Broadening Trade Returns as Conflict Eases. Can It Outlast a Hawkish Fed and Fading Liquidity?

First Half of 2026 Sees a Shift in Leadership

Despite conflict in the Middle East, sharp oil price swings, and resurging inflation concerns, equity markets posted positive returns in the first half of 2026 amid de-escalating geopolitical risk, strong corporate earnings led by the AI infrastructure buildout, and a still-resilient economy. The Nasdaq-100 Index and S&P 500 Index recovered sharply within the period, each rallying over 32% and 18%, respectively, since the March lows. Notably, US small-caps via the Russell 2000 Index saw their strongest first half since 1991, gaining over 22%. US mid-caps (17.4%) and international developed equities (15.1%) followed. Bonds mostly fared well as high yield credits rose 1.9%, municipal bonds gained 1.8%, and Treasury Inflation Protected Notes were up 1.2%. Aside from silver (-17.0%) and gold (-7.0%), commodities posted positive returns as crude oil surged 53.9% and broad-based commodities rose 14.4%.

Fed Holds, Warsh Signals Less Guidance

The Federal Reserve held the federal funds rate steady at the June FOMC meeting, keeping the target range at 3.50–3.75%. This marks the 4th consecutive hold in 2026 and was the first meeting chaired by Kevin Warsh, who succeeded Jerome Powell as Chair. While the decision to hold was widely expected, the accompanying communication shifted in a more hawkish direction. The policy statement was shortened to roughly 130 words from 341 in April, removed prior language signaling a bias toward future cuts, and emphasized that the Committee “will deliver price stability.” Consistent with his prior skepticism of forward guidance, Chair Warsh also declined to submit his own projection in the dot plot. The economic backdrop offered little reason to ease, as May PCE rose 4.1% year-over-year, its highest reading since April 2023, while Nonfarm Payrolls remained firm at 172,000 and the unemployment rate held at 4.3%. The updated Summary of Economic Projections reflected the shift, with nine of eighteen officials now penciling in at least one 25 bps hike in 2026 and six projecting at least two, lifting the median year-end funds rate forecast to 3.8% from 3.4% in March and reversing the cut previously expected. Looking ahead, market pricing via the CME FedWatch Tool implies another hold at the July meeting, with the next move now priced as a hike rather than a cut.

Equal Weight and Small-Caps Regain the Lead as War Tensions Ease

History shows that the early stages of an earnings recovery have often favored the broad market over the largest stocks. As Exhibit 2 illustrates, coming out of past earnings recession troughs (shaded), the equal weigh S&P 500 has tended to outperform its market-cap weighted counterpart, while small-caps, as represented by the Russell 2000, have often outperformed large-caps, with each red arrow marking one of these post-trough periods. The current cycle initially mirrored that pattern, as the average stock outperformed from late 2025 into early 2026 following the trough in the 2022–April 2025 rolling earnings recession, before the Iran conflict disrupted the trend. As oil prices spiked and markets shifted from pricing additional rate cuts toward the possibility of renewed tightening, leadership reverted toward the largest AI-related companies, and from the March lows through May the cap-weighted index, supported by semiconductor strength, regained the lead. With shipping through the Strait of Hormuz resuming and oil prices returning close to pre-conflict levels, those headwinds have eased and signs of market broadening have re-emerged, with equal weight and small-cap indices outperforming again since the end of May. The move also has fundamental support, as the median S&P 1500 company is now growing earnings at a double-digit pace while sales are rising by roughly 7%. If policy rates have indeed peaked this year rather than moving higher, a corresponding decline in real rates could provide additional support for broader market participation.