Mid-Year Outlook: Guarded Optimism for Continued Growth

Equity markets reached record highs in the first half of 2026 amid geopolitical turmoil. While rising inflation and unsettled trade relations remain concerns, a strong fundamental backdrop driven by corporate earnings supports an optimistic perspective moving forward. Members of AGF’s Investment Management Team recently met to discuss what investors can expect from the markets and the economy over the next six months.  

Questions and answers that follow have been edited for clarity and length.

What are your big-picture takeaways from the first half of 2026?

John Porter (JP): The first half of the year was eventful. There was something for everybody: a little bit of war, a little bit of inflation, strong equity markets.

In my opinion, the market’s ability to look through all the geopolitical headlines on the strength of corporate earnings was the defining story. Markets ultimately follow earnings, and they won out in the first half of the year despite global uncertainty.

Bill DeRoche (BD): If you told me we were going to have a war and the Strait of Hormuz were going to be bottled up, I would not have expected equity markets to behave the way they did. I was really surprised.

David Stonehouse (DS): It’s hard to disagree with the fact that the fundamental backdrop remains resilient. I think there is always some reason for concern, but the balance of evidence would suggest that you still want to lean bullish.

The first half of the year was a tale of two different things: a bad shock and a correction associated with it that was appropriate, and a subsequent rebound because the underlying fundamentals were better than anticipated.

Stephen Way (SW): I would highlight the importance of AI, as it continues to dominate U.S. and global markets. Japanese equities did well, for example, largely because of the tech exposure and the AI opportunity. Korean equities did phenomenally well because of the memory prices. AI capital expenditure (CapEx) hugely contributed to U.S. economic growth in Q1.

Regina Chi (RC): Diving more into an emerging markets (EM) perspective, the first half of the year was characterized by a clear bifurcation in performance. Taiwan also benefited from the AI investment cycle like South Korea, while commodity-exporting countries in Latin America were supported by higher oil and metals prices.

In contrast, energy-importing markets such as India faced headwinds from elevated oil prices, and geopolitical tensions in the Middle East created greater uncertainty across parts of the region. Despite these divergent outcomes, corporate earnings remained resilient across much of the emerging market universe, reinforcing the importance of active country and stock selection.

Tom Nakamura (TN): In rates and foreign currency, you can’t escape the war in Iran. It was a very important driver in the shape of the first half of the year and will probably continue to have a lasting impact, especially around inflation and monetary policy.

The war really short-circuited market expectations around what the U.S. federal policy would look like this year. January was a bad month for the U.S. dollar, but this short-circuiting has allowed it to remain a higher carrying currency in the developed world.

What is your overall impression of the global economy and financial markets heading into the second half of the year?

JP: While the potential for rising inflation is a concern and the continued bifurcation between the haves and have-nots continues to be a political stress point, the corporate earnings trends are powerful and appear as if they are going to be unrelenting. That’s a good platform for the market and I think it will continue into the second half of the year.

BD: It’s hard to disagree, right? Corporate earnings revisions have been positive; they’re probably 10% higher than they were at the beginning of the year. Anytime you can see the market being driven by earnings growth, that gets me excited. We don’t need to see multiple expansion to see the market higher by the end of the year.

With that said, there is always something lurking around the corner. The severe correlation between momentum and the market is troublesome when I look at it because a correction in the former would suggest a correction in the latter. I’m not predicting that, but you definitely want to mitigate your exposure to it.

Inflation is the big risk because it could offset any earnings growth we see.

SW: It is worth wondering if profit margins are sustainable at this current level. The 2026 estimates are 75% above the log-linear trend dating back to 1990.

Outside of the United States, Europe remains kind of stalled. It has faced some headwinds from the Strait of Hormuz closure because of its reliance on energy imports. Japan also faced some headwinds from that but fared better because of the technology exposure. So, while the Japanese economy continues to normalize, the European economy remains without a lot of growth drivers.

RC: The outlook for emerging markets remains constructive as easing oil prices should provide a tailwind for many net energy-importing economies, helping to support growth and improve inflation dynamics. At the same time, the AI infrastructure build-out is broadening beyond the U.S. and into emerging markets, with increasing investment in data centers, power infrastructure, semiconductors, and digital connectivity creating a multi-year capital spending cycle that should support corporate earnings across a wider set of countries.

TN: I think the economies are okay, not great. There is vulnerability, whether it comes through sticky inflation or a monetary policy mistake.

SW: There is also this whole AI bubble narrative, right? Private sector non-residential investment in the U.S. is now at 14% of the economy and peaked at 15% during the tech boom and bust in the late 1990’s. We’re getting closer to the peak again – if not beyond it – depending on what measure you use. We need to see some returns on all the AI investments that have been made, either via productivity gains or some other form of monetization. The willingness of the market to continue to fund those AI investments is an important consideration.

DS: That is what I was going to key in on. At the end of the day, the variability in the economy is predominantly driven by investment through cycles. The consumer side is generally more stable. It’s the variability in the business cycle the investment side – predominantly business capital expenditures and housing to a lesser extent – and on the government side that tends to drive the economic cycle. The Citigroup Economic Surprise Index suggests we still have a great backdrop for that.

Moving forward, what kind of action and communication should we be expecting from central banks in the U.S. and beyond?

TN: Less information. A lot less talking, which makes it hard. But if we are right in the U.S. economy being okay, that suggests there is no real reason to cut rates. If we do see the Iran situation continue to improve and energy prices stay modest to ultimately keep inflation steady, then there probably is no real reason to hike, either.

DS: Nominal GDP growth is around 6% annualized in the U.S. – you cannot justify a rate cut in that kind of world.

JP: The challenge with the forecasting question is you need to know the action of the U.S. Federal Reserve (the Fed) and the why, and probably nobody is going to know both of those things.

The U.S. Federal Reserve Chairman Kevin Warsh doesn’t know for sure what his actions are going to be six months from now. If he raises rates, it could be because inflation is continuing to get out of control or because Nominal GDP growth is raging beyond 6%. If he’s cutting rates six months from now, it could be because inflation is subsiding or because the job market is deteriorating rapidly. I just don’t think it’s a knowable situation.

DS: On the communication point, I believe the concern around the withdrawal of forward guidance is overblown. The Fed has had to change their rhetoric and even their outright policy decisions on many occasions when circumstances have veered away from their expectations because the future is so hard to predict.

Forward guidance may be helpful in extreme situations such as promising to keep rates at zero for a while coming out of the 2008 and 2020 crises, but otherwise it has not had any substantial efficacy. There are valid reasons to anticipate more market volatility going forward, but I don’t believe a lack of forward guidance will be a contributing factor. Otherwise, the historical use of forward guidance in and of itself should have dampened market volatility, and yet volatility has directionally been rising ever since Powell became Fed chair in 2018.

SW: Globally, I think the European Central Bank is probably going to hike rates, which is probably a mistake. I don’t think the economy needs it.

The Bank of Japan has continued to normalize rates. We’re at 1% now, but real rates – even if they hike one more time this year, which I think they will – remain negative there. It hasn’t had a negative influence on the stock market so far.

DS: The situation in Canada is not as good as the U.S., but not as bad as the headlines would suggest. The interest rate environment this decade has weighed on both housing markets and still weighs on Canada. That means the consumer here looks weaker.

The benefit for Canada, however, is increased infrastructure spending. It’s more on defense, it’s more on major infrastructure projects, it’s more on trying to catch up in areas where we’ve lagged. We have had a decade of underinvestment and poor productivity, and Prime Minister Mark Carney seems determined to correct that. 

Canada’s GDP for the last two quarters is technically negative, but the underlying demand is not. Business investment is solid. There is just a bit of a timing issue with some of the numbers on the headline GDP that I’m not worried about. We’re not in recession, but it is anemic relative to the U.S.

What impact should we be expecting new and ongoing geopolitical issues to have on the markets and the economy?

SW: The markets really looked through this most recent crisis in Iran. The oil price spiked, but the market wanted to look through it because history suggests geopolitical issues should be looked through unless they impact our economy.

For the second half of the year, obviously midterm elections are coming up. You have got the French presidential elections next year, so there will be some commentary on those starting probably in the fall in Europe. You’ve got the seventh Prime Minister in 10 years in the UK, potentially, if Andy Burnham is elected by the party. Those are all going to be out there, but I don’t know if they will have any meaningful impact on the markets.

JP: A split government in the U.S. is almost certain, which, historically, is good for markets because it means both sides spend the next two years fighting with each other rather than passing bills. The current political divide effectively guarantees inaction.

SW: Markets have generally been weaker in Q2 in the United States leading up to midterm elections. However, if you dig into the numbers a bit, this weak historical trend has been influenced by a few large downdrafts that occurred for reasons not related to the election cycle. If you exclude those specific downdrafts the market data looks better.

DS: The other geopolitical thing that I think is a bit of a risk that people aren’t as focused on is trade. I think it’s going to be a key aspect of the second half of the year. There are a lot of negotiations coming, a lot of sections of different trade acts that will be playing out over the next while. At the margin that has the potential to cause some noise.

RC: Emerging markets have become increasingly resilient to volatility through greater supply chain diversification and stronger domestic growth drivers. While trade negotiations and regional conflicts may create short-term uncertainty, they are also accelerating investment into new manufacturing hubs and reshaping global supply chains in ways that create long-term opportunities.

Are there any reasons to believe that major equity benchmarks won’t keep rising in the coming months?

RC: It would not be surprising to see periods of consolidation as investors digest elevated expectations and ongoing policy uncertainty following such a strong first half of the year.

JP: In terms of things that can help the markets continue to climb, I think it relates to this important topic at the top of the corporate earnings trend. Where do operating margins go in the U.S. – can we see continued, if not accelerating, expansion from AI productivity?

I’m an optimist by nature, so I would say there is a pretty good chance it starts to happen. I don’t know if it will be in the second half of 2026 or start at some point in 2027, but I do think the next leg of growth for the markets will be driven by the magnitude and timing of the benefits from some of this AI spending.

DS: I think you are exactly right with the operating margins, and I don’t think it is a 2026 problem. I still don’t think there will be enormous waves of AI productivity soon though. It’s likely a few quarters, if not a few years, down the line.

SW: There could be some profit taking in sectors like semiconductors that were driven by momentum and produced phenomenal returns in the first half of the year.

BD: Momentum goes up like an escalator and down like an elevator. We’re at the point where you have to be worried about it.

SW: There are also higher levels of leverage in the marketplace. Not at concerning levels, but an unwind of leverage – whether it’s leveraged ETFs or margin – could also cause some volatility. Also, historically, the market will test a new Fed governor.

DS: I’m not overly fussed on the market taking a run at Warsh. He’s a Fed veteran who has already been there once and has already laid out a pretty clear path that suggests he’s being vigilant and not soft. I think those concerns are overblown.

In fact, for the last five Fed chairs going back to Volcker in 1979, the S&P 500 Index’s performance has been less than 5% lower or higher in the first three months after they took office with one notable exception being Black Monday on October 19, 1987, which took place two months after Greenspan started and resulted in a 25% one day decline. Outside of that, there was only one intra-period drawdown of approximately 10% during the first three months of a new chair’s term, which occurred when Volcker raised rates 150 basis points in one session to combat runaway inflation in 1979.

SW: Globally, you do have this huge valuation disparity between the United States and the rest of the world. If you look at the current Cyclically Adjusted Price-to-Earnings (CAPE) ratio – which compares a stock index to the last 10 years of inflation-adjusted earnings – the U.S. is at 40 times versus 20 times for Europe. We’ve never been at that level of dispersion. It tells you the level of optimism that is embedded into U.S. equities and the level of pessimism in European.

JP: I would dispute that. I think what that tells you is the market’s underestimating US corporate earnings growth and overestimating European corporate earnings growth, which would be a continuation of a decade-plus long trend.

BD: We keep seeing emerging markets looking better on our quantitative modelling screens; that may be an area worth taking a peek at as well.

RC: Agreed. They continue to offer attractive opportunities, supported by improving corporate earnings, reasonable valuations relative to many developed markets, and long-term structural growth themes that extend well beyond the current market cycle.

SW: Many stocks in different sectors have also been hurt because they are being viewed as being AI disrupted. I think there will be selective opportunities within that basket for those willing to dig. Software is one area, but you’ve also seen some of the exchanges and industrials sold off due to this disruption.

Healthcare is another more contrarian place to look in the second half. You could get a rebound with a lot of the noise the industry was facing due to Most Favored Nation Drug Pricing and other initiatives kind of behind us.

JP: I like that. The other thing I would say quietly in the same vein is that small capitalization stocks have perked up. So, I’m more optimistic about U.S. stock market performance “broadening down” in terms of market cap size.

Which areas of the fixed income market do you expect to drive performance, and which may be more challenging?

TN: Right now, the non-core areas of the market like high-yield corporate bonds are pretty attractive. For emerging markets, I think there is still an opportunity on both the currency side and the rate side. That’s a pretty good tailwind. I am not particularly down on core rates, but I do think there is limited upside.

I do think there are select global opportunities because the economic cycles are a bit shattered right now. The steepness of the yield curve in Japan is proof of the disparities we’re seeing in rates worldwide. There are some opportunities for active managers in that space.

DS: At the end of the day, despite all the volatility, we have been range bound in North American sovereign bond yields for around four years. The longer that you stay in a range that is not extremely wide, the more likely it is that eventually you are going to break out in one direction or another.

I think corporate bonds look fine as Tom alluded to; the problem is that the spreads are tight and reflect that. We don’t see a lot of room for spread tightening.

It’s been a little disconcerting seeing the degree of flattening in the yield curve over the last while and Warsh’s initial press conference just piled onto that. I don’t think the curve is going to invert, but I do think we’re still in a higher structural inflation environment than we have been historically. That should result in some degree of steepening here. I don’t see a huge tightening cycle in the current environment.

It’s not great for the long end. Still, at the end of the day, the long end is range bound so it’s not overly problematic, either. It would be a healthy backdrop for equities and for the economy overall if you saw that kind of steepening world.

How should we anticipate major currencies to behave?

TN: We’ve seen big moves through the first half of the year in both U.S. dollar and individual currencies. I do think the U.S. dollar looks a little bit stretched in the short term here. Some of the other currencies probably look better.

There are good dynamics in emerging markets as we’ve seen a return to power in elections with more market-friendly governments being put into place. Hungary, Colombia, and then Brazil is the next big one we get later this year. They are all restoring some confidence in investing in EM within the fixed income community.

On the Canadian dollar, I do think the markets have been playing up the trade concerns in contrast to what David expressed earlier. If we do end up with a more benign scenario – which would be my vacant base case – I think there’s some room for the Canadian dollar to rebound. I think it will be a bit of a calmer ride compared to the first half of 2026.