Sector Market Perspectives: Q2 2026

Geopolitics, commodity supply disruptions, and AI CapEx are impacting US sector fundamentals, creating new dynamics for sector investors.

The war in Iran has introduced meaningful supply-side shocks to the global economy, lifting inflation risks and moderating growth expectations. However, the US economy continues to demonstrate resilience, and recession risk has not materially increased. Instead, the current macro backdrop is defined by renewed inflation pressure driven by supply shocks, slower but still-positive growth, and greater dispersion in how sectors absorb and respond to these pressures.

While geopolitical uncertainty has increased, it does not materially overshadow the medium-term forces already shaping the US sector landscape heading into this year. Fiscal support linked to the One Big Beautiful Bill Act (OBBBA) capital expenditure (CapEx) incentives, accelerating AI infrastructure spending, and ongoing supply chain reshoring remain intact. These structural drivers carry clear sector implications—from sustained demand across Industrials, Utilities, and Technology to continued resilience in areas tied to infrastructure and manufacturing buildout.

Meanwhile, consumer conditions were already weakening ahead of the war in Iran, and the current environment amplifies that softness. As wage growth has decelerated to near its pre-pandemic norm,¹ persistent inflation and elevated energy costs are likely to continue to erode real disposable income and personal savings, with the most acute impact felt across lower- and middle-income households. This softening in consumption introduces a more challenging environment for sectors sensitive to household spending such as Consumer Staples and Consumer Discretionary.

The monetary policy outlook has also become more uncertain. The pace at which supply-driven inflation moderates will likely shape the timing and magnitude of the Federal Reserve (Fed) easing with the risk now skewed toward delayed rate cuts—limiting support for rate-sensitive, cyclical sectors such as Financials and Real Estate.

Against this backdrop of elevated geopolitical risk and shifting policy expectations, cross-sector performance is likely to diverge over the next 6–12 months. In addition to interest rates, earnings resilience, margin durability, sensitivity to commodity prices, and exposure to fiscal and AI investment tailwinds will drive sector performance differentiation. These dynamics anchor our sector views and inform the tactical and strategic recommendations in the sections below.

Technology

Quarterly perspective: We are upgrading our stance on Technology to positive based on strong, broad AI-driven earnings growth and attractive valuations.

Technology is poised to continue leading earnings growth across the sectors in 2026 (+37%), more than double the broad market (+16%).² Since December, growth expectations have revised upward by 56%, with all six of Tech’s underlying industries expanding—led by semiconductors at +71%.³

AI demand is the major driver for this broad-based growth. The rapid expansion of AI workloads has led to strong and sustained demand for AI accelerator chips, which are projected to see a 16% compound annual growth rate (CAGR) through 2033.⁴ Meanwhile, memory chips and hardware storage are also in high demand as running large language models requires far more data to be stored, accessed, and delivered than traditional computing. Accelerating AI data center buildouts has led to a shortage of memory chips, and this bottleneck is expected to persist and boost prices through 2027.⁵ The electronic equipment, instruments, and components industry has also been boosted by strong demand for optical fibers, cables, and connectivity associated with AI buildouts, which is expected to see 21% earnings growth in 2026.⁶

The Q1 selloff in software names was largely driven by AI disruption fears rather than deteriorating fundamentals. In fact, the industry is still expected to post double-digit earnings growth (+17%).⁷ We view this re-rating as overly pessimistic, particularly for some dominant large-cap software-as-a-service (SaaS) companies given their deep integration of enterprise data, strong connectivity across enterprise systems, and high security standards. According to our fundamental equity analysts, growth in data infrastructure, cybersecurity, and end-point software is expected to accelerate, driven by increasing adoption of agentic AI.

Strong earnings sentiment and negative price action over the past few months have created attractive valuations in Tech. The sector’s absolute and relative next-12-months (NTM) P/E is in the bottom quintile of its past 5-year history.⁸ Although software led the selloff, valuation pressure has been broader, with semiconductor and software relative NTM P/E falling to their lowest levels since 2022 and 2015, respectively, creating a more attractive sector‑level entry point to AI growth exposure.⁹

Communication Services

Quarterly perspective: We maintain a positive outlook on Communication Services, supported by increasing digital advertising, AI monetization, and constructive valuations.

Digital advertising growth and AI monetization remain key growth drivers for the sector. US ad spending is forecast to accelerate from 5.7% in 2025 to 9.5% this year, boosted by major events such as the US midterm elections and the FIFA World Cup, along with broad-based digital ad growth led by social media and connected TV channels.¹⁰ Digital advertising is expected to comprise about 67% of US advertising spending in 2026, reaching approximately $443 billion,¹¹ and grow at a 15.1% CAGR through 2029.¹² The most compelling opportunity lies in interactive media and digital platforms where AI is directly embedded into existing social media and search products to enhance ad targeting, personalization, and conversion efficiency.

AI-driven monetization continues to underpin a resilient growth outlook for the interactive media & services industry—the largest segment of the sector by market capitalization¹³ —even amid persistent macroeconomic uncertainty and weaker consumer sentiment. The sector’s strong growth in 2025, despite tariff uncertainty, underscored how AI monetization more than offset broader macro headwinds. Looking ahead, the industry revenues are projected to rise 28.3% in 2026, surpassing 2025’s 16% increase, which was already the strongest growth since 2021, reinforcing the durability of its growth profile despite a challenging macro backdrop.¹⁴

Strong fundamentals are also evident across the sector, with upgrades outpacing downgrades, keeping it poised to deliver a fourth consecutive year of double-digit earnings growth in 2026.¹⁵ Valuation multiples have compressed meaningfully since January and relative valuations remain constructive, with NTM P/E remaining in-line with the S&P 500 and below its 15-year median premium of 7%.¹⁶ Overall, Communication Services offers a resilient, AI-powered growth opportunity with attractive valuations.

Consumer Discretionary and Consumer Staples

Quarterly perspective: We are becoming more negative in consumer sectors. While maintaining our negative outlook on Consumer Staples, we are downgrading Consumer Discretionary from neutral to negative.

Although consumer spending has been resilient, the strength has been largely concentrated within a narrow, high‑income cohort, while low‑ and middle‑income households face more acute inflation pressures and rising financial strain. This divergence matters: the financial health of low- and middle-income households is critical to sustainable growth for companies in the Discretionary sector. According to our fundamental equity team, very few businesses and consumer brands rely solely on high-income consumers, and most are not sustainable on high‑end demand alone.

At the same time, a key driver of consumer sector growth¹⁷ is weakening. The personal savings rate hovers near its lowest level since 2022, and consumer spending continues to outpace real income growth. Against this backdrop, higher gasoline prices are likely to offset much of the intended support from the OBBBA tax cuts, raising the risk of weaker consumer demand should elevated fuel prices persist. Eroding real income and low savings rates weaken the growth outlook for both Consumer Staples and Consumer Discretionary sectors.

Higher oil and other commodity prices also have the potential to weigh on profit margins of Consumer Staples companies. Input costs often rise faster than pricing can be passed through, especially in competitive, price‑sensitive categories. And incremental pricing power has become more constrained after repeated increases in recent years. These challenges are increasingly reflected in corporate fundamentals. Staples’ sales and earnings growth expectations for 2026 (5.8% and 6.1%, respectively) are among the lowest across the 11 GICS sectors.¹⁸  Discretionary growth expectations, while somewhat better, remain below the broader market and continue to be revised lower.¹⁹

Valuations offer limited offset. Staples multiples are stretched, ranking in the top decile for the past 15 years.²⁰ Discretionary valuations appear more constructive, but continued downgrades to earnings expectations suggest better news is needed before presenting a compelling entry point.²¹

Financials and Real Estate

Quarterly perspective: As the war with Iran lifts inflation risks and lowers growth expectations, we are moderating our view for the Financials sector from positive to neutral and downgrading Real Estate to negative.

Higher inflation expectations have lowered the probability of Fed rate cuts in 2026, tightening financial conditions and reducing one of the key macro tailwinds for Financials. In a prolonged energy disruption scenario, Financials could become susceptible to weakening consumer and business sentiment, postponements in capital market activity, and a hawkish Fed keeping financial conditions tight that possibly flatten the yield curve. The increasing risk of a prolonged energy disruption supports a more cautious stance on Financials until the terms of resolution become clearer.

Concerns about private credit have also weighed on parts of the sector, particularly in the alternative asset manager space, as retail redemptions from semi-liquid private credit funds have increased significantly. While alternative managers are a small part of the Financials sector, the key question is whether the stress in the private credit market may pose a greater systemic risk to the broader financial system.

We believe the risk is more contained. The most alarming private credit headlines over defaults are in the levered loan market which represent only 4% of all credit to the private non-financial sector.²² Additionally, the credit quality of most private credit borrowers, including software companies, remains stable.²³ That said, we are cautious and continue to monitor credit markets closely, particularly as tightening financial conditions and an uncertain Fed outlook persist.

Despite the evolving risk landscape, bright spots remain in Financials and we maintain a neutral—not negative—position. Notably, the recent dip in performance this year has meaningfully improved valuations for the sector. Financials’ relative NTM P/E valuations are near their lowest level since December 2021.²⁴ Should hostilities in the Middle East abate and productive negotiations begin resolving regional supply disruptions, Financials are poised for a bounce‑back, with performance potentially powered by improved M&A and IPO deal activity, easing financial conditions, and resumed curve steepening. Concurrently, the recently released Basel III Endgame and G-SIB proposals, if approved, will likely lower banks’ capital requirements by $50 billion,²⁵ unlocking greater lending capacity and boosting return on equity through larger buybacks. Should these catalysts begin emerging, Financials may warrant an upgrade.

The Real Estate sector shares similar downside risks to Financials, but with even weaker fundamentals. With lower rate cut expectations and weak earnings sentiment, we are downgrading Real Estate’s neutral position to negative. Rate cut uncertainty has eroded a key tailwind for Real Estate, which typically outperforms in a lower rate environment. Despite attractive sector valuations and light investor positioning, the sector’s low single-digit growth—the lowest across the 11 sectors—and continued downward revision driven by negative sentiment in cell tower, residential, and office REITs point to persistent headwinds for the sector fundamentals.

Industrials

Quarterly perspective: We remain positive on Industrials as the sector continues benefiting from AI‑driven infrastructure buildout, rising defense spending, and pro-CapEx fiscal policy.

Hyperscalers continue boosting AI-related capital spending, with 2026 CapEx projections revised up 29% since November to $651 billion—a 53% increase over the 2025 level.²⁶ Industrials are positioned as a “pick‑and‑shovel” beneficiary across the AI buildout value chain spanning power infrastructure, electrical equipment, advanced cooling systems, and data center construction.

Rising global defense spending provides another tailwind for the sector, particularly for aerospace & defense. Global military outlays reached a record $2.6 trillion in 2025 as geopolitical uncertainty and tensions have risen.²⁷ Escalation in the war with Iran is likely to reinforce this trajectory with shifting perceptions of national security across regions and evolving dynamics within security alliances.

Beyond longer‑term investment in deterrence capabilities, the war has already driven meaningful near‑term demand. In the first 16 days of the Iranian war, the Middle East coalition forces (ex-Iran) reportedly utilized more than 11,000 high-end munitions at an estimated cost of ~$26 billion.²⁸ The resulting need to replenish diminishing inventories by the US and its Middle East allies is likely to further boost new orders for the aerospace & defense industry.

Fiscal impulse with the OBBBA has also brightened the sector’s growth outlook. Through permanent 100% bonus depreciation, the OBBBA has materially lowered the after-tax cost of capital, incentivizing CapEx and boosting industrial activity. Early 2026 indicators point to a gradual revival in industrial activity. As of February, the six-month moving average of year-over-year industrial production growth reached its highest rate since August 2022.²⁹ And survey data point to further gains as the S&P March US Flash Manufacturing PMI shows accelerating new orders and outputs and upbeat growth expectations.³⁰

Taken together, these dynamics are reflected in a growth broadening at the industry level with more than half of the underlying industries expected to see double-digit growth this year, compared to only a third of industries in 2025.³¹ While valuations are elevated and nearly touching a 15-year high,³² accelerating industrial activity, noncyclical and price-insensitive demand from AI data center buildouts, and higher defense spending may justify the valuation levels.

Materials

Quarterly perspective: We are upgrading our view on the Materials sector from neutral to positive on the back of improved supply-demand balance in chemicals, structurally higher demand for precious and industrial metals, and attractive valuations relative to the sector’s strong growth profile.

The Iran war has disrupted the global supply chain of chemicals, creating a near-term opportunity for US producers to gain market share, especially in fertilizers, methanol, and polyethylene (PE) markets. The Middle East accounts for one third of global traded fertilizer feedstocks,³³ ~30% of global PE exports, and ~11% of global methanol capacity.³⁴ As Middle Eastern exports are curtailed by plant shutdowns and constrained logistics, and Asian producers face rising feedstock and energy costs, US producers are likely to benefit from stable, low-cost natural‑gas‑based inputs and rising global commodity chemical prices, supporting margin expansion and stronger sales volumes.

The war also reinforces the need for investment in renewable energy to strengthen energy resilience in Europe and Asia, providing a supportive long-term demand backdrop for copper, aluminum, nickel, and zinc miners and producers. Despite a 19% drawdown in gold prices in Q1,³⁵ structural demand for gold driven by rising global debt, FX debasement fears, and robust physical demand from emerging market central banks remains intact. Gold’s historical outperformance over 6, 12, 18, and 24‑month horizons following past oil shocks suggests medium-term price resilience, boding well for gold miners’ profits.³⁶

Materials’ recent pullback has created a more attractive entry point for investors to capture its strong growth profile. The sector’s NTM P/E has compressed 13% from its recent peak and is now trading at an 8% discount to its three‑year average.³⁷ Earnings growth for 2026 remains strong at 28%—the second highest across all sectors, supported by upbeat earnings revisions year to date.³⁸  Importantly, this growth is broad-based with all industries within the sector projected to deliver double-digit earnings growth in 2026.³⁹

Energy

Quarterly perspective: At the beginning of the Iran war, we upgraded our view on Energy from negative to neutral based on the fact the sector remains one of the most effective equity hedges for balancing spikes in oil and gas prices. Given the increasing risk of a more prolonged energy supply disruption and permanent shifts in Energy’s geopolitical risk premium, we are raising our view further to a positive stance.

The war and disruption to the Strait of Hormuz have spurred the largest global energy supply disruption in the oil market’s recorded history.⁴⁰ Even if the war proves short‑lived, it is likely to have a lasting impact on global energy markets rather than merely causing a temporary transitory shock. Markets can no longer treat disruption risk in the Persian Gulf as a low‑probability tail event where it is driving a higher and more durable geopolitical risk premium across crude, refined products, and liquified natural gas (LNG).

Further, structurally higher insurance, shipping, and financing costs are likely to elevate the marginal cost of energy delivery. And higher strategic reserve targets and inventory buffers may increase energy demand for states and businesses to manage energy security. As a result, spare capacity and reliable production demand are adding to greater scarcity value, creating a more supportive medium‑term backdrop for the Energy sector broadly, even in the absence of ongoing physical disruptions.

From a risk management perspective, adding Energy exposure may help to better manage an energy supply shock that exceeds current market pricing expectations. Despite the significant rally in Energy year to date, investor positioning in the sector remains under the peaks seen in prior oil rallies,⁴¹ and oil prices are still well below peak levels seen during the Russia-Ukraine crisis⁴² —leaving upside potential for revaluation.

Utilities

Quarterly perspective: We remain positive on the Utilities sector, given the sector’s earnings growth visibility and durable structural tailwinds. AI‑driven power demand, accelerating electrification, ongoing transmission and grid upgrades, and manufacturing reshoring continue to underpin the sector’s above‑trend growth profile.

Earnings per share (EPS) estimates for 2026 have steadily risen over the past six months with broad-based upgrades. Utilities now rank third in positive EPS revisions—behind only Tech and Materials.⁴⁴ Its 2026 growth expectation of 12.3% is nearly double its 10-year average.⁴⁵

Because building utility capacity requires significant resources and lead time, transmission and grid constraints increase the strategic value of incumbent utility companies with established footprints. Nuclear and gas‑fired generators could also see further re-rating as reliability and baseload capacity regain importance in both current and future power planning.

We are already seeing re-rating undercurrents, with the sector trading 19.0x next-12-month earnings, but still only 5% and 12% above its 5‑year and 15-year averages, respectively.⁴⁶ Even with this re-rating, valuations remain attractive on a relative basis, sitting in the bottom 31st percentile of their 15‑year range versus the S&P 500.⁴⁷ When factoring in its above-trend growth, valuations remain constructive and not stretched, presenting investors with a potential buying opportunity.

From a portfolio construction perspective, Utilities also offer diversification benefits. Despite the sector’s AI‑linked growth exposure, Utilities maintain a low correlation with traditional AI beneficiaries, such as Technology and Communication Services (0.38 and 0.39, respectively).⁴⁸ The sector’s less cyclical demand profile—anchored by regulated monopolies with stable cash flows—reinforces its defensive characteristics and positions Utilities as a potential diversifier for investors seeking AI‑driven growth with lower volatility.⁴⁹

That said, the sector is not without risk. Policy uncertainty around utility affordability has resurfaced, and the current war with Iran adds another layer of complexity. Utility companies generally pass through higher fuel costs via rate cases, offering investors stable income and margins despite a regulatory lag. But surging fuel costs may elevate affordability concerns ahead of the midterms. In our view, this is more likely to represent headline noise rather than serve as a catalyst for material policy intervention, given high legal hurdles, limited executive authority, and concerns that intervention could deter investment and exacerbate supply constraints.

Health Care

Quarterly perspective: We maintain a Neutral position on Health Care as the sector’s earnings growth is moderating, visibility on growth inflections remains low, and policy uncertainty persists, despite its attractive valuations.

While the long‑term outlook remains constructive—supported by aging demographics and product innovations addressing unmet needs in obesity, oncology, cardiology, and neurodegenerative diseases—the sector lacks near‑term, transformative catalysts to re‑accelerate growth in 2026. This is particularly evident in biopharmaceuticals, where visibility on major inflection points remains limited.

The highly anticipated weight loss/diabetes GLP‑1 theme alone has not been sufficient to lift the broader sector. At present, it remains a concentrated, two‑company story (with only one incorporated in the US) generating meaningful earnings from GLP‑1 therapies. As a result, the contribution to the rest of the biopharmaceuticals industry has been more muted than initially hoped.

Reflecting this backdrop, Health Care sector CY2026 earnings growth is now expected at +6.7%, with estimates having drifted lower from +8.9% at the start of the year.⁵⁰ If realized, this would mark the fourth time in five years that earnings growth has fallen below the long‑term average, reinforcing the sector’s near‑term growth challenges.⁵¹

Policy remains another source of uncertainty. While drug‑pricing risk for large pharmaceutical companies may be peaking following pricing agreements with the White House, policy uncertainty for managed care insurers remains elevated and is unlikely to be fully eliminated ahead of the midterm elections. Managed care companies continue to face margin pressure from tighter government reimbursement, ongoing pricing and transparency scrutiny, and persistent increases in labor and medical costs.

On the positive side, the sector’s defensive business mix and high‑quality characteristics have historically supported outperformance in periods of weaker growth and higher inflation.⁵² In a more adverse macro backdrop—such as a protracted war scenario that leads to demand destruction—Health Care could regain appeal, as it is the only defensive sector trading below its 5-year median valuation on both an absolute basis and relative to the broader market.⁵³

Potential catalysts that could support an upgrade to a positive view include an above-expectation successful launch of GLP-1 oral pill that meaningfully reinvigorates investor expectations around the obesity total addressable market, breakthroughs in the cardiovascular space, and clearer signs of earnings stabilization across sub-industries within the sector.