The Strategy Signal Quarterly Investment Report 3Q 2026

For those not familiar with Yogi Berra, he was a member of the New York Yankees from 1946 to 1963 and was the anchor of the Yankee’s mid-century dynasty. Yogi was a World series Champion, a league MVP, a perennial All-Star, and finally a Major League manager. But one of his most endearing qualities was his gift of language.

Yogi had a legendary knack for uttering unintentional, paradoxical, and amusingly confusing phrases that somehow made perfect sense to his listeners. These became known as “Yogisms.” It was said that Yogi once explained his habit by saying, “I really didn’t say everything I said.”

The quote attributed to Yogi that seems to fit best in today’s economic and investment environment is, “It’s tough to make predictions, especially about the future.” Early in 2026, market prognosticators missed the mark on quite a few predictions. Among them were the following:

• Rate cuts didn't happen. The consensus heading into January was for multiple Fed cuts in 2026 — many large investment firms were penciling in a June cut at minimum. The Federal Funds Futures now predict rate hikes over the next year.

• Inflation re-accelerated instead of cooling. The January consensus thinking was that core inflation was on a clear downward path toward 2%. Instead, headline CPI hit 4.2% year-over-year in May, and headline PCE ran at 4.1%.

• A Middle East conflict became the dominant macro variable. No major consensus forecast in January modeled a war with Iran and a prolonged Strait of Hormuz shutdown. The four-month conflict transformed a shipping disruption into a severe and lasting energy supply shortfall, upending inflation and growth forecasts globally. Crude oil prices, around the $60 per barrel level pre-war, rose dramatically after the start of the Iran War.

• Stocks recovered far faster than many expected after a correction. After the start of the Iran War in February, the S&P 500 bottomed at the end of March, then rose dramatically (18.57%) in the second quarter despite the ongoing conflict. In our Q1 Strategy Signal Report, we concluded, “Markets traditionally ‘look through’ short-term oil spikes and military conflicts and price in what the economic environment will be six months to a year out. We believe this time will be no different and we maintain our positive bias toward stocks.”

• The EM rally was really a semiconductor rally. Emerging markets rose ~24% YTD, but most of that came from just TSMC, Samsung, and SK Hynix. Broad EM as a diversification play did not materialize — it was a chip-stock story in disguise.

• AI capex remained unabated. Business investment in AI infrastructure was the single largest contributor to Q1 GDP growth — defying predictions that AI spending would slow as monetization questions mounted. Hyperscaler stocks like Meta, Microsoft, Amazon, and Alphabet went from leaders to laggards as investors began to worry about a possible AI “overspend.” Software stocks collapsed despite solid earnings reports due to AI disintermediation fears. The market essentially repriced the AI trade from "who is building AI" to "who benefits from the spending without bearing the capex risk." Chipmakers and memory suppliers captured the upside; the hyperscalers bore the cost and got punished for the uncertainty around payback timelines.

• The dollar strengthened instead of weakening. Many analysts entered the year bearish on the dollar and bullish on the euro. After the Fed's hawkish June shift, the dollar had its best single day in nearly a year.

The overarching theme:

The year started with an unusually comfortable consensus — soft landing, rate cuts, disinflation, and dollar weakness. The Middle East conflict was the exogenous shock that broke nearly all of it simultaneously.

However, markets staged an impressive rebound in the second quarter as a surge in tech-related corporate earnings growth combined with rising hopes for a U.S./Iran ceasefire to push stocks sharply higher, as the major U.S. averages hit new all-time highs.

In sum, the stock market completed an impressive rebound from the steep declines of late March, as much-better-than-expected earnings growth (powered primarily by AI-linked tech stocks), continued solid economic activity, and the signing of a U.S./Iran ceasefire helped send the S&P 500 to new all-time highs.

So where do we go from here?

In light of the on again, off again war with Iran, volatile fuel prices and their overall impact on inflation, and worries about the impact of AI overspending and fears of a bubble in technology stocks, I’ll discuss our take on the economy and markets for this year in the Outlook for the Rest of 2026 section of this report.

Second Quarter Performance Review

The gains in the S&P 500 in the second quarter were broad, but the impact of the AI boom was evident across and throughout markets.

• By market capitalization, small caps (Russell 2000) outperformed large caps thanks to a combination of strong economic growth (which can disproportionately benefit smaller company earnings), falling oil prices and the “trickle down” of AI optimism towards small-cap tech and AI infrastructure companies.
• From an investment style standpoint, growth outperformed value but not as much as one would think given the strength in AI-linked tech stocks in the second quarter. Growth styles benefited from a surge in AI infrastructure stocks such as memory and semiconductor manufacturers while value strategies received a boost from industrials.

• On a sector level, 10 of the 11 S&P 500 sectors finished the second quarter with positive returns. The best performing sector in Q2 was, by a very wide margin, the technology sector as it benefited from huge rallies in memory stocks such as Micron and SanDisk as well as continued gains in the semiconductor stocks. Industrials also logged strong gains as companies in that sector were poised to benefit from increased AI data center construction as well as more defense spending. Finally, real estate also posted strong returns on anticipated data center demand, as several tech and AI-linked REITs posted very strong gains in the second quarter.
  • Turning to the sector laggards, energy was the only sector to post a negative return for the quarter. The energy sector was pressured primarily by falling oil prices as they were sharply higher at the start of April before the U.S./Iran ceasefire process started. The communication services sector was the other clear laggard in the second quarter (that sector saw only a small gain) as weakness in the legacy internet and mobile providers weighed on the sector (the IPO of SpaceX reminded investors Starlink and other satellite internet providers are legitimate threats to those legacy business models).

• International market performance was also influenced by tech/AI as emerging markets handily outperformed the S&P 500 in the second quarter thanks to an extreme rally in South Korean shares, as they benefited from the boom in memory companies. Foreign developed markets, however, lagged the S&P 500 as they received little AI performance-related boost compared to the S&P 500.
• Commodities saw moderate declines in the second quarter, thanks primarily to the drop in oil prices due to reduced geopolitical tensions. Oil prices were volatile but ended the quarter solidly lower on a combination of increased ship transit through the Strait of Hormuz and the U.S./Iran ceasefire agreement. Gold prices also fell during the quarter on the aforementioned decline in geopolitical concerns and a stronger U.S. dollar, which hit a one-year high in June on rising rate hike expectations.
• Switching to fixed income markets, the leading benchmark for bonds (Bloomberg U.S. Aggregate Bond Index) realized a modest positive return for the second quarter as falling commodity prices reduced inflation concerns.
  • Looking deeper into the fixed income markets, shorter-duration bonds again outperformed longer-duration fixed income as some inflation statistics hit multi-year highs and ended Q2 far above the Fed’s 2.0% target.
  • Turning to the corporate bond market, both investment grade and lower quality, but higher-yielding bonds posted solidly positive quarterly returns. High-yield bonds outperformed investment grade debt, as generally resilient economic growth and falling geopolitical risks prompted investors to reach for higher yield despite greater credit risks.

What actions did we take in McKinley Carter portfolios last quarter?

• In our fixed income portfolios, we maintained a shorter-than-benchmark duration to lessen long-term interest rate risk and associated volatility. Also, as corporate high yield spreads over U.S. Treasuries remained compressed (expressing optimism on the economy), we maintained our modest high yield and nontraditional bond allocations.
• In our Earnings Focus and Hybrid models, we removed the shares of Home Depot, Intuit, Acuity Inc., Arthur J. Gallagher & Co., Jacobs Solutions, and Intercontinental Exchange and replaced them with positions in Nvidia, Alphabet, Dell Technologies, Advanced Micro Devices, Citigroup, and Eli Lilly and Co. These changes were made in order to take advantage of pullbacks in market leading technology stocks and to add diversifying sectors (financial and health care) with superior earnings growth.
• In our Tactical investment sleeve, we added the State Street SPDR S&P Biotech ETF (XBI) to take advantage of burgeoning biotech investment opportunities.
• In our Alternatives Focus program, we replaced the Bluerock Private Real Estate Fund with the Ares Core Infrastructure Fund to provide a stable monthly income vehicle that benefits from the high cash flow opportunities found in infrastructure investments.
• For our clients with unique investment needs such as hedging concentrated stock positions or implementing creative tax strategies using direct indexing, options, or long/short positioning, we established the McKinley Carter Portfolio Solutions Team to better serve our High Net Worth clients.

Outlook for the Rest of 2026

As Yogi so aptly put it, “It’s tough to make predictions, especially about the future.” Investors face big macro calls that could lead to a variety of outcomes, multiple plausible paths, and very different scenarios. That means uncertainty across incompatible regimes, not just around a base case.

When confronted with uncertainty about the Iran War, rising consumer prices for food, gasoline, computers, phones, etc., combined with investor doubts about the sustainability of massive AI spending on data centers, it’s best to anchor around the important data that drives the economy and investment markets.

We believe the overall economy in the U.S. is on sound footing despite evidence of what may be long-term employment challenges brought about by a flattening in domestic population growth and a sharp decline in immigration. U.S. employment, a critical factor in retail spending and overall GDP, seems to be stable in the current “low hire, low fire” environment.

Additionally, we believe that the weekly unemployment claims data acts as a “canary in the coal mine” as it indicates how many Americans are filing for both first time unemployment (Initial Claims) as well as those who reapply for ongoing unemployment support (Insured Unemployment). Fortunately, both have been consistently tame in 2026.

Globally, The S&P Global Composite Purchasing Managers Index continues to show expansion (scores above 50). While Europe has been disproportionately impacted by the higher oil prices associated with the Iran War, U.S Manufacturing and Services data point to ongoing expansion.

Critical Factors

When deciding on our broad asset allocations, we focus on three primary factors: inflation, interest rates, and earnings, as we believe these act as guideposts for appropriate stock and bond allocations. We refer to these as the “three legs of the investment stool” as they allow us to cut through extraneous “noise” in the economy and to concentrate on what the data (the signal) tell us about the investment landscape.

Inflation:

While we are cognizant of the optics and practical impact of rising short term inflation indicators such as the Consumer Price Index (CPI) and the Personal Consumption Expenditures Index (PCE), we believe a better gauge of market expectations for inflation is the 5-yr. Breakeven Inflation Rate produced by the St. Louis Federal Reserve. By focusing on the longer term market expectation for inflation, we believe that we better capture a significant data point that investors and the Fed use in decision making. As oil prices dropped precipitously recently, the 5-yr. Breakeven Inflation Rate fell as well and remains in a range that is supportive of equities and bonds.

Interest rates:

It is clear to us that the Federal Reserve, led by new Chairman, Kevin Warsh, is primarily focused on their 2% inflation target and is not inclined to lower interest rates in the face of short term inflationary pressures brought on by elevated oil prices and a stable jobs market. Likewise, it seems unlikely that the Fed will raise rates in the near future unless they believe inflationary trends are accelerating and not a temporary phenomenon. Currently, the Fed Funds Futures are predicting up to two interest rate increases in the next twelve months. If the Iran War is protracted, the Fed may feel pressure to act though their ability to slow commodity inflation brought on by the war is suspect.

While the yield curve has risen of late in response to the impact of rising oil prices and disruptions of supply chains for critical goods such as fertilizers and industrial chemicals, yields remain in a zone that is not yet punitive to the equity markets. We believe that short to intermediate bonds represent good value at these levels and that short-term bond investors will be rewarded with 2-yr. Treasury Bonds or CDs that yield in excess of 4%.

Earnings:

During 2026, a constant theme has been the persistent rise in earnings projections for the stock market. Earlier in the year, estimates for 2026 S&P 500 earnings were less than half the current estimates. Technology stocks, led by semiconductor manufacturers and other AI-related companies have experienced dramatic earnings revisions due to what seems to be an insatiable appetite for data center construction and the associated component manufacturers. Emerging markets’ earnings estimates have risen several fold this year due to prominent tech companies in Taiwan and South Korea that dominate their respective country indexes.

Despite concerns over the impact of President Trump’s tariffs early in the year, corporate profit margins have not been negatively impacted and continue to rise. Profit margin increases are also being felt in international markets as well. The increase in corporate profitability in 2026 has driven stock markets to new high territory and bodes well for future gains in the second half of the year. The AI revolution is serving as a catalyst for improved productivity and efficiency despite prominent tech company layoff announcements. A catalyst for the market in the second half would be any evidence that the large hyperscalers’ AI spending is starting to bear fruit.

Conclusion

Fundamentally, we believe the current “signal” for the markets is a favorable one for equities and short-to-intermediate bonds. This is based on declining longer term inflation expectations, range-bound interest rates, and robust earnings growth in the U.S. and abroad.

However, while the markets and the U.S. economy were again impressively buoyant in the first half of 2026, we must caution against allowing this resilient market to lull us into a false sense of security as we embark on the second half of the year, because risks to this bull market remain.

First, expectations for Fed rate hikes are rising. At the start of 2026, investors widely expected one or two rate cuts in 2026. Now, because of elevated short term inflation data, the market is expecting one or two rate hikes. And while that is not automatically negative for markets, the reality is that the last time the Fed embarked on a rate hike campaign (2022) stocks dropped sharply.

Second, the exposure of the entire economy and market to continued AI investment remains a source of concern. Massive AI infrastructure investment is helping to power the economy, but if the companies spending that money begin to doubt the return on investment of AI infrastructure growth, they could reduce spending and that would be an economic negative that impacts markets.

Finally, the U.S. economy has proved historically resilient over the past several years, but it is not infallible. The rebound in inflation, if it continues, threatens consumer spending and the housing market because, at elevated valuations, the stock market is not at all pricing in a loss of economic momentum.

In sum, we start the second half of 2026 with a strong market. Earnings growth is well above historical averages, economic growth is solid, and AI enthusiasm remains as boisterous as ever. However, risks remain in the form of sustained inflation (which could hurt economic growth), potential rate hikes, and vulnerability to AI infrastructure spending and the associated earnings impact.