After a volatile start to the year, financial markets rebounded during the second quarter as corporate earnings continued to come in stronger than expected and concerns surrounding the conflict with Iran eased. While international markets have produced the strongest returns so far this year, U.S. technology stocks and small-cap companies led market gains during the quarter.
At the beginning of the year, many investors expected the Federal Reserve to lower interest rates several times in 2026. Those expectations have shifted considerably, with financial markets now reflecting the possibility of additional rate hikes before year-end, though our outlook remains unchanged. Unless economic conditions change meaningfully, we believe the Federal Reserve is most likely to leave interest rates unchanged for the remainder of the year.
Economic Outlook
Our view of the economy remains largely the same. We continue to believe the U.S. economy is in the middle-to-late stages of the business cycle, which supports maintaining a well-diversified portfolio with a modest emphasis on value-oriented investments.
Although market volatility has made valuations of U.S. large-cap stocks somewhat more attractive, they remain above long-term historical averages. As a result, we believe future stock market gains will depend more on continued earnings growth than on investors simply paying higher prices for stocks. Encouragingly, corporate earnings have remained resilient and continue to provide an important foundation for the market.
Inflation and the Labor Market
Inflation has continued to move closer to the Federal Reserve's long-term target, although certain areas— including housing, dining, recreation, and the effects of tariffs—continue to keep price pressures somewhat elevated.
The labor market has cooled from the exceptionally strong conditions of recent years but remains fundamentally healthy. Unemployment remains relatively low, hiring has slowed, and layoffs continue to be historically modest. Many businesses are focusing on improving productivity and investing in artificial intelligence rather than significantly expanding their workforce, which has helped support healthy corporate profit margins.
Consumer Spending Remains a Key Strength
Consumer spending continues to be one of the primary drivers of economic growth. While higher-income households account for a growing share of spending, overall consumer finances remain in good shape. Household debt payments remain well below historical averages relative to income, despite gradually increasing over the past several quarters.
Although delinquency rates have risen in areas such as credit cards, auto loans, and student loans, these increases have remained relatively contained and have not significantly affected overall consumer spending. Taken together, these factors continue to support our expectation of slower—but still positive—economic growth rather than an imminent recession.
Portfolio Positioning
We made very few changes to our equity allocations during the first half of the year. Our balanced approach and modest value tilt continued to perform well during both the first-quarter market pullback and the second-quarter recovery.
International Markets Continue to Offer Opportunity
International equities remain one of our highest-conviction investment areas. Developed international markets continue to benefit from attractive valuations, improving corporate earnings, supportive fiscal policies in Europe, and ongoing corporate governance reforms in Japan.
Emerging markets have also continued to perform well, supported by stronger corporate earnings and improving domestic economic conditions. We believe both developed international and emerging market stocks continue to offer attractive long-term return potential compared with current U.S. market valuations.
Despite ongoing geopolitical headlines, we are not making broad portfolio changes based on short-term events. International investments have continued to provide valuable diversification, and we have modestly increased our allocation to emerging markets to reflect our long-term conviction.
Fixed Income Outlook
Our outlook for fixed income remains largely unchanged. The Treasury yield curve has continued to normalize, while the 10-year Treasury yield has remained within a relatively narrow range. Although interest rate expectations have shifted throughout the year, we continue to believe the Federal Reserve is likely to keep rates steady through year-end.
Credit conditions also remain healthy. Investment-grade and high-yield bonds continue to benefit from low default rates and relatively strong corporate fundamentals.
Given today's attractive income opportunities, we continue to favor a shorter-than-benchmark duration while emphasizing higher-yielding and strategic income investments. We believe investors are currently being better compensated through higher yields than by extending maturities into more interest rate-sensitive bonds.
Looking Ahead
Overall, our portfolios remain positioned close to their long-term strategic allocations. While the economic backdrop remains constructive, we recognize that markets may experience periods of volatility during the second half of the year as investors monitor developments surrounding the conflict in Iran, Federal Reserve policy, and the upcoming U.S. midterm elections.
As always, our focus remains on maintaining disciplined, diversified portfolios designed to help clients achieve their long-term financial goals, rather than reacting to short-term market fluctuations.