Commentary

 2026 Second Quarter Investment Report

After a brief decline in March following the outbreak of the Iran conflict, global stock markets rebounded quickly and posted strong gains in the second quarter. Emerging markets led the way, rising 24%, driven largely by strong earnings from chip manufacturing companies. U.S. and international developed market stocks also delivered double-digit returns. In fixed income markets, modestly higher interest rates as a result of higher gas prices weighed on bond performance.

Here is a summary of benchmark returns across the categories in our client portfolios:

One of the quarter's most notable developments was the speed of the market recovery. The S&P 500 Index regained its previous peak just 44 days after the Iran conflict began. This mirrors last year's rapid recovery following tariff announcements and highlights how quickly markets are looking beyond current events. In both cases, investors anticipated future economic and corporate earnings trends rather than waiting for new earnings reports or inflation data. These swift and largely unexpected recoveries reinforce the importance of staying invested rather than attempting to time market highs and lows.

While geopolitical events dominated headlines in the second quarter, corporate earnings remained the primary driver of stock market gains. At the start of the year, analysts expected U.S. companies to increase earnings by 13% in 2026. Those expectations have since risen to 22%, supported by growth in artificial intelligence and increasing productivity. In addition, 85% of companies exceeded earnings forecasts in the first quarter, the highest share since 2021. Strong earnings growth has helped lift stock prices without significantly increasing stock valuations.

Small company stocks have been the standout in the U.S. markets. The Russell 2000 Index, which tracks a broad array of small U.S. companies, has outperformed the S&P 500 by 12% this year, marking the highest level of relative outperformance since 2003. Yet again, earnings growth has been the main catalyst driving returns. Analysts expect small company earnings to grow 54% this year, which is more than double the projected growth rate for large companies. Encouragingly, the rally has been broad-based, with roughly two-thirds of Russell 2000 stocks trading above their 50-day moving average.

Chip manufacturers have also benefited from rising demand tied to artificial intelligence. Taiwan and South Korea, which are both heavily exposed to the chip industry, have been major beneficiaries and key drivers of emerging market performance. Taiwan’s stock market is up 98% over the past year while South Korea’s is up 188%. As a result, the composition of the MSCI Emerging Markets Index has shifted significantly. Taiwan now represents 27.8% of the index and South Korea 23.7%, both surpassing China at 18.3% and India at 11%. China's weighting has fallen dramatically from 44% in 2020, illustrating how quickly market leadership can change. This underscores the value of maintaining diversified international exposure rather than trying to identify individual winners in specific countries.

In the bond markets, higher inflation drove interest rates slightly higher in the quarter, weighing on bond performance. The Consumer Price Index (CPI) rose by 4.2% year-over-year in May, which was its highest reading in years. This was largely due to a 40% increase in gas prices in the quarter. As a result, the bond market has shifted its outlook for interest rate changes by the Federal Reserve. Before the Iran conflict, bond markets expected two interest rate cuts later in 2026. Today, markets are pricing in no rate cuts and potentially one rate increase.

This quarter demonstrated how quickly market conditions can change, but it also reinforced the enduring principles of successful investing. Maintaining a disciplined asset allocation, staying broadly diversified across regions, sectors, and company sizes, and remaining patient through periods of uncertainty continue to be effective strategies. We remain focused on building portfolios that reflect these principles and are positioned to benefit from opportunities across an ever-changing market landscape.

Sincerely,

Your Harbor Group Team