The second quarter proved positive for investors, as most saw gains. Equities delivered double-digit gains, while bonds posted moderate, yet positive, returns. Some of the favorites from the first quarter, namely oil and gold, experienced price reversals and finished the second quarter in the red. Overall, investors emerged with more comfort in the economy, more confidence in the market, and a little less ambiguity around ITAP (Iran, Tariffs, Artificial Intelligence, Private Credit) concerns.
ECONOMY
The U.S. economy continues to chug along, and if anything, it picked up the pace during the second quarter. The two drivers of this were indiscriminate consumer spending spurred by larger tax refunds and insatiable spending on AI data centers and infrastructure. We identified both as key tent poles for the economy in 2025, and they have only strengthened in 2026, now becoming foundational pillars.
Despite elevated gasoline prices, consumers continued to spend. Tax refunds, which averaged 11%¹ more than last year, helped drive elevated consumption. While spending growth among higher-income consumers continues to outpace that of middle- and lower-income consumers, spending across all cohorts accelerated. As the second quarter came to a close, the personal savings rate stood at 3.0%, well below this century's average savings rate of 5.7%². This suggests the pace of consumer spending is unsustainable, and we'd expect spending levels to moderate in the second half of 2026, particularly as tax refund balances begin to dry up.
MARKETS
After declining during the first quarter following the war in Iran, stocks rebounded strongly in the second quarter, with the S&P 500 appreciating 15.2%. Across nearly all segments of the equity market, returns were up double digits. Bonds were also positive, although a more muted +0.7% return for taxable bonds is less electrifying.
The rebound in equities came as a result of stronger-than-projected first-quarter financial results and even stronger expectations for the pace of corporate earnings growth in the quarters and years to come. Coming into the second quarter, expectations were for S&P 500 components to report average earnings growth of 17%. By quarter's end, expectations were at 24%, with the upside almost entirely driven by energy and semiconductor companies. The energy sector has benefited from higher oil prices, while insatiable demand for memory and computing capability has fueled the semiconductor industry.
AI model development and user adoption have created a dynamic in which the current demand for computing outstrips supply. This is not uncommon for semiconductor companies, as the industry has always had a degree of cyclicality: periods of insufficient supply, followed by periods of excess. What has given us and the broader market greater conviction is that this doesn't appear to be a short-term cycle. Many semiconductor companies are discussing backlogs extending beyond 2027, and some are now entering into multi-year production contracts. For a sector notorious for its cyclicality, it seems that, at least in the intermediate term, this is not an overarching fundamental risk for investors.
This combination of a strong economy, improving corporate conditions, and expectations that the current climate will persist for at least the next few years gives us confidence in current equity conditions. The strong rally in stock prices during the second quarter, however, has adequately priced in many of these positives.
We do worry about market concentration, which has shifted from large tech companies (the Magnificent 7) to semiconductor companies in the recent quarter. This could create pockets of volatility along the way as investors adjust their positions, though we feel comfortable that the economic backdrop will provide strong support for stock and bond prices.
LOOKING FORWARD
The U.S. economy not only remains steadfast, but we've seen signs of economic momentum broadening beyond AI and higher-income consumer spending. We believe this backdrop is supportive of stocks, although, given that stocks remain priced at above-average valuations, we expect returns to moderate relative to those seen in recent years. We expect AI-related technology companies to remain the focal point for investors. However, we expect the market to evolve over the next 12-36 months as we foresee a shift in emphasis away from stocks tied to AI infrastructure toward those companies that are AI users and beneficiaries of the technology.
The investment opportunities can range from financial companies that enhance the productivity of back-office functions to healthcare businesses that become more efficient with their R&D funding. This evolution will take time and be uneven. However, with our forward-looking lens, we will seek opportunities to lay the foundation in portfolios, gradually adjusting toward AI beneficiaries as we navigate the path ahead.
Given the sharp surge in semiconductor stock prices this past quarter, we have heard from clients asking whether we are in a market bubble. This is a fair question, and it is increasingly debated in the press. Bubbles often arise from excessive valuations and over-concentration among investors in a specific market segment. As it pertains to valuation, while valuations are above average, they aren't at extreme levels. In fact, we've seen valuation multiples in the broader market decline in 2026 as earnings have improved faster than stock returns.
We believe market valuations are far from levels that would concern us about bubble territory. In reference to the second consideration, concentration, there are elements of growing concentration in the market.
For years, investors have been increasingly allocating to technology-oriented companies. As a result, technology's representation in the S&P has increased. We are more attuned to the level of concentration, but we also see it supported by companies with improving earnings growth and sound underlying business fundamentals. As such, we don't see the level of concentration as an indication of a bubble, but do see it as a risk factor that could lead to episodes of increased volatility as concentration levels unfold.
CONCLUSION
The second quarter of 2026 experienced a positive rebound, fueled by an improving economy and more upbeat expectations out of energy and semiconductor companies. Our comfort in the economic backdrop, along with attractive multi-year investment opportunities, leaves us optimistic about the investment prospects ahead.
What's unique at this point is that the typical economic cycle is being further complicated by secular trends in AI, as well as geopolitical undertones. These additional considerations increase the complexity of portfolio management, which becomes even more multifaceted when taxes are involved. In such an environment, we believe it's important to lean into tailoring our clients' portfolios to their specifications, helping bring purpose to their investments. If you wish to discuss our views in greater detail, please reach out to your Composition Wealth Advisor.
[1] Source: Internal Revenue Service, as of April 17, 2026
[2] Source: Bureau of Economic Analysis, FRED Database - St. Louise Federal Reserve. As of June 30, 2026.
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