British economist John Maynard Keynes famously noted that “the markets can remain irrational longer than most investors can remain solvent.” If there was any doubt regarding the legitimacy of that perspective, the just-concluded second quarter provided an excellent example of just how counterintuitive (and arguably even irrational) equity markets can be.
Indeed, if an investor knew in advance that the second quarter would include a war with Iran that would impact virtually all countries in the region and effectively shut down what is perhaps the most important waterway in the world (the Strait of Hormuz); an initial $45 per barrel surge in crude oil prices that would drive a surge in U.S. inflation back above 4%; a somewhat controversial change in leadership at the Federal Reserve; record levels of new equity markets supply (through the Space-X initial public offering and various secondary offerings), and growing concerns about a potential bubble in artificial intelligence-related stocks, they would almost certainly have entered the quarter with a cautionary, if not outright bearish, outlook.
And yet, despite this array of perceived headwinds, the global equity markets managed to defy almost all expectations. Indeed, U.S. stocks enjoyed their largest quarterly gain in six years, including an advance for the Nasdaq of 21.4% (its second-best quarterly performance of the past quarter century), and a massive 88.4% quarterly gain in semiconductor stocks. In addition, the broader, more sector-diverse S&P 500 Index posted a remarkable quarterly gain of 14.9%.1,2,3
Not to be outdone, the Russell 2000 Index of smaller domestic companies advanced by a stunning 21.5%, while the world’s emerging markets (led largely by semiconductor stocks in South Korea and Taiwan) gained a remarkable 24.1% during the quarter. Even the equity markets of the industrialized countries in Europe and the Pacific averaged gains of just under 11%.4 The top performing market among the non-U.S. industrialized nations was Japan’s Nikkei 225, which gained a remarkable 37%, marking its largest quarterly advance since 1965.5
Many of these global gains were driven by an eventual drop in oil and commodity prices based upon hopes for a diplomatic solution to the war with Iran; by the perception that the war would not derail the massive investment (capital expenditure cycle) supporting the build-out of AI infrastructure, and by a dramatic surge in overall corporate profits.
However, it is important to emphasize that, when you look under the surface, the advances were anything but universal. Indeed, the “Magnificent 7” stocks (Nvidia, Alphabet, Apple, Microsoft, Amazon, Tesla, and Meta Platforms) that have powered the bull market over recent years lost approximately $2.3 trillion of value in a late-June market selloff6, which represented the group’s largest monthly decline ever, while much of the strength in the equity markets was concentrated in those smaller and mid-sized companies on the receiving end of the AI-related capital expenditures. That said, market breadth did improve significantly, as exemplified by the outperformance of small and mid-sized companies.
In contrast to the euphoria in most of the world’s equity markets, most of the world’s debt and credit markets were largely unchanged to slightly positive during the quarter. High yield bonds and leveraged loans generally outperformed due to tightening credit spreads (a reduction in the risk premium associated with lower quality debt) amid strong corporate earnings, which improved the perceived ability of indebted companies to service their debt.
We believe that the second quarter reinforced a central theme of 2026, which is that the AI super‑cycle appears to be the dominant force shaping global capital markets, overshadowing geopolitical shocks and driving economic growth, earnings expectations and investor sentiment.
Indeed, in the firm’s midyear outlook webcast, Vanguard’s global chief economist, Joe Davis, predicted that artificial intelligence may propel the U.S. economy to one of its strongest growth rates in years. Specifically, Vanguard projects roughly 3% U.S. GDP growth in 2027 and credits AI investment with driving nearly all of that acceleration. As noted by Davis, “it’s almost solely coming from the AI investment.”7
In general, second-quarter economic data improved from already impressive levels. Much of the strength was driven by this massive capital investment being made into artificial intelligence (AI) infrastructure and was aided by wage growth generally keeping pace with inflation, and solid consumer spending by the wealthiest segments of the U.S. population. In this environment, we believe that recession risks in most of the world remain quite low, with Europe being a potential exception.
It is noteworthy that, on a global basis, technology stocks and stocks related to the buildout of the AI economy dominated second quarter returns. Indeed, the technology sector (see above) was the only S&P sector to outperform the S&P 500 Index as a whole.8 Remarkably, as was pointed out by Bespoke Investment Group, “it’s not only uncommon for just one sector to outperform the S&P 500 in a quarter, but before Q2, it had never happened before!”9 That very narrow concentration makes returns look deceivingly strong compared to both the average stock and/or any portfolio that is not very heavily weighted toward the technology sector.
That said, while we still like the technology sector, we suspect that investors will ultimately start to reward not only the stocks of the technology, energy and industrial companies that enable AI, but also those that will utilize AI to increase both productivity and profitability.
Thus far, AI adoption has been relatively limited, which helps to explain why the stock market rally has just started broadening out to include some of the other sectors that we believe will eventually benefit greatly from AI adoption. We are perhaps most optimistic about the impact that AI will ultimately have on healthcare in general and drug development in particular.
For our part, we do expect for the market rally to broaden out beyond the technology sector and believe that a question of seminal short-term importance is whether the technology sector will continue to dominate the equity markets, or if much of the bullish AI-related news is at least temporarily already reflected in the price of technology stocks.
Indeed, while we do suspect that technology stocks may need some time to consolidate the past quarter’s dramatic gains, we are still inclined to give the sector the benefit of the doubt over the intermediate and longer term. Indeed, if technology sector earnings manage to meet their lofty expectations, we are still inclined to view the sector as being rather reasonably valued. Moreover, we believe that this same perspective, and the need to consolidate their recent gains, likely also applies to domestic small-cap stocks after their massive second quarter advance.
If there is a more immediate threat to the longevity of this bull market, it is likely inflation that, at 4.2%, remains over twice as high as the Fed’s 2% target, and which is being driven largely by tariffs, higher commodity prices (largely due to the closure of the Strait of Hormuz), and a massive surge in the price of electronic components (again, being driven largely by the buildout of the AI infrastructure). The impact of the AI buildout on the Producer Price Index is illustrated below.
Inflation remains one of the most significant challenges for the investment markets for three primary reasons. First, as the AI buildout is increasingly being financed rather than being paid for via free cash flow, the higher interest rates being driven by higher inflation are increasing the cost of the buildout. Second, the recent spike in inflation has caused a reversal in monetary policy expectations, where investors are now expecting at least one rate hike by the Federal Reserve in 2026, as opposed to previous expectations for at least two rate cuts. Third, higher interest rates have traditionally weighed on both stock and bond prices, as they both increase the cost of doing business and make debt and credit markets more attractive relative to equities.
That said, if shipping traffic traveling through the Strait of Hormuz can return to pre-war levels (a notably big “if”), thus reducing the price of oil, liquified natural gas, fertilizer and a variety of other commodities, we believe that we may have already seen peak inflation for the year, and perhaps even this economic cycle as a whole. Such a reduction in inflation should reduce the pressure on the world’s central banks to raise interest rates, and perhaps even restore the potential of rate cuts. We would view such an outcome as being very bullish for most global stock and bond markets.
The risk of persistent inflation aside, there are an array of factors that keep us bullish on equity markets in general and domestic equities specifically, particularly over the intermediate and longer term. This is despite most foreign stock markets being much less expensive than domestic stocks (relative to corporate earnings).
Over the short term, we expect equity markets to be heavily influenced by the upcoming earnings season and, to a lesser extent, the tendency for third quarters in general and third quarters during mid-term election years in particular, to be unusually volatile. There are also indications of a rotation in equity market leadership, with more value-oriented stocks and year-to-date laggards at least temporarily stepping into a leadership role, while the biggest gainers of 2026 pause to consolidate this year’s impressive advance.
We would consider this to be a very healthy outcome, as broad-based advances tend to be more sustainable, while very narrow rallies can prove rather perilous, if and when the leadership sectors fall out of favor. Even allowing for a potential short-term consolidation in the equity markets, we believe that the weight of the evidence continues to favor the bulls over the longer term.
Disclosures
Advisory services offered through Per Stirling Capital Management, LLC. Securities offered through B. B. Graham & Co., Inc., member FINRA/SIPC. Per Stirling Capital Management, LLC, DBA Per Stirling Private Wealth and B. B. Graham & Co., Inc., are separate and otherwise unrelated companies.
This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Nothing contained herein is to be considered a solicitation, research material, an investment recommendation or advice of any kind. The information contained herein may contain information that is subject to change without notice. Any investments or strategies referenced herein do not take into account the investment objectives, financial situation or particular needs of any specific person. Product suitability must be independently determined for each individual investor.
This document may contain forward-looking statements based on Per Stirling Capital Management, LLC’s (hereafter PSCM) expectations and projections about the methods by which it expects to invest. Those statements are sometimes indicated by words such as “expects,” “believes,” “will” and similar expressions. In addition, any statements that refer to expectations, projections or characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Such statements are not guarantying future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual returns could differ materially and adversely from those expressed or implied in any forward-looking statements as a result of various factors. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of PSCM’s Investment Advisor Representatives.
Past performance is no guarantee of future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance quoted.
Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.
Small capitalization securities involve greater issuer risk than larger capitalization securities, and the markets for such securities may be more volatile and less liquid. Specifically, small capitalization companies may be subject to more volatile market movements than securities of larger, more established companies, both because the securities typically are traded in lower volume and because the issuers typically are more subject to changes in earnings and prospects.
Sector Strategies: Portfolios that invest exclusively in one sector or industry involve additional risks. The lack of industry diversification subjects the investor to increased industry-specific risks.
Definitions
Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.
The Standard & Poor's 500 (S&P 500) is a market-capitalization-weighted index of the 500 largest publicly-traded companies in the U.S with each stock's weight in the index proportionate to its market. It is not an exact list of the top 500 U.S. companies by market capitalization because there are other criteria to be included in the index.
The Nasdaq Composite Index is a market-capitalization weighted index of the more than 3,000 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks. The index includes all Nasdaq listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debentures.
The Russell 2000 Index is an unmanaged index that measures the performance of the small-cap segment of the U.S. equity universe.
The Nikkei 225 is Japan’s most widely followed stock market index, tracking 225 major publicly owned companies on the Tokyo Stock Exchange (TSE).
The Producer Price Index (PPI) measures the average changes in selling prices received by domestic producers for their output over time, tracking prices at the wholesale level before they reach the consumer.
Citations
1. “Why the Stock Market’s Staggering Quarterly Gains Will Be Tough to Match”, Teresa Rivas, Janet H. Cho, Posted 6/30/2026, https://www.barrons.com/articles/stock-market-quarter-things-to-know-today-fa999173
2. “Wall Street concludes the best quarter in 6 years”, Walla! Money, Posted 7/1/2026, https://www.jpost.com/business-and-innovation/banking-and-finance/article-901069
3. “The Closer”, Bespoke Investment Group, Posted 6/30/2026, https://www.bespokepremium.com/
4. “Total Return Review”, Bianco Research LLC, Posted 7/1/2026, https://www.biancoresearch.com/
5. “Japan's Nikkei clocks best quarter on record on tech rebound”, Rocky Swift, Posted 6/29/2026, https://www.reuters.com/world/asia-pacific/japans-nikkei-adds-record-quarterly-gain-tech-rebound-2026-06-30/
6. “The Mag7 Just lost $2.3 Trillion in a Single Month. Here’s the AI Fear Behind it.”, Omor Ibne Ehsan, Posted 7/2/2026, https://finance.yahoo.com/markets/stocks/articles/mag-7-just-lost-2-152206055.html
7. “Vanguard Predicts AI Could Drive 3% GDP, But Advisors Should Broaden Portfolios”, Tracey Longo, Posted 7/8/2026, https://www.fa-mag.com/news/vanguard-predicts-ai-could-drive-3--gdp--but-advisors-should-broaden-portfolios-87683.html
8. “Q2 Recap: Markets Get Back on Track”, RiverFront Investment Group, Posted 7/10/2026, https://etfdb.com/etf-strategist-channel/markets-back-track/
9. “The Bespoke Report”, Bespoke Investment Group, Posted 7/10/2026, https://www.bespokepremium.com/