Quarterly Review: Big Gains, Bigger Questions

John Campbell: The second quarter of 2026 delivered the best quarter for global equities since 2020, with an AI (artificial intelligence)-driven semiconductor surge and a recovery from war-fueled lows. You’re probably already aware of those market dynamics. However, I want to talk to you about what happened in relation to factor returns. From a factor perspective, momentum was a dominant factor, with retail traders driving momentum stocks to record quarterly outperformance. The momentum factor did experience a sharp mid-quarter unwind in early May as the AI trade briefly reversed, but dip buyers quickly reengaged. Value also posted exceptional returns, reflecting the energy sector’s recovery, as oil prices normalized and cyclical names rerated. However, low volatility significantly lagged, consistent with a high-beta, risk-on quarter where defensive positioning was penalized. Looking forward to the third quarter, the global economic outlook is clouded by the energy-driven supply shock and the elevated rate of inflation. The economy has shown great resilience to shocks, and we expect continued strength with the AI theme a driver of growth. However, central bank policies are likely to present a modest headwind, as many are expected to raise interest rates to address the above target inflation. As we head into the earnings reporting season for Q2 earnings, the estimated year-over-year growth rate for the S&P 500 is 23%. This consensus estimate has risen by 5% over the last three months. If we do achieve 23%, it will mark the second straight quarter of earnings growth over 20% and the seventh consecutive quarter of double-digit earnings growth for the index. Given the heightened earnings expectations and a forward price-to-earnings ratio above 20, any disappointing results or weaker earnings guidance could make for a bumpy ride in the market. Given how stretched the momentum factor is and the amount of concentration in the market, we believe it’s prudent to diversify with exposure to value and quality factors and to also look at smaller caps and global equities, where you can find strong earnings at cheaper valuations. And as always, risk management will be key to navigating volatile markets. Given the potential changes in the macro environment and the dominance of the AI theme, we think that managing risks along these dimensions will be important for the remainder of 2026.