Can the 2026 Rally Continue? Earnings Say Yes. The Fed Says "Maybe"

The S&P 500 has rallied roughly 9% through the first half of the year despite navigating a war between the U.S. and Iran, a spike in oil prices, and a leadership change at the Federal Reserve. That combination naturally raises an important question for investors: Can this rally continue into the second half of the year?

We believe the answer depends on three factors. First, corporate earnings remain exceptionally strong and continue to provide the foundation for this bull market. Second, the transition to a new Federal Reserve Chair has introduced a new source of uncertainty. Finally, history suggests midterm election years often bring increased volatility, even when the longer-term trend remains positive.

Taken together, we believe the fundamental backdrop continues to support equities. The market has already demonstrated remarkable resilience this year, but we expect that resilience will continue to be tested as investors navigate the evolving outlook for inflation, monetary policy, and geopolitics.

Strong Earnings Continue to Support the Market

One of the most important developments during the first half of the year has been a rally driven by improving corporate earnings rather than expanding valuations. According to FactSet Research, first-quarter earnings grew nearly 28.8% year over year, and second-quarter earnings are currently tracking toward more than 23% growth. If those estimates hold, it would mark the second consecutive quarter of earnings growth above 20% and the seventh straight quarter of double-digit earnings growth for the S&P 500.

Source: FactSet Earnings Insight, June 26, 2026[1]

More importantly, analysts continue raising the bar, and the climb has been steady. At the start of the year, analysts expected roughly 14.9% earnings growth in 2026. By March, that estimate had risen to 17.1%, and today it stands at 24%. Estimates for 2027 have followed a similar trajectory, rising from about 14.7% at the start of the year to 16.5% in March and nearly 17% today. That steady progression across three separate points in time is unusual. Earnings estimates typically move lower as the year unfolds, not higher.

Chart. S&P 500 Calendar Year 2026 & Calendar Year 2027 Bottom-Up Earnings Per Share Estimates

The S&P 500's forward price-to-earnings multiple is lower today than it was at the start of the year (20.1x as of June 26 versus 22.0x at year-end 2025), despite the index posting double-digit gains and earnings expectations improving significantly over that same period. In other words, the market's advance has been driven primarily by stronger earnings expectations rather than investors simply paying more for the same dollar of profit. The table below illustrates this progression. Throughout the year, earnings expectations have steadily increased, while the valuation investors assign to those earnings has changed very little and remains below where the year began.

Sources: FactSet Earnings Insight January 9, 2026[2] and June 26, 2026 reports[3]

Research from Fundstrat reaches a similar conclusion. As shown in the chart below, consensus 2027 earnings estimates have increased by roughly $48 per share since December 2025, even as the forward valuation multiple has compressed by a full point. That reinforces our view that improving earnings, not higher valuations, have been the primary driver of this year's rally.

Source: Fundstrat, FS Insight Macro Research, June 25, 2026.[4]

A New Fed Chair Brings New Challenges

Strong earnings continue to provide the foundation for this rally. However, even fundamentally healthy markets experience periods of uncertainty, and we believe the Federal Reserve transition represents an important near-term test. Kevin Warsh was sworn in as Fed Chair in May 2026, and history is not entirely kind to new Fed chairs: across the last several transitions, the S&P 500 has averaged a meaningful drawdown within the first three to six months as markets “test” a new chair's policy approach.

Source: Bureau of Economic Analysis[5], Federal Reserve Board[6] and Carson Research[7]

Warsh enters the role in a challenging environment. At the June FOMC meeting, the Committee's projections shifted meaningfully from March. Rather than expecting one rate cut in 2026, half of the Committee now projects at least one rate hike. As the chart below illustrates, Core PCE inflation has continued to move higher, rising to 3.3% in April and 3.4% in May, the highest readings since late 2023. Unlike headline inflation, Core PCE excludes food and energy prices, making it one of the Federal Reserve's preferred measures of underlying inflation. The recent increase suggests inflation pressures extend beyond higher oil prices alone and likely reflect a combination of tariff-related price increases and persistent inflation in the services sector. While inflation has moved well below its 2022 peak, the Federal Reserve remains above its 2% target, giving policymakers a reasonable basis for remaining cautious.

Chart. PCE Inflation

One indicator we're watching particularly closely is the 2-year Treasury yield. Historically, it has tracked the Federal Reserve's policy rate because it reflects where investors expect short-term interest rates to average over the next two years. As the chart below illustrates, the 2-year Treasury yield has recently moved meaningfully above the current Fed funds target range, signaling that investors expect monetary policy to remain tighter than today's policy rate would suggest.

Chart. 2-Year Treasury Yield vesus the Fed Funds Target Range

That shift in expectations is worth monitoring closely. If expectations for additional tightening begin to ease, lower 2-year Treasury yields would likely provide support for both bond and equity markets. Conversely, if yields remain elevated, financial conditions could remain restrictive for longer, weighing on equity valuations and increasing concerns about economic growth.

Whether the market's expectations ultimately prove correct depends largely on what is driving inflation and how persistent it proves to be. In our view, the source of inflation matters just as much as the inflation rate itself. As the chart below illustrates, wage growth continues to trend lower even as Core PCE has moved higher. Because wage growth is one of the Federal Reserve's key indicators of persistent inflation, that divergence suggests today's inflation is being driven primarily by higher energy prices and other supply-side pressures rather than broad-based inflationary pressures. While this is not a reason for complacency, it does suggest the market may be overestimating how much additional tightening will ultimately be needed.

Chart. Employment Cost Index: Wage Growth

The uncertainty surrounding inflation and monetary policy is likely to keep markets volatile as investors reassess the outlook. We do not, however, believe those risks are sufficient to outweigh the improving earnings picture discussed earlier.

Midterm Years Are Bumpy, But They Tend to Resolve Higher

2026 is a U.S. midterm election year, and markets have historically followed a fairly consistent pattern during midterm election cycles. Returns tend to be weak and choppy in the run-up to the election, with the market historically not bottoming until the August-to-September window. The more important point is what happens afterward. Since 1950, the S&P 500 has never posted a single negative one-year return in the 12 months following a midterm election, and average returns over that 12-month window have historically run well above the market's long-run norm. [8]

History is never a guarantee. The historical sample is relatively small, and today's environment includes challenges that previous midterm cycles did not, including sticky inflation, a new Federal Reserve Chair, and a geopolitically driven oil shock. While no two market cycles are identical, we believe history provides a reasonable framework for viewing any pre-election turbulence, combined with the Federal Reserve transition discussed above, as part of a normal market cycle rather than a reason to materially reduce equity exposure.

Other Supportive Indicators We’re Watching

• Credit spreads remain stable and historically tight. The bond market, which tends to lead equities into trouble, is not signaling stress.
• The AI investment cycle remains intact, with corporate capital spending and management guidance continuing to support long-term earnings growth.
• More than $8.2 trillion remains in money market funds, providing ample liquidity that could support the market as cash is redeployed into equities.[9]
• Consumer confidence is sitting near depressed levels, historically a contrarian indicator that has preceded above-average forward equity returns rather than a warning sign.

One Short-Term Risk to Watch

Margin debt has climbed to record highs, reflecting increased investor optimism. Historically, elevated leverage has often been followed by periods of consolidation as investors reduce risk. While that can lead to increased volatility, it has typically been a feature of ongoing bull markets rather than a signal that the broader trend has ended.

Conclusion

It's worth stepping back and remembering what this market has already endured. Since 2020, investors have navigated a once-in-a-century pandemic, a global supply chain shock, the fastest inflation surge in four decades, one of the most aggressive Federal Reserve tightening cycles in history, sweeping tariff disruptions, the bombing of Iran's nuclear facilities, and a subsequent U.S.–Iran conflict. That is seven extraordinary shocks in six years, yet the S&P 500 has continued to reach new highs along the way. While that resilience does not guarantee the next challenge will be absorbed as easily, it is a reminder that markets have repeatedly proven more durable than the headlines would have suggested.

The evidence continues to support a constructive outlook. Earnings are accelerating, valuations remain supported by improving earnings, and the broader investment cycle continues to benefit from healthy corporate fundamentals. At the same time, a new Federal Reserve Chair, an unsettled inflation outlook, and the historical volatility associated with midterm election years suggest investors should expect periods of increased volatility.

Our overall view has not changed. We believe the rally can continue, but we do not expect the path higher to be a straight line. As always, we'll remain focused on the long-term fundamentals that drive markets rather than the short-term headlines that often dominate investor sentiment.

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