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The second quarter of 2026 marked a sharp turnaround for markets. Major equity indices, including the S&P 500, Nasdaq and Russell 2000, delivered their strongest quarterly gains since 2020, driven by continued enthusiasm for artificial intelligence (AI), easing geopolitical concerns and shifting expectations for monetary policy.
Three themes helped fuel the market recovery in Q2 2026. Firstly, Artificial Intelligence (AI) continued to lead the market, supported by strong corporate earnings and sustained investment, reinforcing confidence in its role as an economic and market growth driver. Secondly, diplomatic progress in the Middle East, including the temporary resumption of shipping through the Strait of Hormuz, eased geopolitical tensions and improved investor sentiment. Lastly, markets began adapting to a new Federal Reserve Chair, Kevin Warsh, whose emphasis on inflation control led to a reassessment of future interest rate cut expectations. A positive sign was the broadening market participation, with small-cap stocks and emerging markets contributing to returns alongside large-cap tech, indicating a healthier market. Fixed income also saw positive, though more modest, returns.
Markets are currently evaluating the implications of a Warsh-led Federal Reserve, with the clear message being a priority on restoring inflation credibility. Recent inflation data is encouraging, suggesting a gradual moderation of price pressures. The current outlook predicts inflation to remain elevated but gradually ease over the coming months, with economic growth sustained above 2% and unemployment stabilizing near 4.3%. The Federal Reserve is expected to maintain its current stance as it assesses economic data, with potential interest rate cuts resuming in 2027. Geopolitical developments in the Middle East remain the primary source of uncertainty; a lasting resolution could accelerate inflation decline and boost global growth.
Higher oil prices present a manageable risk under current conditions, as the U.S. economy is less energy-intensive, benefits from being a net energy exporter, and is supported by strong consumer finances. However, extended energy supply disruptions or escalating regional tensions could alter the economic outlook. Concurrently, there's a constructive view on the AI investment cycle, not considering it a speculative bubble. While increasing debt for AI infrastructure needs monitoring, capital spending is driving significant earnings growth. AI-related investment is expanding beyond tech and semiconductor companies, creating opportunities in industrials, infrastructure, power, and real estate. As AI advances into robotics, autonomous vehicles, and AI-powered manufacturing, the scope of opportunities continues to broaden.
The outlook remains modestly positive due to strong earnings growth, broadening market leadership, ongoing AI investment, supportive fiscal policy, and improving labor market conditions. Investors should remain aware of risks such as renewed geopolitical tensions, inflation staying above target, and overvalued segments of the market. TD Wealth maintains a modest overweight in equities and a modest underweight in fixed income. Within fixed income, a preference is given to higher-quality sectors and a short-to-intermediate duration focus, considering inflation uncertainty and future Fed rate cuts. In equities, diversification is crucial, with opportunities seen in U.S. large-cap, small- and mid-cap companies, international equities, and emerging markets as market leadership expands.
The first half of 2026 underscored the importance of diversification and sustained investment. Despite ongoing geopolitical conflict, inflationary pressures, and evolving monetary policy expectations, markets demonstrated resilience. While volatility is expected to continue, maintaining diversification across both equities and fixed income, coupled with a focus on long-term investment objectives, remains fundamental to successful investing.
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