It is impossible to predict the markets, but useful to consider possible outcomes for the economy and markets, and implications for asset allocation. Each quarter, we lay out four to five scenarios that could play out in the months ahead. Typically, reality reflects aspects of one of these scenarios, but in the first half of the year, we’ve sampled a taste of at least three, which may continue to dictate markets in the second half of 2026:
- AI course correction – AI anxieties crystallize, resulting in an AI bust. Circular deals unravel, competition and commoditization erode the economics for companies, adoption slows, and overcapacity abounds. Profit growth decelerates for the Mag 7 and hyperscalers, which feeds downstream to AI enablers within industrials, utilities and materials. AI capex spending, a driver of GDP growth, stalls. U.S. and EM stocks fall given AI exposure but developed market equities fare better. Opportunities: Core bonds, U.S. dollar | Risks: U.S. and EM stocks.
1H26 reality: Markets have agitated about AI competition, compute, and capex this year, only to be subsequently soothed by stellar earnings growth. However, as the AI trade grows more volatile, investors are rotating away from the Mag 7 and hyperscalers to the AI builders within semis, hardware and power. - Stagflation – An energy-driven jump in headline inflation fuels inflation expectations and raises core inflation. Elevated prices stunt the consumer, and growth sputters but avoids recession. The Fed hikes rates. Stocks stumble while yields spike above 5%. Earnings take a hit. Opportunities: Short-term fixed income, alternatives | Risks: Large cap, small cap, core bonds
1H26 reality: Inflation has likely peaked but could remain above 3% by year end. The market went from pricing in two rate cuts to a hike this year, validated by new Fed Chairman Warsh. The yield curve has flattened, with short rates rising more than long rates, and the dollar maintaining recent strength. - Accelerating growth – Stabilizing geopolitics brings energy prices down, relieving pressure from lower- and middle-income consumers. Weakness in the labor market proves to be a head fake and unemployment remains low. Profits grow double-digits, with particular strength in tech, enabling robust AI capex spending. Economic growth accelerates above trend. Stocks rise, particularly small caps. Yields move higher, as does the U.S. dollar. The Fed stays on hold. Opportunities: Large cap, small cap, international stocks, high yield | Risks: Core bonds.
1H26 reality: Consumers are resilient, but growth and profits have been buoyed by AI capex. Earnings expectations have been revised up by 9%-points YTD. Small cap and EM stocks have outperformed U.S. stocks.
So where do we go from here? We expect echoes of these three scenarios in 2H26, with the Fed on hold as inflation crests, resulting in rangebound bond yields and ample income. AI momentum should continue, although investors ought to be nimble as beneficiaries of this trade evolve domestically and internationally. Importantly, most major asset classes have had negative YTD returns at some point in 2026, and yet are now at the top of their ranges, reminding us to diversify sensibly to ride out bouts of volatility.
By Meera Pandit - July 1, 2026