May 19, 2026 Signal Through the Noise: A Mid-Year Check-In on Policy, Profits, and the Path Forward
Five months into 2026, the headlines have been dominated by a Middle East conflict that has lasted longer than markets expected and an oil shock that has pushed gasoline prices to multi-year highs. But beneath the noise, two things matter far more for long-term investors: the U.S. economy remains in healthy shape, and corporate profits are growing at one of the strongest paces we have seen in years. In this commentary, we revisit the six themes we laid out in January, share our view on the recent move higher in interest rates, and look ahead to what we believe will drive markets in the second half.
Revisiting Our 2026 Themes
When we sat down in January to write our annual outlook, we titled it “Cautious Optimism” and laid out six themes we expected to shape the year. With nearly five months of data, here is where each one stands today.
The AI investment cycle. AI is moving from hype to real, measurable revenue, as we expected. The largest cloud computing companies in the United States have committed to roughly $650 to $700 billion in AI infrastructure spending this year — an increase of approximately 60% over 2025. Cloud businesses are growing at their fastest pace in years, and each of these companies has reported that demand for AI computing capacity is exceeding what they are able to supply. That is the foundation of a multi-year investment cycle.
Geopolitical fragmentation and defense. We expected defense budgets to grow and global friction to remain elevated. We did not anticipate a multi-month armed conflict involving the United States, Israel, and Iran. Defense companies have been among the strongest performers in the market this year, and energy prices have surged. Our broader view — that the world is moving toward higher defense and infrastructure spending — has held, even if the form has been more dramatic than anticipated.
A change at the Federal Reserve. We flagged the second-half leadership change at the Fed. That change is now official: Kevin Warsh was confirmed by the Senate as the new Chair on May 13, succeeding Jerome Powell, whose term as Chair ends today. In an unusual move, Mr. Powell will remain on the Fed’s Board for some period of time — a step that may help smooth the handoff. We discuss this in more detail below.
Continued earnings strength. We expected another strong year for corporate profits. The reality has been even better. Profit margins have continued to expand, and first-quarter earnings growth is tracking at one of the strongest paces we have seen in years. This is the most important — and most underappreciated — story in markets right now, and we return to it below.
A rebound in mergers and acquisitions. Deal activity has continued to pick up after a few quieter years, particularly in financial services, energy, and technology. Lower borrowing costs relative to a year ago and a more flexible regulatory environment have created conditions in which corporate leaders are willing to commit to long-term deals again. That is generally a healthy sign of corporate confidence.
A broadening market. We expected market leadership to widen beyond a handful of dominant names. We are seeing some of this — mid-sized U.S. companies have shown signs of life, and international stocks started the year strong before the oil shock cooled them. The largest U.S. companies remain the dominant story; the broadening is real, but it remains partial.
Policy: A New Chair, A Familiar Framework
Mr. Warsh assumes the Fed chairmanship as Mr. Powell steps down today. For clients wondering what this change means for their portfolios, the most important point is that the Federal Reserve is an institution, not one individual. The Chair sets the tone and leads the discussion, but interest rate decisions are made by a group of twelve members who vote together at each policy meeting. The Fed’s framework — keeping employment high and inflation low — is set by Congress and does not change with the Chair.
That said, leadership matters. Mr. Warsh served on the Fed’s Board during the 2008 financial crisis and is broadly seen as more market-oriented in his communications and less inclined toward unusual or experimental policy tools. Markets are interpreting his appointment as a modest tightening of the Fed’s overall posture, though we would caution against reading too much into the change at this early stage.
The more interesting question is what has happened to investors’ expectations. Coming into the year, the bond market expected two to three small rate cuts from the Fed in 2026. After the oil shock, those expected cuts have largely been removed and a small chance of a rate increase has even been priced in. We think the market is overreacting. Higher gasoline prices feed into the overall inflation number, but the measure of inflation the Fed actually focuses on excludes volatile items like food and energy. Historically, the Fed has been reluctant to raise rates in response to a supply disruption it cannot influence, and we see little reason for this time to be different.
Profits: The Story Investors Should Be Watching
If a single theme deserves more of clients’ attention right now, it is the strength of corporate profits. With the vast majority of S&P 500 companies having reported their first-quarter results, earnings growth is tracking at one of the strongest paces we have seen since the immediate post-COVID recovery. Profit margins have continued to expand, and the AI investment cycle is producing real, measurable revenue — not just promises about the future.
The scale is staggering. The largest cloud computing providers in the country are collectively spending approximately $700 billion on AI infrastructure this year, up roughly 60% from last year. Every one of them has reported that they cannot keep up with demand for AI computing capacity. Outside of technology, financial services, industrial companies, and healthcare businesses have all delivered better-than-expected results. American businesses, broadly, are operating at very high levels of profitability.
The point we want to emphasize: the U.S. economy is in healthy shape, and the businesses inside it are some of the most profitable they have been in a long time. That is the signal. Everything else — including the conflict in the Middle East — is, in our view, noise compared to that fundamental backdrop.
The Conflict, the Oil Shock, and Why We’re Not Chasing the Bond Trade
We owe clients a candid update on the situation in Iran, because we did not get the timing right. In our March commentary, we wrote that markets were pricing in a four-to-five-week disruption and that the administration’s stated timeline matched. Ten weeks later, the conflict continues. Oil prices have spiked, gasoline at the pump now averages roughly $4.50 per gallon — more than 50% higher than before the conflict — and shipping through the Strait of Hormuz has cycled through partial reopenings and re-closures.
It is worth keeping the historical context in mind. Years in which the United States has been involved in active armed conflict have, on average, not been bad ones for U.S. stock investors. From World War II through the Korean War, the first Gulf War, and the various post-9/11 conflicts, the underlying strength of American businesses generally proved larger than the conflicts themselves. Across 17 major geopolitical events since 1939, the average S&P 500 return in the 12 months that followed has been positive. Markets are not insensitive to human costs; they simply reflect the fact that the long-term growth of the U.S. economy is larger than any single geopolitical shock.
The more pressing question right now is what to make of the bond market. As the conflict has dragged on, interest rates have moved higher and bond prices have moved lower. Long-term interest rates are now meaningfully above where they sat at the start of the year. The market has removed any expected rate cuts this year and is implicitly assigning a small chance to a rate increase — all consistent with investors worried that a prolonged oil shock will lead to more persistent inflation.
Here is where we want to be clear: we don’t think that is the right read on the situation. The shock to oil markets, while longer-lived than initially expected, remains a shorter-term issue in our view. The United States produces more oil than it consumes — the pain is at the gas pump, not in the availability of oil for the U.S. economy. That is a meaningfully different setup from the 1970s, which is the comparison most people are reaching for. OPEC has announced production increases. The U.S. has a Strategic Petroleum Reserve it can draw on. Heading into a midterm election, the administration has every political incentive to bring gasoline prices down. And the Fed, as we noted, focuses on a measure of inflation that excludes energy prices.
In our view, the bond market is currently positioned for a permanent change in the inflation environment that we don’t believe a temporary oil shock can actually produce. When the oil situation eventually settles down — and we believe it will — interest rates are more likely to move lower than higher. That is why we have not been chasing the recent move toward shorter-term bonds and higher yields, and why we continue to view bonds broadly as an important part of well-balanced portfolios.
Looking Forward: What Drives the Second Half
Five developments will shape markets through the end of the year.
A resolution to the Iran conflict. Whether through a negotiated settlement, a clear military endpoint, or a phased de-escalation, normalization of shipping through the Strait of Hormuz is the single most important short-term catalyst. A move back toward more normal oil prices would lower inflation expectations, restore the traditional role of bonds as a portfolio cushion, and give the Fed room to consider easing — possibly sooner than the market currently expects.
Chair Warsh’s first policy meetings. The Fed’s June and July meetings will be the first read on how the new Chair communicates. We expect a more market-friendly tone and a willingness to look through energy-driven inflation, though it would be unusual for any new Chair to signal rate cuts before the data clearly supports it.
Second-quarter earnings. Results in mid-to-late July will tell us whether the AI investment cycle continues to translate into broad corporate profitability. If it does — and we expect it will — this should become the most important story of the year.
Continued deal activity. With stable financial conditions and a more accommodating regulatory backdrop, we expect deal activity to keep building. That is generally a healthy sign for the broader economy.
Midterm elections. The period from the fourth quarter of a midterm election year through the second quarter of the year that follows has historically been one of the strongest stretches in the four-year political cycle. We do not invest based on political outcomes, but the seasonal pattern is worth keeping in mind.
How We Are Thinking About Portfolios
Above all, we encourage clients to keep the signal-versus-noise framework in mind. The noise — daily headlines about tankers, missile exchanges, and the Strait of Hormuz — has been loud. The signal — that U.S. corporate profits are strong, the AI investment cycle is real and accelerating, and the underlying economy is in healthy shape — is quieter, but far more consequential for long-term portfolio outcomes.
In an environment like this, our philosophy is straightforward. We continue to lean on high-quality, profitable companies that are participating in the broader economic and technology shifts underway. We are not turning away from bonds despite the recent rough stretch; today’s interest rate levels offer real income and an important diversification benefit for balanced portfolios. And we believe staying engaged with your financial advisor — periodically reviewing how your portfolio is positioned, especially in noisy markets — matters more during periods like this than in calmer ones.
The first half of 2026 has tested investor patience. Periods like this are precisely when staying focused on fundamentals — on profits, on policy, on the underlying health of the U.S. economy — separates successful long-term investors from those who get whipsawed by the headlines. We remain cautiously optimistic. As always, please do not hesitate to reach out to your financial advisor with any questions or to discuss how your portfolio is positioned for the road ahead.
Michael Levitsky, CFA®, CAIA®
Chief Investment Officer
Sources
Hyperscaler AI infrastructure spending and cloud growth (approximately $650–$700 billion in combined 2026 capital expenditures across the largest U.S. cloud computing providers; approximately 60% increase over 2025; demand exceeding supply for AI computing capacity): CNBC, “Tech hyperscalers Q1 earnings after Iran war lifts energy, AI prices,” April 28, 2026; 24/7 Wall St., “Hyperscalers Hit $700 Billion in 2026 AI Spending Plans,” May 1, 2026; Data Center Knowledge, “Hyperscaler Earnings Show AI Demand Outrunning Infrastructure,” April 2026.
Federal Reserve leadership transition (Kevin Warsh confirmation as Chair on May 13, 2026; Jerome Powell remaining on the Board of Governors): NPR, “Senate confirms Kevin Warsh as next chair of the Federal Reserve,” May 13, 2026; CNBC, “Jerome Powell says he will continue to serve as a Fed governor even after chairmanship ends,” April 29, 2026.
Iran conflict, oil prices, and retail gasoline (Brent crude price movements; retail gasoline averaging approximately $4.50 per gallon, more than 50% above pre-conflict levels; Strait of Hormuz shipping disruptions): CNBC, “A timeline of how the Iran war shook oil prices — and what comes next,” April 21, 2026; FactCheck.org, “What Will Happen To Gasoline Prices When the Iran War Ends?” May 2026; Axios, “Oil prices jump after US seizes Iran ship, Strait of Hormuz setbacks,” April 19, 2026.
Historical S&P 500 performance following major geopolitical events (17 events since 1939, average positive 12-month return): Stock Trader’s Almanac, compiled by Jeffrey Hirsch; as previously cited in our March 2026 commentary, “Steady Through the Storm: Making Sense of AI Disruption and the Iran Conflict.”
First-quarter 2026 corporate earnings (margin expansion, broad-based earnings strength, AI revenue contribution): Aggregate S&P 500 reporting data and consensus estimates through the Q1 2026 earnings season.