Khan Capitals | July 2026
Key Takeaways
- The best quarter since 2020, against the odds. The S&P 500 rose about 14.9% in the second quarter and the Nasdaq about 21.4%, the strongest quarter for both since 2020, even as an oil shock and rising inflation ran in the background.
- Semiconductors led an extraordinary run. The Philadelphia Semiconductor Index rose roughly 88% in the quarter, its best on record, as the artificial intelligence trade dominated returns.
- Earnings, not just sentiment, did the work. Blended second-quarter earnings growth ran near 23%, well above the 18.8% expected at the quarter’s start, led by technology and communication services.
- The gains were narrow. A handful of AI-linked giants, Alphabet, Amazon, Meta, Micron, and Nvidia, drove the bulk of the index’s earnings growth, leaving the rally dependent on a small group.
- Inflation is the shadow over the second half. With core inflation at a three-year high and the Federal Reserve leaning hawkish, the calm that powered the rally is the very thing most at risk.
A Half That Began in a Correction and Ended at Records
It is easy to forget, looking at the closing figures, how badly the year began. The first quarter of 2026 delivered a genuine correction, a drawdown driven by the Iran conflict, an oil spike, and a growth scare that we chronicled in our Q1 market correction wrap. An investor who looked away in March and back in late June would see a market at record highs and assume a placid six months. The reality was a round trip: a sharp fall, then one of the most powerful quarterly rallies in a generation, producing the best quarter since 2020 for the major US indices and a first half that finished firmly in the green.
The turn came as the war premium drained away. A US-Iran memorandum of understanding in mid-June, and the ceasefire framework that followed, pulled the geopolitical risk out of oil and equities alike. As crude fell back towards $70 and volatility subsided, the conditions were set for risk appetite to return, and it returned with force. By the end of June the Dow had closed above 52,000 for the first time, the S&P 500 had booked its best quarter in six years, and the Nasdaq had posted its strongest quarter since the pandemic rebound of 2020.
The Numbers Behind the Best Quarter Since 2020
The scale of the second-quarter move is worth setting out precisely, because the headline masks how concentrated the leadership was.
| Index | Q2 2026 return (approx.) | Context |
|---|---|---|
| S&P 500 | +14.9% | Best quarter in six years |
| Nasdaq Composite | +21.4% | Best since Q2 2020 |
| Philadelphia Semiconductor Index | +87.8% | Best quarter on record |
| Dow Jones Industrial Average | Record high | Best first half in five years; closed above 52,000 |
Across the full half, the S&P 500 finished up roughly 9%, a more modest figure that reflects the first-quarter hole the second quarter had to climb out of. The distance between that 9% half-year gain and the near-15% quarterly surge is the story of the year in a single contrast: a market that fell hard, then rallied harder, and ended up ahead.
What Drove It: AI, Oil, and Calm
Three forces combined to produce the rally. The first and most powerful was artificial intelligence. The build-out that has dominated markets for two years moved from promise to hard numbers this quarter, and the companies at its centre delivered results that justified, at least for now, the capital pouring into them. The memory supercycle we examined in Micron’s record quarter was one expression of it; the reach of the theme into consumer prices, traced in the AI memory price shock, was another. The trade even reshaped the market’s most-quoted benchmark, as Alphabet joined the Dow at the end of June.
The second force was oil, or rather its retreat. The same collapse in the war premium that ended the first-quarter correction removed a major headwind, easing the inflation and margin fears that a triple-digit crude price had stoked. The third was volatility, or the lack of it. As the geopolitical risk faded, equity volatility fell, and calm markets are fertile ground for rallies: they encourage risk-taking, they reopen the issuance window, a dynamic we covered in the record first half for IPOs, and they let fundamentals rather than fear set prices.
Earnings Did the Heavy Lifting
What separates this rally from a purely sentiment-driven melt-up is that the earnings arrived to support it. Blended second-quarter earnings growth for the S&P 500 ran near 23%, comfortably above the 18.8% analysts had pencilled in at the start of the quarter, and ten of the eleven sectors were on track for year-on-year growth. The leadership was emphatic: information technology delivered earnings growth of around 55% and communication services around 49%, the two sectors most exposed to the AI theme. Only healthcare was expected to post a decline.
That earnings backdrop matters because it changes the character of the move. A rally built on multiple expansion alone is fragile, vulnerable to any shift in sentiment or rates. A rally underwritten by 23% earnings growth has firmer foundations, even if the valuations layered on top remain demanding. For the moment, profits have a genuine claim on the market’s direction, and that is the strongest argument the bulls have.
A Rally on Narrow Shoulders
The caveat is concentration. The top five contributors to the index’s earnings growth were Alphabet, Amazon, Meta, Micron, and Nvidia, the same cluster of AI-infrastructure names that has led the market for two years. When a handful of companies account for a disproportionate share of both the earnings and the price gains, the index becomes a leveraged bet on a single theme, however well that theme is currently performing. The chart below shows how lopsided the earnings leadership was.
There were, encouragingly, early signs of the leadership broadening. In the final weeks of the quarter, as technology paused, money rotated towards healthcare, industrials, and financials, and the equal-weighted S&P held up better than the headline index on several sessions. Whether that rotation deepens or fades is one of the more important questions for the second half. A rally that broadens is durable; one that stays confined to five names is exposed to any stumble by those five.
The Shadow Over the Rally
For all the strength of the quarter, the second half opens under a cloud that the rally has so far chosen to look past. Inflation is reaccelerating. Core inflation reached a three-year high in the spring, a print we analysed in our note on the core PCE reading behind the Fed’s hawkish turn, and the Federal Reserve under its new leadership has shifted from debating cuts to openly weighing hikes, a regime change we have tracked through Warsh’s first FOMC. Markets now assign meaningful odds to a rate rise later in the year.
This is the central tension of the second half. The rally was built on calm markets, contained yields, and the assumption that policy would not tighten further. Each of those foundations is now in question. A renewed climb in yields would compress the valuations on which the AI leaders most depend, and would test whether 23% earnings growth is enough to offset a higher discount rate. The market has, for now, decided that earnings win. The inflation data will decide whether that confidence was justified.
What History Says About Narrow Rallies
Narrow leadership is not new, and the historical record offers a mixed verdict on what tends to follow it. The 2020 recovery, the last time the major indices posted a quarter this strong, was itself powered by a small group of mega-cap technology names, and that concentration persisted well into 2021 before the market briefly broadened. The artificial intelligence rally of 2023 was narrower still at its outset, carried by a handful of chip and platform companies before participation slowly widened. In both cases, the concentration was sustainable for longer than sceptics expected, precisely because the leading companies kept delivering the earnings that justified their weight.
The cautionary chapter is 2022. When the cost of money rose sharply, the same concentration that had amplified the gains amplified the losses, and the mega-cap leaders that had carried the indices up carried them back down. The lesson is not that narrow rallies must end badly, but that their fate is tied unusually tightly to a single variable. In 2021 and 2022 that variable was interest rates, and it is interest rates again that pose the clearest threat now. A rally concentrated in long-duration growth stocks is, in effect, a leveraged position on the path of yields, whatever else it appears to be about.
What distinguishes 2026 from the more speculative episodes is the quality of the earnings underneath. This is not a rally of profitless promise but of companies generating enormous and growing cash flows. That does not make the concentration risk disappear, but it does mean the market has more to fall back on than sentiment if conditions tighten. The question is whether even strong earnings can hold valuations up against a rising discount rate, a test the second half seems likely to set.
How the Pieces Fit
The individual stories of the half all trace back to a single engine. The AI build-out drove the earnings that powered the rally, created the memory shortage that reached consumer prices, reshaped the composition of the Dow, and supplied much of the issuance behind a record IPO market. Even the macro backdrop bends around it: part of the inflation pressure now worrying the Fed originates in the same data-centre demand that is lifting the chipmakers. To understand the best quarter since 2020 is to understand that one theme has become the market, for better and, eventually, perhaps for worse.
Investor Implications
In equities, the half leaves investors with a familiar dilemma sharpened by strong returns: the leadership is expensive and concentrated, yet it is backed by real and growing profits. The case for participation rests on earnings; the case for caution rests on valuation and breadth. A rotation towards the lagging sectors, if it holds, would be the healthiest possible development, spreading the market’s reliance across more shoulders. In fixed income, the signal points the other way: reaccelerating inflation and a hawkish Fed argue for higher-for-longer yields, the single greatest threat to the equity rally’s valuation support.
Cross-asset, the half confirms a theme rather than resolving it. Capital is concentrating around artificial intelligence with a force that has now touched equities, credit, commodities through the memory-driven demand for power, and even the definition of the headline indices. The opportunity and the risk are two sides of the same coin: a market this dependent on one story will move a long way in whichever direction that story next turns.
What to Watch
- The autumn FOMC meetings: whether the Fed follows through on the hawkish turn, the most direct threat to the rally’s valuation foundation.
- Second-quarter and third-quarter earnings: whether the AI leaders keep delivering the growth that has justified their weight, and whether the rest of the market catches up.
- Market breadth: whether the late-quarter rotation into healthcare, industrials, and financials broadens the rally or fizzles.
- Oil and geopolitics: whether the Iran ceasefire holds, since a renewed spike in crude would revive the inflation and growth fears that defined the first quarter.
Conclusion
The first half of 2026 will be remembered for its shape as much as its size: a frightening correction, then a rally of a scale the market has not seen since 2020, ending at record highs. It was a half in which earnings genuinely delivered, in which the AI build-out proved it could produce profits and not just promises, and in which the calm that followed a geopolitical de-escalation let those profits set prices. Yet the same half planted the seeds of its own test. Inflation is rising, the Fed is turning, and a market that has climbed on the assumption of continued calm now has to prove it can hold those gains as that assumption comes under pressure. The best quarter since 2020 was real. Whether it was also durable is the question the second half will answer.
Frequently Asked Questions
How did the stock market do in the first half of 2026?
After a first-quarter correction, US stocks staged a powerful recovery. The S&P 500 rose about 14.9% in the second quarter, its best in six years, and finished the half up roughly 9%. The Nasdaq gained about 21.4% in the quarter, its strongest since 2020.
Why did stocks rise so much in the second quarter of 2026?
Three factors aligned: strong AI-driven earnings, a fall in oil prices as the Iran conflict eased, and lower volatility. Blended second-quarter earnings growth ran near 23%, above expectations, giving the rally a genuine profit foundation rather than sentiment alone.
Which sector performed best?
Semiconductors led decisively. The Philadelphia Semiconductor Index rose roughly 88% in the quarter, its best on record. More broadly, information technology and communication services delivered the strongest earnings growth, at around 55% and 49% respectively.
Is the rally sustainable?
That is the central question for the second half. The rally is supported by real earnings but is narrow and expensive, and it faces a clear risk from reaccelerating inflation and a hawkish Federal Reserve. A rise in yields would test the valuations of the AI leaders that have driven the gains.
Sources: Reuters via Investing.com; FactSet Earnings Insight; CNBC; EBC.
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Related Reading: The quarter’s threads are told in full across the AI memory price shock, Alphabet joining the Dow, and the record IPO first half. The correction that opened the year is covered in the Q1 2026 market wrap, and the policy risk hanging over the second half in the core PCE reading behind the Fed’s hawkish turn. The story continues in The June Jobs Report: 57,000 and the Hike That Faded. The banks then reported the earnings that rally produced, in Wall Street’s record quarter. For the fundamentals, start with how IPOs work. See also market breadth and rotation.
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