Market Outlook
The dominant factor for markets in the second quarter was the shift in Fed expectations toward hikes and the unstoppable earnings and spending cycle in the U.S. For equities, the result was a risk-on rebound from Q1 and large gains; for fixed income, returns were positive but muted. After a negative first quarter, global equities and the S&P 500 powered ahead to 15% gains, the best quarter since the 2Q2020 COVID rebound. Fixed income returns were modest (+0.65% Aggregate), with yields under upward pressure from a more hawkish Fed, but high levels of income carry provided an offset to total returns.
The global growth picture looks to remain firm and supportive of markets and sentiment going into the back half of the year, especially in the U.S., where a strong profit cycle that is showing signs of broadening and a historic spending cycle tied to AI continue to provide dominant tailwinds. It is not an even growth picture globally, with weak European GDP and structural headwinds for China providing some drag; however, recession calls have faded, and we expect stable growth and easing inflation fears to leave some upside room for risk assets and a higher probability of range-bound yields. For the back half of the year, we do not believe the primary challenge for investors will be monetary tightening or economic weakness, but rather, high expectations. Valuations are fuller across most asset classes and returns are more dependent on continued robust earnings growth, corporate spending, and fading geopolitical risk. With a lot of this priced into multiples and spreads, gains could be more capped in the back half, and markets could become more sensitive to disappointments.
For investors, this creates a backdrop that remains constructive but less forgiving than earlier in the cycle. Market pricing has moved higher but macro conditions still suggest a wide range of potential outcomes. The Iran cease-fire has reduced near-term risks, but the path toward a lasting resolution is uncertain. The balance of growth and price stability is improving but not resolved from a policy perspective, and we are entering a period of less transparency from the Fed. To that end, we enter the back half not overly defensive, but with key positioning themes focused on income carry, diversification, and risk rotation rather than risk-off positioning. Income carry, in a world with fewer bargains but higher yields, is a key theme for the back half. Rate pressures will linger, but attractive yields keep the table set for solid forward returns for core fixed income. Within fixed income allocations, we continue to drive excess yield through sector selection, with a higher-quality bias. We retain a large allocation to agency MBS, which improves portfolio quality and provides dry powder in any spread-widening scenarios. In broader allocation strategies, we continue to hold an equity overweight, reflecting medium‑term upside potential, but we have increased diversification in other sectors, such as banks and healthcare, as offsets to AI- and tech-related volatility and concentration.
Equities vs. Fixed Income
We carry an overweight in equities vs. fixed income. Given our base case that the U.S. will avoid a recession and benefit from strong earnings and an AI-driven spending cycle, we see relative upside potential in equities compared to bonds.
| Equity | View | Reasoning |
|---|---|---|
| US Equities | Positive | We carry a modest overweight in U.S. equities relative to international markets. The U.S. continues to have larger near-term tailwinds with a stronger earnings outlook, capex trends, and economic momentum. Stretched valuations vs. most other regions and policy uncertainty keep our overweight small. |
| Developed International | Negative | After a strong start to the year in developed markets, we moved to an underweight, seeing better risk/reward in the U.S. Despite progress with Iran, Europe and other energy importers will likely feel the Q1 energy shock drag longer than the U.S. Additionally, core Europe has less technology and AI exposure, limiting earnings growth and margin expansion relative to the U.S. |
| Emerging Markets | Neutral | We maintain a neutral allocation to EM as valuations are attractive and there is growth upside in India and parts of Asia and LATAM. This is countered by structural weakness in China and elevated macro and geopolitical risks globally. |
| Style/Sector/Factor | Large Cap | In addition to tilts toward large-cap growth sectors, we carry increased exposure to banks, industrials, and healthcare, where improving earnings breadth, attractive relative valuations, and diversified return drivers provide a compelling complement to technology and AI-related exposures. |
| Fixed Income | View | Reasoning |
|---|---|---|
| US Treasuries | Underweight | We are underweight Treasuries overall, with a tilt toward long-end curve exposure. Longer duration Treasuries provide an offset to our spread overweight and help us maintain an overall long duration posture at the portfolio level. The hawkish pivot recently has caused more movement at the front end of the curve, and we remain convinced in carrying a long duration position as inflation fears fade. |
| Investment Grade Credit | Market Weight | Market weight-type exposure still makes sense in IG credit given strong fundamentals and demand for yield, but full valuations. Rather than take a large overweight in IG spread risk, we continue to enhance our spread overweight position and overall yield with non-core sectors and increased MBS exposure. |
| Securitized | Positive | We continue to like the agency mortgage sector from both a relative value and macroeconomic standpoint. Mortgages offer attractive yields to Treasuries and IG credit without the credit risk and should benefit from lower rate volatility. We have increasingly skewed exposure toward actively managed ETFs as issuer and structural selection are an important excess return driver within securitized markets. |
| Non-Core Fixed Income | Positive | We believe a moderate allocation to non-core assets is appropriate to diversify sources of yield and return. Given tight U.S. credit spreads, we have less high yield and loan allocations in favor of increased preferred stock and high-income securitized exposure. |
Illustration of Themes – What Matters in 2026
Let Income Work for You and Don’t Fear Duration
Our base case for the back half of the year calls for range-bound rates at slightly higher levels, reflecting an environment of still-muted core inflation dynamics, easing energy-related pressures, and firm growth but with pockets of weakness. That view reinforces our income-driven return theme for core fixed income — strong carry at this higher base level provides meaningful cushion and attractive return potential through the back half. At the index level, yields are almost 3x higher than they were at the end of 2021, and duration is a year shorter.
Balancing Risk: Equity Overweight but AI Offsets
We see further upside in equities going into the back half of the year, but we also expect a bumpier road ahead given lofty valuations, questions around AI monetization, and geopolitical uncertainty. Our positioning reflects the upside potential, with an overweight to equities vs. fixed income and a modestly above-benchmark beta within our equity allocations. At the same time, we have broadened portfolio exposures as market concentration and valuation disparities have increased. We carry increased exposure to banks, industrials, and healthcare, where different return drivers provide a compelling complement to technology and AI-related exposures. These sectors have provided strong excess returns vs. the S&P this year.
