Investors have a lot on their minds as we move into the second half of 2026. Inflation remains above the Federal Reserve's target, but the economy continues to grow and corporate profits are strong. The S&P 500 is up around 10% year-to-date, with gains finally expanding beyond the largest technology companies. We see this broadening as a healthy development for the market, and it suggests investor confidence is extending across a wider range of industries.

The gains in the stock market have been supported by very strong corporate earnings. At the start of the second-quarter earnings season, analysts expect S&P 500 earnings to jump roughly 24%. That would be a second consecutive quarter of growth above 20%. Energy, Technology, and Materials are expected to see the largest growth. Reports early in the earnings cycle have generally exceeded estimates, helping validate the market's strength. Banks and other financial companies kicked off the season with great results. Valuations are a little above long-term averages, with the S&P 500 trading at a forward price-to-earnings ratio of 20.5 compared to its 10-year average of 19.0, though upward revisions to earnings have brought the forward multiple down since the start of the year.

The overall economy is holding up. Real GDP grew at a 2.1% annual rate in the first quarter, while consumer spending continued to support growth. Excluding gasoline stations, June retail sales rose 0.7% from May and 5.7% from a year ago. Business surveys also remained positive, with both the manufacturing and services indexes above the 50 level that signals expansion. The labor market has cooled but remains stable, with unemployment at 4.2% in June and wage growth moderating to 3.5%.

Higher oil prices are causing economic uncertainty and short-term inflation risk. Brent crude averaged $85 per barrel in June, down $22 from May. This welcome decline helped pull headline inflation lower. Oil prices, however, moved back into the mid-$80s as geopolitical tensions in the Middle East resurfaced. A temporary rise in oil prices would have little effect on the broader economy. But if prices stay elevated, that will weigh on household budgets, transport costs, and corporate profit margins. It will also make the job of central bankers much harder, even if longer-term inflation expectations remain contained.

The good news is that the June inflation report was not as bad as many feared. The Consumer Price Index (CPI) fell 0.4 percent for the month, largely due to falling energy prices, while the core index, which excludes food and energy, was unchanged. Headline CPI climbed 3.5% during the past year and core CPI rose 2.6%. The cooling trend could ease some of the immediate pressure on the Federal Reserve to raise interest rates, although a renewed rise in oil prices could complicate that outlook going forward.

The Fed left the federal funds target unchanged at between 3.50% and 3.75% at its June meeting. Their median year-end forecast now stands at 3.75%. The Fed also released updated Summary of Economic Projections for 2026, including 2.2% economic growth, 4.3% unemployment, 3.6% headline PCE inflation and 3.3% core PCE inflation.

Newly appointed Federal Reserve Chairman, Kevin Warsh, delivered his first semiannual testimony on monetary policy, speaking before the House Financial Services Committee and the Senate Banking Committee. Warsh emphasized that the central bank will remain strictly independent in setting monetary policy, unswayed by political pressures. He made it clear that the Federal Reserve will not tolerate persistently high inflation and that achieving the right monetary policy is their clear and constant goal.

Chairman Warsh also outlined a broader vision for institutional reform, announcing the creation of five distinct task forces. These groups will conduct comprehensive reviews of Federal Reserve communications, balance sheet policy, economic data gathering, productivity and jobs, and the underlying inflation framework. The review of communications appears likely to result in less forward guidance and fewer efforts to shape market expectations between official meetings. Markets may have to get used to fewer advance warnings on policy decisions.

Warsh spoke about the huge impact of technological progress on the economy. During his testimony, he pointed out that high-tech spending increased close to 25% during the last year, noting that what we now call artificial intelligence (AI) investment will very soon just be considered normal business investment. This massive adoption of AI could raise the overall speed limit of the economy. Faster productivity growth could also buy the Fed more time to determine inflationary trends, rather than feeling the need to act right away with higher rates.

The Treasury curve in the bond market has returned to its normal upward slope. Recent yields have been around 4.2% on the two-year Treasury, 4.3% on the five-year, 4.6% on the ten-year, and more than 5% on the thirty-year. Perhaps more notable, real yields on Treasury Inflation-Protected Securities (TIPS) currently offer about 2% over inflation at five years, 2.3% at ten years, and nearly 2.9% at thirty years. Implied inflation expectations are in the 2.2%-2.3% range across maturities, well within the range that suggests inflation is not the bond market’s main worry for the long term.

A real return approaching 3% changes the competition for capital in a fundamental way. Treasury securities now offer a meaningful real return, without the business risk of equities or private investments. There are two ways to interpret this dynamic. The optimistic view is that investors are looking for stronger productivity and better real growth, driven by the take-up of AI. If AI boosts the return on capital, firms could potentially invest profitably even at higher interest rates. A less favorable explanation is that fiscal pressures are producing an oversupply of debt. Large deficits require significant Treasury issuance, and investors are demanding a higher premium to absorb that supply.

Despite the uncertainty, the fundamental drivers of long-term returns remain largely unchanged. Strong companies with durable cash flows, reasonable debt levels, and the ability to manage higher costs should continue to be rewarded over time. Markets may react sharply to individual inflation reports, geopolitical headlines, or Fed commentary, but long-term results are more likely to depend on earnings, valuation, and the discipline to remain invested through periods of uncertainty.

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The commentary is excerpted from the issue of the Investor Advisory Service newsletter published at the end of July 2026. To receive commentary like this in a timely matter and receive actionable stock ideas each and every month, subscribe today. The Investor Advisory Service stock newsletter was named to the Hulbert Investment Newsletter Honor Roll for the 16th consecutive year for outperforming every up and down market cycle since 2007.

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