When we published our 2026 outlook, we spent time talking about how policy is increasingly a driver of capital markets. The Iran conflict, and the resulting market disjoint, certainly served as another example of how policy should be top of mind when investors consider portfolio construction and risk management.
So, what now? The answer is we expect more of the same. Policy again will be front and center as we turn our attention to U.S. midterm elections and the uncertainty surrounding Kevin Warsh as the new chair of the Federal Reserve (Fed). Warsh’s ability to influence his colleagues, and questions around congressional balance of power, should be key items that help shape the second half of 2026.
This does not mean we have lost focus on artificial intelligence (AI) and the definitive upside trend we have seen in corporate earnings. Strength in earnings is a key reason we have added to our 2026 return expectations for equities. While some frothiness around AI expectations and market concentration do leave us a bit concerned, the wave of earnings growth we have seen could persist.
Internationally, we are less sanguine, as European economies again have fallen behind, and emerging markets may continue to be hit-or-miss in aggregate. Simply stated, while our bias for U.S. equity exposure remains, the variance between the U.S. and the rest of the world may not be as pronounced as in years past.
The key question is: How should investors position themselves to optimize investment opportunities? The answer is grounded in the expectation that we believe equity markets should indeed be constructive in the second half, yet historical precedent also tells us election years make for a bumpy investment ride.
HIGHLIGHTS AT A GLANCE
THE BIG PICTURE: RESILIENCE TESTED, RESILIENCE CONFIRMED
The first half of 2026 delivered three challenging dynamics in quick succession: a new Fed chair, a geopolitical shock in the Middle East that pushed oil prices and bond yields higher, and a wave of AI spending that began reshaping the corporate bond market. Despite all of it, stocks kept climbing and the economy kept growing.
The second half looks constructive but remains complicated. We expect four key themes will shape markets: the rapidly approaching midterm elections, a maturing AI cycle, rising resource nationalism around the globe, and the Fed navigating a leadership transition. Each one brings opportunity and uncertainty in equal measure.
THE ECONOMY: SLOWING DOWN BUT NOT STOPPING
Economic growth is expected to moderate through the rest of 2026, driven by strong business investment in AI and infrastructure that offsets weakness in housing and other rate-sensitive parts of the economy.
Inflation climbed to 4.2 percent in recent months, pushed mainly by energy prices tied to the ongoing conflict in the Middle East. We expect inflation to cool toward 2.9 percent by year-end if geopolitical tensions ease, because the recent spike in inflation has been driven by energy costs.
Recession is not in the base case. A job market in a “low-hiring, low-firing” equilibrium, resilient household balance sheets, and continued AI-driven business investment are keeping economic expansion on track.
THE FED: A NEW CHAIR, THE SAME CHALLENGE
In early May, Warsh replaced Jerome Powell as his term as Fed Chair closed. Warsh has long favored a smaller Fed footprint: a leaner balance sheet, fewer promises about the future path of interest rates, and more room for markets to discover prices on their own.
With inflation still above the Fed’s target and geopolitical uncertainty elevated, the Fed is expected to remain on pause most of the year.
The 10-year Treasury yield is expected to finish 2026 between 4 percent and 4.50 percent.
STOCKS: BULL MARKET, BUT EXPECT SOME TURBULENCE
The bull market is expected to continue, supported by strong earnings growth, AI investment, and an economy that is slowing but still expanding. LPL Research’s updated year-end S&P 500 target is 7,650 to 7,750.
Gains so far this year have been driven by earnings, not higher valuations, which is a healthier foundation. Overall, S&P 500 earnings are on track to grow more than 20 percent in 2026.
Midterm election years produce more volatility historically, and AI spending scrutiny, energy-related inflation risks, and a new Fed chair all add to the potential for turbulence.
Diversification between AI-related names and the sectors positioned to benefit from a broader market rotation could be critical in the near-term. As such, recently we moved to favor a slightly conservative sector mix given the magnitude of AI-driven gains so far this year.
BONDS: PRIORITIZE INCOME OVER PRICE GAINS
With the Fed on hold and Treasury yields expected to stay range-bound, returns from bonds are more likely to be driven by income rather than price appreciation.
Shorter-maturity treasuries and short-to-intermediate corporate bonds are the most attractive spots on their respective curves. Treasury Inflation-Protected Securities (TIPS) offer an additional hedge against any unexpected inflation surprises.
Long-duration bonds face headwinds from persistent Treasury supply, sticky inflation, and higher developed market yields.
ALTERNATIVE INVESTMENTS: ADDING FLEXIBILITY WHEN YOU NEED IT MOST
Markets increasingly are being defined by dispersion, structural change, and complexity. That environment makes the case for alternatives in a well-diversified portfolio stronger than it has been in years.
Infrastructure stands out for its stable, often inflation-linked cash flows, and it is benefiting directly from data center construction, fiber networks, and the broader digital buildout.
Equity market-neutral strategies and global macro managers are well positioned to capitalize on stock-level dispersion and the kind of policy driven volatility that is likely in the second half, respectively.
FOUR THEMES THAT SHAPE THE SECOND HALF
MIDTERM ELECTIONS: POLICY UNCERTAINTY COMES BACK INTO FOCUS
Our base case is a split Congress after November’s elections. In that scenario, expect fewer large legislative changes and more volatility around issues like government funding and the debt ceiling.
Financial services, digital asset companies, and healthcare could see meaningful regulatory or legislative shifts depending on the outcome.
ARTIFICIAL INTELLIGENCE: FROM BUILDING TO PROVING IT WORKS
The five largest AI spenders are on track to invest more than $750 billion in AI infrastructure in 2026.
Bottlenecks in memory and materials, power supply, and permitting likely are to stretch out the investment cycle, which broadly supports AI-adjacent equities and industrials.
RESOURCE NATIONALISM: A NEW FORCE IN GLOBAL MARKETS
Governments around the world are asserting more control over natural resources, treating energy, metals, and critical minerals as national security assets.
For investors, this means commodity-linked equities in the energy and materials sectors may stand to benefit. Industrial metals are benefiting from constrained supply, while AI infrastructure spending and clean energy investment are driving demand higher.
A NEW ERA AT THE FED: LESS GUIDANCE, MORE UNCERTAINTY
Warsh brings a more market-determined, less interventionist philosophy to the Fed. That introduces near-term uncertainty, especially if markets test the new chair’s resolve early on.
In this environment, U.S. bonds, shorter-maturity U.S. Treasuries, and TIPS stand to benefit relative to longer duration, non-U.S. bonds, and nominal securities.
The LPL Financial Research team provided this information. LPL Financial is located in Chesterfield, Missouri. Contact Jonathan Benner, Certified Financial Planner™ with LPL Financial, at jonathan.benner@lpl.com or 636.200.4204. To view the complete Midyear Outlook 2026: Policy, Buildouts, and Bottlenecks, visit lplmycfo.com. The opinions, statements, and forecasts presented herein are general information only and are not intended to provide specific investment advice or recommendations for any individual.