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Following a tumultuous final month in Q1, markets had an outstanding second quarter of 2026 as easing tensions in the Middle East helped ignite a recovery rally for beaten-down stocks across the globe. While the process of reopening the Strait of Hormuz has not been smooth (with renewed tanker strikes from Iran & retaliation strikes from the US resuming on July 7th[1]), the markets bottomed in late March as worst-case scenarios regarding the Middle East conflict became less likely. The S&P 500 rallied over 15% during the quarter, the strongest quarter of performance for the index since the Q2 2020 COVID recovery[2].
But geopolitics weren’t the only driver of returns during the past three months. Even with the oil shock, forward looking earnings expectations have inflected higher, driven largely by the continued strength of the Artificial Intelligence infrastructure buildout[3]. However, after years of the ‘Magnificent 7’ and mega-cap technology stocks being the primary beneficiaries of the AI trade, 2026 has seen the largest names in the index underperform as investors have begun to grow more cautious over the rapid growth of capital expenditures from these companies. While many have been championing the growing breadth of winners in the stock market, the market remains narrowly concentrated in AI beneficiaries, even if they span a wider range of industries.
The Return of Breadth?
Equity markets rallied back hard in Q2 as crude oil prices gradually fell back to pre-Iran War levels. The S&P returned over 15% as sentiment recovered, while Crude Oil, Gold, Bitcoin, and broad commodities sold off. Even with the S&P’s extraordinary quarter of performance, small caps (via the Russell 2000), the Nasdaq, and Emerging Market stocks outperformed.
Q2 2026 Index Performance
Source: YCharts, as of 6/30/2026
While investors may be growing used to double digit returns from the S&P within the first half of the calendar year, the composition of this performance is notably different from recent years. After years of highly concentrated market performance where mega-cap tech/the Magnificent 7 did the heavy lifting for the S&P, 2026 has seen a significant broadening out of this performance. Through early July, only one of the Magnificent 7 is outperforming the S&P (Alphabet), while three of the stocks are negative on the year (Meta, Tesla, and Microsoft).
Magnificent 7 and S&P 500 Performance
Source: YCharts, as of 6/30/2026
One theory for the generally disappointing performance from the Magnificent 7 is due to the explosion in capital expenditures from the cohort of “hyperscalers” (Amazon, Microsoft, Google & Meta), or the businesses mainly responsible for the financing of datacenters designed to power artificial intelligence models. After more than doubling from 2023-2025, the total amount of capex from these hyperscalers is expected to nearly double again in 2026 and surpass $700 billion. These are businesses that have historically seen very high margins due in part to their asset-light business models, and investors appear to be reassessing the value of these equities as they go through a potentially transformative capex cycle.
Hyperscaler Combined Annual Capital Expenditures ($B)
Source: Company 10-K/earnings filings with the SEC. 2026 estimated figures are company guidance from Q1 2026 earnings.
However, despite the relative softness of the largest names in the S&P, the index is still up double digits through the first half of the year. An equal weighted index of the S&P, in which each company has a roughly 0.2% weighting, is outperforming the market cap weighted and more commonly cited S&P 500 index; a sign that the average stock in the S&P (or the S&P 493, excluding the Magnificent 7) is outperforming the top names in the index.
S&P 500 Market Cap Weighted vs S&P 500 Equal Weighted
Source: YCharts, as of 6/30/2026
Furthermore, the value factor and small caps have roared back to life in 2026. Through early July, Small Caps and value, defined by the Russell 1000 Value index, have generated close to 20% returns while the Russell 1000 Growth is up under 6%. This once again reverses the trend we’ve experienced over most of this bull market, where Growth and Large Cap have strongly outperformed.
Growth, Value, and Small Cap Performance
Source: YCharts
So if market performance has broadened away from the Magnificent 7, where has it gone? From a sector perspective, Industrials, Info Tech, and Energy have led the market with the sectors up roughly 20% in the first half of the year. Despite the broadening of performance to value & small caps, only 3 sectors appear to be doing the heavy lifting in terms of index performance. And you may be asking, if the mega-cap tech stocks aren’t performing as strong as they have in recent years, what’s driving Info Tech to a roughly 20% return so far in 2026?
S&P 500 Sector Performance
Source: Bloomberg, as of 6/30/2026
Diving in a step deeper, you can see the dramatic level of dispersion experienced within the Info Tech sector. While the sector is up nearly 20%, software stocks (defined by the iShares Software Sector ETF) are down over 14% and semiconductor stocks (defined by the iShares Semiconductor ETF) are up over 110%. As the capex guidance from the mega-cap tech companies has continued to grow, the companies creating the chips and devices that flow into the datacenters have benefited, while the businesses that may be at risk from AI disruption have been sold off.
Software vs Semiconductor Performance
Source: YCharts, as of 6/30/2026
Even within Industrials, the sector’s performance appears to have some AI-linkage to it. For instance, the industrial sector’s returns were supported by a handful of companies benefiting from the demand for powering AI-datacenters, including Caterpillar, GE Vernova, Vertiv, Eaton, and Quanta services. These five names contributed roughly 50% of the Industrial sector’s return during the first half of the year but only comprised 17% of the sector, highlighting the heavy lifting the AI theme is doing within the Industrial sector[4]. Shown another way, Bloomberg maintains an index of the S&P 500 AI Enablers & Adopters and an index of the S&P 500 Excluding AI Enablers & Adopters. As shown below, the AI enabler & adopter index has returned over 40% in the first half of the year while the ex-AI enabler/adopter index was up just over 5%.
Bloomberg S&P 500 AI Enablers & Adopters vs S&P 500 ex-AI Enablers & Adopters
Source: Bloomberg, as of 6/30/2026
Lastly, the MSCI Emerging Markets index has also seen extremely strong performance through the first half of the year. The index has advanced over 24%, but, as you may have guessed, AI linked exposure has done the heavy lifting for the index. Two of the best performing country stock markets of 2026 fall within the MSCI EM Index; South Korea and Taiwan. The iShares MSCI South Korea ETF was up 107% through the first half of the year with the iShares MSCI Taiwan ETF up over 70%. These are two countries that have benefited from their equity markets being concentrated in semiconductor businesses that have done extremely well amidst the AI enthusiasm. Taiwan Semiconductor Manufacturing Co., the world’s largest semiconductor manufacturer, comprises over 50% of the MSCI Taiwan Index[5], while Samsung and SK Hynix, global leaders in memory chip production, comprise over 60% of the MSCI South Korea Index[6]. These two countries have grown to be the largest country weightings within the MSCI EM Index at over 50% combined[7], and contributed over 100% of the MSCI EM’s return for the first half of the year[8].
Emerging Market Equity Performance
Source: YCharts, as of 6/30/2026
So, while we continue to benefit from the move higher in equities and have been positioned for a broadening of the equity market away from just the Magnificent 7, we remain cognizant that enthusiasm for AI enablers has been the primary driver of equity market performance so far this year. We believe that we are likely in the early innings of the development of AI tools and products, but the market sentiment regarding these semiconductor and datacenter supply chain businesses can change rapidly. We continue to value diversification within client portfolios, including non-AI linked equities, fixed income and alternative investments that can complement the current growth driver in portfolios, AI enablers.
Resources
[4] Bloomberg
[5] https://www.msci.com/documents/10199/6f36d84d-425d-4e1f-8d56-e65c455ebda1
[6] https://www.msci.com/documents/10199/e8fc2a89-b809-4088-a807-4b9d9ec04abc
[7] https://www.msci.com/documents/10199/c0db0a48-01f2-4ba9-ad01-226fd5678111
[8] Bloomberg
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