Market Insights: Addressing Client Questions on the Mid-Year 2026 Outlook

[00:00:00] Speaker 1: We actually do get clients saying, why are you telling us stay invested at all-time highs? And the reality is earnings are upward sloping. The U.S. economy grows. Corporations benefit from that economic growth. They generate earnings. Generally, prices follow those earnings. So our view is start getting invested, average over time, and recognize that all these headlines are actually irrelevant. [00:00:30] Speaker 2: Sharmine, Matt, it's great to sit down with you both and discuss your investment views midway through 2026. Despite a global energy shock, geopolitical tensions, and volatility in the first six months of the year, if we take a step back, the U.S. economy and U.S. equities have been resilient. Sharmine, if we start with you, what's driven the market performance year to date, and how has your macroeconomic outlook changed as a result? [00:01:01] Speaker 1: We always keep on saying that the U.S. economy, U.S. corporations, U.S. households are incredibly resilient. And we have seen this this year, the oil shocks that one would have thought would have derailed the economy, maybe derailed the equity market, maybe derailed household consumption. We would have expected a bigger slowdown. In our outlook, we had said GDP for 2026 would be about 2.3%. The latest number is about 2.2%. So obviously, the economy, corporate America, households have absorbed this shock and actually done quite well. Now, there are a lot of headlines about gasoline prices. Those have come down. It didn't last such a long time. The U.S. economy's energy intensity in terms of oil has actually decreased substantially. During the Arab oil embargo and the Iran-Iraq war, it was around 30 barrels per capita. Now, that number is more like 22, 23 barrels per capita. And finally, U.S. is actually a major oil and natural gas producer now. The largest exporter of liquefied natural gas, substantially greater than Qatar, the largest producer of oil, nearly double that of Saudi Arabia. The U.S. has become energy independent. And so those mix of factors make the U.S. economy very resilient. [00:02:21] Speaker 2: Alongside that incredible U.S. growth, corporate earnings have been resilient. Can you speak a little bit more about the drivers of that resilience and what your outlook is for 2026 with respect to earnings and U.S. equities? [00:02:34] Speaker 1: So earnings have definitely surprised to the upside by a huge margin. I don't think anybody was expecting this kind of earnings. Our earnings expectation for 2026 was about 10% plus or minus 1% on each side, roughly. And now we've actually increased that number to about 17%. Now, people keep on saying, oh, that's all because of the magnificent seven companies. But that's actually not correct. If you look at the rest of the S&P 500, whether you're looking at the remaining 493 companies or you take the median stock in the S&P 500, the numbers are around 10 to 12%, which is pretty significant when you think trend earnings growth in the United States since World War II has been around 6.5%. The other thing that's pretty incredible about the U.S. has been the margin expansion. Quarter after quarter, the S&P 500 companies across the board eke out a few extra basis points of margins. And that just is really important to the sustainability of this earnings trajectory. [00:03:38] Speaker 2: Given this resilience, have you made any changes to investment portfolios? [00:03:43] Speaker 3: We haven't made a change specifically to the U.S. allocation. That's that outside of the U.S., we have made a change to what we recommend. Specifically, within emerging markets, we've added exposure, but to emerging markets outside of China. Now, we've talked about a lot of AI exposure existing in the U.S. One of the things that's powering much higher earnings growth in some of the emerging markets than others is actually exposure to AI. Think of Korea. Think of Taiwan. And so to capture that opportunity, we've increased the allocation slightly to emerging markets, but specifically to markets outside of China. [00:04:23] Speaker 2: Matt, another key focus in the market has been on IPOs and activity is expected to accelerate as we continue through the year. Some investors are a little bit concerned that this new equity supply into the market might overwhelm market liquidity and some of the momentum that we've seen already this year. How do you view that dynamic? [00:04:43] Speaker 3: Well, there are a few reasons why we don't think investors should be that concerned. The first is, according to our analysis, we don't find that IPO activity has actually any bearing on one-year or five-year forward returns for the market overall. So both IPOs as well as other forms of equity issuance, that amounts to about 1.7% of Russell 3000 market cap. That's actually right in line with 1.8%, which is the median amount of equity issuance per year, going back to 1995. And then lastly, corporate demand in terms of share buybacks is still growing. We're expecting that buybacks will grow by about 3% this year compared to last year, and that the total amount of demand will be $1.3 trillion, which is in excess of the expected IPO issuance this year. [00:05:36] Speaker 2: You mentioned that buybacks for the index are going to grow. [00:05:39] Speaker 3: Yes. [00:05:40] Speaker 2: One of the concerns has been the reduction of buybacks at some large tech stocks called hyperscalers to fund some of their AI CapEx plans. [00:05:49] Speaker 3: If you look at projections for operating cash flow this year, the hyperscalers are expected to use 100% of their operating cash flow on AI-related CapEx. Hence, that's why buybacks are being reduced among the hyperscalers. Now, we don't think a slowdown will significantly alter our or the market's expectations of forward earnings growth. With regards to the hyperscalers specifically, the outlook for buybacks is ultimately predicated on how profitable the CapEx investment is or isn't that the hyperscalers are making. If it doesn't turn out to be all that profitable, that there isn't an attractive ROI, we do expect that CapEx will come down, which then increases capacity for those companies to be increasing buyback activity. If, however, the CapEx ultimately does prove to be profitable, that level of current CapEx could continue. [00:06:41] Speaker 2: Charmin, there's some hesitation amongst investors to invest in the equity market when it's at all-time highs or around all-time highs. How do you address that concern and advise entering the market? [00:06:54] Speaker 1: One of the messages that we actually have for clients throughout this year is the need to separate noise from signal. So, the noise in the media has reached an all-time high, record high. The reality is earnings are upward sloping, right? U.S. economy grows, corporations benefit from that economic growth, they generate earnings, generally prices follow those earnings. So, prices are an upward trajectory as well. Sometimes they diverge, sometimes they converge, but generally that's the direction of travel. So, if you want to get on that bandwagon as quickly as possible and capture that really steady growth of earnings. But the idea is you should average it. You don't want to be investing all your money at the peak. And we always actually joke with clients that once you've deployed your first part of the capital, let's say you average over four quarters and you invest 25%, do you want the market to go up or do you want it to go down? Obviously, you've deployed your first part. Oh, I want it to go up, but the reality is you actually want it to continue going down to lower your average cost. So, our view is start getting invested average over time and recognize that all these headlines about record levels on the S&P are actually irrelevant. [00:08:09] Speaker 2: You spoke a bit about drawdowns, Matt spoke about the uncertainty around AI development. Are there any other risks more broadly that you're monitoring? [00:08:17] Speaker 1: Well, at this point, there are tons of geopolitical risks, right, escalation between the US and Iran. Iran trying to make a point that they want to control the Straits, Hormuz and the United States and its allies in the region saying absolutely not. So, it's something to watch. As long as oil prices don't skyrocket and the war becomes much more kinetic and problematic, then I think these will just introduce volatility in the marketplace. The other big question is long term with China. What about the geopolitical tensions between the US and China? And that is not going to go away. Right now, everybody probably likes the status quo. A little bit of muscle flexing on each side, but nobody wants it to get any worse. President Trump for his own political and domestic agenda. And in China, the economy is just so weak, they cannot afford to have anything significant. So, those are the type of risks that we look at. Matt, any other risks that you can think of? [00:09:13] Speaker 3: With regards to the potential for drawdowns, one of the questions that comes up frequently among clients is, Should they be systematically buying put options to protect the volatility of their equity allocations and their overall portfolios? That's not something we think is the best course of action. Rather, we think owning an allocation investment grade bonds is the better hedge. The primary reason for that is buying put options on a strategic basis or systematic basis is prohibitively expensive, Depending on the amount of insurance bought, it could be at a cost of 3% to 7% per year, which relative to a long-term average equity return in the US of nearly 10%, that of course eats into much of that upside. [00:09:56] Speaker 2: I think we've discussed some of our key themes and the advice, but is there any key messages you'd like to leave clients as they enter the second half of this year? [00:10:05] Speaker 1: We continue to say our view of US preeminence is intact, and the gap between the US and the rest of the world keeps on widening. Now, China is catching up to the US in certain areas like biotech. But in general, economic growth, GDP per capita, productivity, the gap just widens. And we continue to recommend clients stay invested. Don't get so worried about these headlines because there's not much one can do about it. [00:10:30] Speaker 3: And I think about the second half of this year, so much value in financial markets is now beyond 2026. So starting to think about what may happen in 2027 and beyond is also something smart to do, especially for our clients who are such long-term investors. [00:10:46] Speaker 2: Thank you both for your time and insights. I look forward to sitting down with you both again soon. Thank you. [00:10:52] Speaker 3: Thank you. [00:11:07] Speaker ?: Thank you. Thank you.