The year, so far, has delivered two very different market environments. 2026 began with expectations of moderating inflation, lower interest rates and strong earnings-driven equity returns. Instead, the first quarter brought rising Treasury yields, persistent inflation, renewed trade-policy uncertainty and the outbreak of war involving the United States, Israel and Iran.
The rise in energy prices, largely driven by the war, complicated the outlook for inflation and monetary policy. Expectations for multiple Federal Reserve rate cuts faded, Treasury yields increased, and the possibility of the Fed increasing rates became a concern. Those higher rates had a greater impact on growth stocks whose valuations were more dependent on future earnings.
Importantly, though the S&P 500 returned -4.4% in the 1st quarter, the was not driven by falling earnings. It was largely a repricing of what investors thought those earnings were worth. And while much of the economic data was mixed, the underlying economy performed better than many had feared. GDP in the 1st quarter rose at a 2.1% annual rate, up from 0.5% in the prior quarter. Despite the tech sell off in the stock market, information technology and related capital spending – especially that associated with artificial intelligence (AI) – led the economy. At the same time, consumer spending expanded at a much slower pace. Still, the underlying economy remained relatively resilient.
The ensuing months reversed much of the market damage that occurred in the first quarter. Economic growth and corporate earnings held up better than feared, oil prices retreated from their wartime highs, progress toward a U.S.-Iran ceasefire improved sentiment and enthusiasm surrounding AI infrastructure returned with considerable force.
By July 31, the S&P 500 had returned 10.1% for the year, while the Nasdaq Composite returned 9.53%. In essence, the first seven months of 2026 was a period in which expectations were reset, tested and then rebuilt.
Inflation became one of the most important differences between the first and second quarters. In the first quarter, inflation was broad, with tariffs still impacting prices. Services inflation accelerated, as demand remained robust. Energy impacted inflation towards the end of the quarter. In the second quarter, the breadth in inflation subsided, with energy being the main driver. During April and May, energy prices accelerated, while they fell in June as the war in Iran subsided.
Looking more specifically at the 2nd quarter, we can see several developments. Economic growth remained positive. Corporate earnings exceeded expectations. A recession did not materialize. Oil prices declined from their peak – though they rose in July with renewed hostilities. Investors also returned aggressively to companies involved in AI hardware, semiconductors, memory, data centers and related infrastructure.
By June, concerns about the size and profitability of hyperscalers had reappeared. The S&P 500 and Nasdaq both declined in June and July despite their exceptionally strong second-quarter returns. AI remained the most important investment theme, but the debate evolved from whether AI would create significant economic value to which companies would capture that value—and whether current valuations already assumed too much of it.
The shift was dramatic. While the Philadelphia Semiconductor Index recorded its strongest quarter on record, the AI trade was not uniform. Semiconductor and infrastructure suppliers substantially outperformed many of the large technology platforms financing the AI buildout. The “Magnificent 7” declined as a group during the first half, while several chip and memory companies produced extraordinary gains.
The good news for investors was that investment returns were broad in the first 7 months of 2026 with the Equal Weighted S&P 500 returning 13.2%, outperforming the S&P 500. The biggest reason for this outperformance was the weak performance of the Magnificent 7 tech stocks which dominate the weighting of the S&P 500.
The first 7 months of 2026 demonstrated that markets can absorb geopolitical and economic shocks when earnings remain intact and investors believe those shocks will eventually moderate. That resilience should not be mistaken for immunity. Several issues are likely to determine market performance during the remainder of 2026:
The Fed will need evidence that inflation is declining sustainably before it can consider easing policy. Energy, tariff or demand-driven inflation could keep interest rates elevated or lead to renewed tightening. The breakdown in the cease fire in Iran is already shifting the economic and inflation outlook for the rest of the year. We have no way of predicting the outcome, nor do we know how long the conflict will impact the economy and markets. But this is one more hurdle for the Fed and markets to negotiate.
At the same time, stock valuations increasingly require more than positive earnings growth. Companies will need to meet high expectations, maintain margins and demonstrate that capital expenditures—particularly AI-related spending—are producing measurable returns.
Another question is consumer demand. Employment remains positive, but slower hiring, a low saving rate, and elevated prices leave consumers vulnerable to another shock. While we don’t subscribe to the direst warnings regarding AI related layoffs, we have no doubt that there will be some disruption. The question is will the actual disruption and fear of disruption impact consumer behavior.
And let’s not forget that though tariff uncertainty has diminished it has not disappeared. Meanwhile, government borrowing requirements, rising interest expense, and the supply of Treasury securities may also keep longer-term yields elevated even without additional Fed tightening.
Our final thoughts are that despite all the uncertainty, opportunities remain plentiful. But selectivity, diversification and a disciplined focus on earnings and cash flow are critical. The market may continue to rise, but the second half is likely to reward companies that can deliver measurable results rather than those supported primarily by narrative and expectations.
Past performance does not guarantee future results. Pinnacle Capital Management is an SEC Registered Investment Advisor and proud member of the Pinnacle Family of Companies, an organization designed to provide a full range of financial solutions to individuals, businesses, and institutions. For more information on our member companies, visit Pinnacle-LLC.com. Opinions are our own and do not constitute financial advice. Talk to your financial professional for any advice specific to your situation.