After a turbulent first few months of the year, markets staged an impressive recovery in the second quarter. The S&P 500 returned 15.2%, bringing its year-to-date total return to 10.2%. As the quarter began, investors became increasingly optimistic that negotiations would eventually lead to an end to the conflict in Iran, easing concerns over a prolonged disruption to global energy markets. At the same time, enthusiasm around the artificial intelligence trade regained momentum and drove the rally, particularly among semiconductor companies. The Information Technology sector rebounded sharply, returning more than 30% after declining roughly 9% during the first quarter. Market leadership also broadened, with both small-cap stocks and emerging markets posting gains of more than 20% during the quarter. Energy was the notable laggard as expectations for an eventual easing of geopolitical tensions weighed on oil prices.
Semiconductor companies supporting the AI infrastructure buildout led market performance during the quarter. As spending on data centers, networking equipment, and computing capacity continues at an unprecedented pace, the market has become more focused on whether those investments will ultimately translate into stronger earnings growth. Companies supplying the hardware that powers AI have generally been the biggest beneficiaries, while those investing heavily in AI applications have seen more mixed reactions. This distinction between AI beneficiaries and AI spenders has become an important driver of market leadership and is likely to remain a key theme throughout the remainder of the year.
Treasury yields moved higher across the curve as investors priced in the inflationary impact of elevated energy prices following the disruptions to oil shipments through the Strait of Hormuz. While inflation readings have moved higher, the extent and duration of the upward pressure remain uncertain. Despite the rise in yields, the Bloomberg U.S. Aggregate Bond Index returned 0.67% during the quarter and remains slightly positive for the year.
The Federal Reserve entered a new chapter under Chairman Kevin Warsh, who took office in May. Earlier this year, markets anticipated interest rate cuts in 2026, but rising inflation coupled with a stable labor market shifted the conversation toward the possibility of rates remaining higher for longer, and even the potential for a rate hike should inflation prove more persistent. With the labor market remaining steady and monthly job growth healthy, the Fed has placed renewed focus on inflation before making any adjustments to interest rates. Recent data has been volatile, and it may still be too early to determine whether a lasting trend has emerged. A surge in investment for the AI infrastructure buildout, along with the lingering effects of tariffs, add additional layers of uncertainty to the outlook. As a result, we believe a wait-and-see approach remains the most likely course for the Federal Reserve at this stage.
Looking ahead to the second half of the year, the fundamental backdrop remains constructive. The economy continues to expand at a healthy pace, the labor market has remained stable, and companies are expected to continue generating solid earnings growth. Risks that will remain in focus include the lasting economic effects of the conflict in Iran, particularly its impact on inflation and the Federal Reserve’s response. However, recent data suggest price pressure may gradually ease as energy markets continue to normalize. Investors will also continue to scrutinize companies’ AI spending and their ability to generate returns on those investments. AI continues to influence a growing number of industries beyond Information Technology, making its impact increasingly broad-based. As adoption expands and investment continues, the sector’s performance will likely remain an important driver of both the broader market and the economy.