ECONOMIC HIGHLIGHTS

• Equities ended the quarter with an extended and powerful, multi-week rally.  The S&P 500 was up approximately 15% in Q2, one of the strongest midterm-election-year quarters on record. This resilience is due to strong earnings growth, easing concerns about Iran, and continued AI-related capital spending.
• The U.S. economy remains in expansion mode, supported by business investment, AI-related capital spending, improving manufacturing activity, and a healthy labor market.
• This continues to look more like a capex-driven cycle than a consumer-driven cycle, with corporate investment carrying much of the economic growth burden.
• Market leadership is beginning to broaden beyond the largest technology companies, a constructive development for the durability of the bull market.
• Inflation pressures appear to be easing as oil prices retreat from recent geopolitical highs, supporting the view that headline inflation may be nearing a peak.
• Wage growth remains contained near 3.5%, while market-based inflation expectations remain well anchored.
• The June employment report showed slower job growth, but unemployment declined to 4.2% and jobless claims remain low, suggesting labor market conditions remain broadly healthy.
• Corporate earnings expectations continue to move higher with expectations for over 20% y/y growth, supported by strong profit margins, productivity gains, and ongoing AI investment.
• Credit markets are not signaling economic stress. Investment-grade spreads, private-credit proxies, and technology-sector credit metrics remain relatively stable.
• Internationally, technology-oriented economies such as Taiwan, Japan, and South Korea continue to benefit from strong semiconductor and AI-related demand, while China remains a notable area of weakness.
• Key risks include renewed geopolitical tensions, persistent housing weakness, elevated fiscal deficits, and increasingly leveraged investor positioning beneath an otherwise calm market backdrop.

China Remains the Largest Global Weak Spot: Chinese consumer confidence remains subdued, business sentiment has weakened, and foreign direct investment trends remain challenging. Economic momentum remains considerably weaker than in most developed-market economies.

Manufacturing has become a bright spot: After several years of sluggish activity, U.S. manufacturing has shown meaningful improvement in 2026. ISM manufacturing surveys remain in expansion territory, industrial production has improved, and factory order activity continues to benefit from AI investment and reshoring initiatives.

Consumer Spending Continues to Hold Up: Although confidence measures remain weak, actual spending has proven resilient. Rising bank deposits, tax refunds, and improving labor market conditions have helped support household spending.

Bottom Line: The United States continues to benefit from robust business investment and AI-related spending, while technology-focused export economies are performing well. Housing activity and the Chinese economy remain notable areas of weakness. Overall, conditions remain consistent with slower but positive economic growth.

Labor Market no Longer Driving Inflation Risk: Wage growth has remained near 3.5% year-over-year, a level that appears more consistent with stable inflation. Slower hiring and moderate compensation trends reduce the likelihood of a wage-price spiral.

Market Appears More Hawkish Than the Fed: Interest rate futures continue to price a more aggressive path than many policymakers currently project. Strategas continues to favor a prolonged pause as inflation trends improve.  Balance sheet policy remains important:  Fed balance sheet expansion has contributed to stronger liquidity and deposit growth. In the longer term, policymakers continue to debate ways to reduce balance-sheet dependence while maintaining financial system liquidity.

Chair Kevin Warsh has highlighted the potential role of regulatory reform and balance-sheet normalization in improving the effectiveness of monetary policy. These discussions are expected to remain an important theme through 2027.

Financial Conditions Have Tightened Modestly: Higher yields and fewer expected rate cuts have tightened financial conditions compared with earlier in the year. Even so, credit spreads and broader financial conditions remain far from recessionary levels.

Bottom Line: Inflation appears to be moving in the right direction, while growth remains positive. Unless energy prices reaccelerate materially, the most likely outcome remains an extended Federal Reserve pause rather than a return to active rate hikes. Lower oil prices, moderating wage growth, and anchored inflation expectations have strengthened the case that headline inflation may be nearing a cyclical peak. Commodity markets remain among the most important variables for the inflation outlook.

Profit Margins Remain Near Record Levels: Despite concerns surrounding tariffs, labor costs, and geopolitical developments, corporate profit margins remain exceptionally strong. Forward operating margins for the S&P 500 remain near historical highs, reflecting pricing power, productivity improvements, and disciplined expense management. Elevated margins have allowed many companies to absorb cost pressures without materially impacting profitability.

AI Spending Continues to Support Corporate Results: Artificial intelligence remains one of the most important profit drivers across corporate America. Large technology companies, cloud providers, semiconductor manufacturers, and infrastructure suppliers continue to invest aggressively in data centers, computing power, networking equipment, and related technologies. Demand continues to outpace supply in many areas of the AI ecosystem, supporting revenue growth and earnings expansion.

Capital Spending is Supporting Productivity Gains: Unlike prior cycles that relied heavily on consumer demand, the current expansion is increasingly supported by business investment. Spending on technology, automation, manufacturing facilities, and infrastructure can improve productivity and offset rising labor and input costs. These investments provide an important foundation for sustaining profit growth even as economic growth moderates.

Credit Markets Continue to Support Corporate Activity: Corporate credit markets remain remarkably stable despite concerns about private credit, elevated government borrowing, and higher interest rates. Investment-grade spreads remain tight, credit dispersion is contained, and sector-level bond markets show little evidence of widespread stress. Healthy credit conditions continue to support capital investment, refinancing activity, and shareholder return programs.

Manufacturing Recovery is Becoming More Meaningful: Several previously weak areas of the economy, including manufacturing and industrial activity, have shown signs of improvement in recent months. Improving factory activity, stronger order backlogs, and increased spending on equipment and technology are helping support earnings growth outside of traditional technology sectors. Broader participation in profit growth is a constructive sign for the durability of the current expansion.

Earnings Growth Remains Inconsistent with A Recessionary Environment: historically, recessions are typically accompanied by deteriorating earnings expectations, widening credit spreads, and contracting profit margins. Current conditions show the opposite trend. Earnings estimates continue to rise, margins remain elevated, and credit markets remain constructive. While economic growth is slowing, corporate profitability data continues to support a base case of continued expansion rather than a recession.

Bottom Line: Corporate America remains a pillar of the economy and financial markets. Strong earnings growth, elevated margins, healthy credit conditions, and ongoing capital investment are helping businesses absorb economic, political, and geopolitical pressures. While growth is likely to moderate from recent highs, current profitability trends remain broadly supportive of continued economic expansion and favorable long-term market fundamentals.