Markets spent the first half of 2026 climbing yet another wall of worry. Geopolitical conflict, inflation pressures, economic uncertainty, and rapid technological disruption dominated the news flow. Despite these concerns, investors who maintained their poise were rewarded as stocks rebounded sharply and opportunities emerged across a much broader set of asset classes than many expected.
The AI boom is reminiscent of past technological revolutions such as railroads, electrification, and the internet. While the long-term benefits may ultimately prove transformative, history suggests the path is rarely smooth. As the AI story continues to unfold, we believe discipline will become an even more important virtue for investment success.
Stocks rebounded in Q2 on AI and easing Iran conflict
The stock rally in Q2 rewarded investors who stayed patience through a start to the year that generated a growing list of potential concerns surrounding the Iran war and Artificial Intelligence (AI) disruption. History has shown that US stocks are quite adept at climbing that wall of worry. Yet not all segments of the market participated in the Q2 rebound.
The AI theme is moving forward at great speed, leaving a cast of winners and losers in its wake, which remains an important nuance to the rally. Technology hardware, like the semiconductor chips that power AI, are clear winners. The S&P 500 Semiconductors & Semiconductor Equipment industry is up 46% in the first half of the year. Software has not fared so well, as investors fear their products will be too easy to replicate with AI. The S&P 500 Software industry is down 20%.
Our preferred way to capture trends like AI are academically backed Momentum strategies. Rather than trying to capture some elusive unicorn, Momentum seeks to overweight investments that have shown a track record of outperformance in recent history. Funds, such as iShares’ USA Momentum Factor ETF (MTUM) and Vanguard’s US Momentum Factor ETF (VFMO), utilize this approach.
Chart 1: A tale of two quarters
Source: S&P 500 Index total return
Diversification benefits driven by Emerging Markets and Small Cap
US Large Cap stocks had a great first of the year by all objective measures. But the positive effects of the AI boom are being felt around the globe, particularly in Emerging Markets. As a result, diversification was a big positive.
Most notable among the Emerging Markest was Korea. The Korea KOSPI 200 index was up 110% in the first half of the year. It is a very concentrated index, with its two biggest constituents, Samsung and Hynix, accounting for over 50% of the market cap. Thanks to AI investments, those two stocks (in US dollar terms) were up about 160% and 280% in the first six months of the year.
Korea is a little over 20% of the MSCI EM index. The largest geographic exposure is Taiwan, at close to 30%. Over half that exposure is Taiwan Semiconductor, another AI benefactor.
Domestically, US Small Cap stocks provided additional diversification benefits, outpacing their Large Cap peers. While some AI sectors continued to boom, we also saw outperformance growing in more value-oriented spaces, like Small Cap.
Chart 2: Emerging Markets boosted by AI
Source: MSCI EM, KOSPI 200 total return
New leadership at The Fed faces challenging economic data
The Federal Reserve’s newly appointed leader is stepping into a difficult economic environment. Fed Chair Kevin Warsh began his term on May 22 and is confronting a combination that policymakers typically hope to avoid: rising inflation alongside slowing employment growth. While financial markets often focus on one side of the equation or the other, the latest data suggest challenges on both fronts.
Inflation has been trending higher for more than a year. Core inflation has officially broken above the 2.5% to 3.0% range that has defined the past few years, having steadily risen since its April 2025 low. Including food and energy, headline inflation has now moved above 4%.
At the same time, the labor market is sending mixed signals. The unemployment rate remains relatively low at 4.2%, suggesting overall labor market stability. However, growth in new jobs has slowed considerably, with year-over-year job creation hovering near zero. This combination of elevated inflation and weakening employment momentum could complicate the Fed’s policy decisions in the months ahead.
Warsh has signaled that his vision of the Fed is one of less guidance and communication which was evident in his first policy statement. The market seems content to give him the benefit of the doubt thus far.
Chart 3: The Fed’s new leadership faces rising inflation
Source: The US Federal Reserve, Bureau of Economic Analysis
Credit exposure most warranted at the short end of the curve
In the fixed income space, corporate bond spreads remain historically tight. This is a combination of a sanguine attitude towards corporate risk and a heightened concern about the rising US debt burden. As a result, investors are receiving relatively little additional yield for taking on credit risk. In this environment, U.S. Treasuries appear more attractive on a relative basis than they have during many periods over the past decade.
At the short end of the yield curve, we see the most favorable risk-reward tradeoff for credit risk. Over the past 15 years, when credit spreads have been near current levels, short-duration corporate bonds outperformed comparable-maturity Treasuries over the following year approximately 73% of the time. Even with tight spreads, the additional yield has historically been enough to overcome the modest level of credit risk involved.
The picture changes further out on the curve. As we get to intermediate duration investments (5-10 years and 7-10 years) when spreads have been this tight, corporate bonds have historically provided little advantage over Treasuries. Our study of the past 15 years shows that corporate bonds funds in those ranges, outperformed comparable Treasuries only 46% and 42% of the time, respectively, over the subsequent year. In other words, investors have not historically been rewarded for taking this credit risk.
Today’s bond market rewards selectivity. While credit risk can still add value, particularly in shorter maturities, investors are no longer being broadly compensated for extending that exposure further out the curve. In our view, this argues for a more deliberate approach to fixed income positioning, where credit risk is concentrated in areas with a favorable historical payoff and Treasuries play a larger role where the reward for additional risk appears limited.
Chart 4: Credit spreads historically tight
Source: Bloomberg, US Treasury. Spread between Corporate bond index and comparable Treasuries. For hit rates, 15 years of historical spreads are arranged in quintiles. The hit rate is the percent of time that credit outperforms Treasuries of the subsequent one year for the given quintile.
Factor roundup: A big half for US Value and Momentum
As evidence-based investors, we focus on investment factors that historically have outperformed the broader market such as Quality, Value, Momentum, Small Size and Minimum Volatility. Each plays an important role at different points in the economic cycle.
Looking at the US market, Momentum was the clear standout in Q2, rising 46.6%, while Value also delivered a very strong 41.5% return. Both factors benefited from a market environment that quickly shifted back toward optimism, helped by renewed enthusiasm around the AI buildout and a de-escalation in the Middle East.
On a full year basis, all factors, with the exception of Minimum Volatility, outperformed the broader market through the first half of the year. Minimum Volatility is built for stability, and will almost always lag in a risk-on upward trending market.
Chart 5: YTD 2026 factor roundup
Source: MSCI USA factor indices
A note on initial public offerings (IPOs)
The second quarter saw a resurgence in IPO activity, led by the highly anticipated debut of SpaceX and as well as Cerebras Systems. As we discussed in recent Insights articles, periods of intense enthusiasm often share common characteristics. Investors have a tendency to focus on the stories of spectacular winners while overlooking the much larger number of disappointing outcomes.
The evidence1 shows that IPOs as a group have historically underperformed the broader market, in part because public investors often gain access only after valuations have already been bid up. Time will tell how these two new issues play out, as well as additional IPOs to come (OpenAI and Anthropic are likely soon). We won’t be chasing these in our strategies. Instead, we’ll continue to focus on investments where the odds are more consistently in our favor.
1. Ritter, Jay R., “Initial Public Offerings: Updated Long-run Statistics,” University of Florida, Warrington College of Business (March 23, 2026).
“Happiness and freedom begin with a clear understanding of one principle: Some things are within our control, and some things are not.” — Epictetus
As I look back on the second quarter and first half of 2026, I am reminded how quickly market narratives can change. Just three months ago, investors were focused on geopolitical conflict, rising inflation, slowing job growth, and growing anxiety surrounding the disruptive impact of artificial intelligence. Today, many of those concerns remain, yet broad equity markets sit at new highs and investor optimism has returned.
That shift is a reminder of how difficult markets are to predict. The future rarely unfolds in the way consensus expects. Risks that seem obvious often fail to materialize, while the events that ultimately move markets tend to come from directions few anticipated. The first half of the year reinforced a lesson we have written about many times: successful investing depends less on forecasting and more on maintaining a disciplined process that can adapt to an uncertain future.
As we look toward the remainder of the year, there is no shortage of questions.
- Will inflation continue to rise?
- Can economic growth withstand higher prices and slower job creation?
- How much of the AI spending boom is sustainable?
- Will the recent wave of IPO activity mark the beginning of a new investment cycle or another period of excessive enthusiasm?
We do not pretend to know the answers… and we believe that gives us an edge. Once an investor acknowledges that the future is unknowable, they can focus their energy on finding other avenues to tip the scales in their favor. Our focus in the second half is as much about what we want to own as it is about what we want to avoid. Those include:
- Diversification (particularly away from sectors, like semiconductors, where valuations are looking stretched).
- Seeking proven factors such as stocks exhibiting Quality, Value, Momentum and Small Size characteristics.
- Avoiding the hype of IPOs. In aggregate, new issues have historically underperformed in the two years following their public debut.
- Avoiding other shiny objects that tend to abound in buoyant markets. Historical examples include cryptocurrency, NFT art and SPACs.
- Systematically selling high and buying low as markets shift through opportunistic rebalancing.
While we do not predict the future, history can often serve as a useful guide. This moment has many of the hallmarks of past technological revolutions such as railroads, electrification, and the internet. Thirty years on, the latter is still fresh in the minds of many investors. What these all had in common is that they were economically disruptive and experienced periods of overinvestment.
As the AI boom or bubble (whatever you want to call it) pushes onward, overinvestment seems inevitable. That doesn’t necessarily mean boom will lead to widespread bust. But there will almost certainly be busts in some segments of the market where enthusiastic investors got too far out over their skis. We see our role in this environment as helping investors stay grounded and avoid the temptation to chase the many fleeting “sure things” that will surface throughout this latest technological revolution.
As always, we are grateful for the trust our clients place in us and honored to have you all as part of our growing Strategic community.
About Strategic
Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on total client assets of over $3 billion, as of 6/3/26.
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