth continues at a sustainable pace, inflation has moderated considerably from its peak, labor markets remain healthy, and corporate profitability continues to surprise to the upside. The GSAM Investment Committee remains focused on economic data, market fundamentals and thoughtfully positioned client portfolios to support clients’ long-term goals. We are grateful for your continued trust and partnership.

Sincerely,

The Grant Street Asset Management Investment Committee