The second quarter (Q2) delivered one of the most powerful equity rebounds of the century, as the resolution of the US-Iran conflict removed the shock that had derailed markets late in Q1. Just as we anticipated, a ceasefire and the reopening of the Strait of Hormuz sent oil sharply lower and risk assets sharply higher. Brent crude, which had spiked to $118 per barrel at the end of Q1, fell back to $73 by the end of Q2, erasing the war premium to end below its pre-war level of $74. With the energy shock fading as quickly as it arrived, the underlying strength of the global expansion – broadening growth, robust earnings and an accelerating artificial intelligence (AI) investment boom – reasserted itself, carrying several major indices to record highs. The episode again showed that geopolitical shocks unaccompanied by fundamental deterioration tend to be buying opportunities rather than the start of bear markets.

The US led the recovery in Q2. The S&P 500 surged 14.9%, its best quarter since 2020, while the Nasdaq posted its strongest quarter in six years, driven by a 15.7% gain in April alone. The Philadelphia Semiconductor index rocketed 87.8% higher, its best quarter since inception in 1994, as demand for memory and AI chips overwhelmed all else. The rally also broadened: the Russell 2000 rebounded more than 26% from its April low, and equal-weight, value and micro-cap benchmarks set fresh record highs. Gains elsewhere were more measured. The UK’s FTSE 100 rose 3.2%, helped by its defence, banking and mining constituents, for its best run of consecutive quarterly gains since 2022, while Germany’s Dax recovered its first-quarter losses with a 10.2% advance. Japan’s Nikkei 225 reached a record high 70,062, capping one of its strongest quarters on record in local terms, with a gain of 37.2%, although a weaker yen trimmed the dollar return. China’s CSI 300 returned 11.9%, although it lagged compared with Far East emerging markets, held back by rotation into North Asian chipmakers and continued property weakness. The MSCI All Country World index (dollar-based) rose 14.5%, more than reversing its first-quarter fall, and the MSCI Emerging Market index (dollar-based) gained 23.3%, led by a surge in Taiwan and South Korea. The S&P Global Developed Sovereign Ex-US Bond index, also dollar-based, gained just 0.3% as a firmer dollar late in the quarter eroded returns. The US dollar index rebounded after the June policy meeting, breaking above 100 to its highest since May 2025, with a 1.2% increase in Q2, while the US 10-year Treasury yield rose from 4.31% at end-March to 4.42% at end-June.

The larger story is the durability of the global expansion. The International Monetary Fund forecasts world growth of 3.1% in 2026 – a modest slowdown, but solid given the shocks absorbed – and assumed geopolitical disruption would fade by mid-year, which the swift de-escalation has vindicated. Growth is also broadening beyond the US. Global purchasing managers’ indices softened during the conflict but falling energy prices and easy monetary settings and fiscal support should rebuild momentum into the second half. This broadening of both activity and market leadership is the defining feature of the cycle and lends the expansion a firmer footing than the narrow, US-centric advance of a year ago.

The US nonetheless remained the engine of global growth and the centre of the earnings recovery. With second-quarter reporting approaching, consensus S&P 500 earnings growth has been revised up to 23.1% year-on-year, from 18.8% at end-March, and revenue growth to 12.3%, the strongest since 2022, implying further margin expansion. The advance is also broad, with nine of eleven sectors showing an expected acceleration in earnings growth. Resilient consumer demand, business investment and the fiscal impulse of the One Big Beautiful Bill Act have sustained activity, even as earlier energy-price gains left their mark on inflation.

In Europe, the feared energy blow proved short-lived. Eurozone inflation eased to 2.8% in June, from 3.2% in May, as the price of crude retreated. The European Central Bank hiked its benchmark interest rate by 25 basis points in June, as expected, but further tightening is unlikely, keeping monetary policy accommodative. Germany’s fiscal reawakening continues to underpin the recovery. Having scrapped its constitutional ‘debt brake’, Berlin’s programme of defence and infrastructure spending should add around half a percentage point to growth and spill over to its trading partners. Eurozone growth of roughly 1% in 2026 looks pedestrian beside the US, but improves markedly on recent stagnation, with stimulative monetary and fiscal policy and cheaper energy tilting risks to the upside.

Asia and the emerging world diverged sharply. Japan’s growth will likely stay below 1%, but its mix is improving: rising real wages and is reviving consumer spending, emboldening the Bank of Japan to lift its policy rate and begin scaling back bond purchases after decades of ultra-loose policy. China still labours under a property downturn and weak sentiment, with growth slowing towards 4.5%; front-loaded fiscal measures, extended trade-in subsidies and cuts to rates and reserve requirements have stabilised activity more than revived it. India remains the standout, on track for 6.5% growth on strong domestic demand and manufacturing investment. Across emerging markets, fortunes now hinge on technology – Taiwan and South Korea soared on the AI boom while domestically-oriented economies lagged – but consensus earnings growth is the highest of any region.

The quarter’s most consequential shift came in US monetary policy. The Federal Reserve, now chaired by Kevin Warsh after Jerome Powell’s term expired in May, struck an unexpectedly hawkish tone at its inaugural meeting in June. Markets that began the year expecting further easing now price some 30-50 basis points of increases by year-end – in contrast to the ECB’s more cautious bias, the Bank of Japan’s gradual normalisation, and the People’s Bank of China, which alone is loosening in earnest to fight deflation. Inflation, the chief threat to the goldilocks mix of solid growth and easy policy, is again to the fore, and the bond market is its transmission channel. Core PCE, the Fed’s preferred inflation gauge, rose for a third consecutive month to 3.4% in May, well above the 2% target. The oil-price reversal should ease some pressure, but sticky underlying inflation reflects the late-cycle bind in which robust demand, scarce spare capacity and tight labour markets feed prices as much as activity. The 10-year Treasury yield rose to 4.42% and the Fed’s hawkish signal flattened the curve, narrowing the two-to-ten-year spread to its slimmest since March 2025. Higher yields have so far been absorbed by an earnings-driven market, but a decisive break to new cycle highs would reprice financial assets and compress valuation multiples far more seriously than any geopolitical flashpoint.

The other principal risk lies in the very sector leading the market. The vertical ascent of semiconductor shares and the concentration of returns in AI related stocks carry clear echoes of past technological exuberance, and with the S&P 500 on a forward multiple near 20 times – above its five- and ten-year averages – the market has priced in much good news. Given the US’ roughly two-thirds weight in global indices, and technology’s outsized share within it, any disappointment in AI monetisation or capital spending would be felt worldwide. Policy error is another danger: the Fed transition places its credibility and independence under scrutiny, while high public debt and fiscal-sustainability doubts leave little room for missteps before a watchful bond market.

Yet economists tend to caution, and bull markets climb a wall of worry. The upside equity market risks merit equal weight. The broadening of both the rally and the expansion beyond the mega-cap leaders places the market advance on wider foundations than a year ago. The AI investment cycle may still be in its early innings, its productivity gains yet to spread across industries and geographies; a replay of the late-1990s boom would imply meaningful further upside. Cheaper oil, double-digit earnings growth across most regions and still-expansionary PMIs all point to a durable expansion. We continue to see 2027, rather than 2026, as the more likely year for tighter policy and stretched valuations to catch up with markets. For now, with inflation the variable to watch and the 10-year yield its best barometer, we remain constructively positioned, mindful that the quarter’s exuberance leaves less room for error than existed at the depths of the first.