With a total return of approximately 10% in the first half of the year, the S&P 500 is on track to achieve a feat that has only occurred once in its 68-year history if it closes above 7,530 points for the full year. In his mid-year market review, Tony Pasquariello, head of the hedge fund business at Goldman Sachs, noted that the current market environment is the most dynamic he has witnessed in his 27-year career.
The accelerated build-out of AI infrastructure has been the dominant theme of the first half. According to Goldman Sachs custom basket data, the memory sector has surged 250% year-to-date, the data center sector is up 115%, and the AI semiconductor sector has gained 101%. Concurrently, North Asian equity markets have delivered standout performances, with the South Korean KOSPI posting a 102% total return in local currency terms, the Taiwan Weighted Index rising 62%, and Japan's Nikkei 225 climbing 40%, all deeply benefiting from the wave of AI infrastructure investment.
Pasquariello also cautions that the market path has not been smooth. Front-end interest rate expectations have swung dramatically from pricing in about 50 basis points of cuts at the start of the year to now pricing in roughly 37 basis points of hikes. Sentiment on the US dollar has flipped from broadly bearish in March to broadly bullish currently, while commodity markets have also experienced significant volatility. Looking ahead to the second half, he maintains an overall portfolio positioning of "long delta, long volatility."
Four Consecutive Years of Double-Digit Gains: A Historic Rarity
The S&P 500's roughly 10% first-half return represents solid performance within the context of long-term market history and is stronger than the same period last year.
Pasquariello points out that if the S&P 500 closes the year above 7,530, it would mark a fourth consecutive year of double-digit returns for the index. In the index's 68-year history, this scenario has occurred only once before—the five-year stretch from 1995 to 1999.
The internal composition of the index is also noteworthy. Despite some high-profile names having retreated significantly from their highs, the index overall shows a pronounced positive skew: 44 constituents are up more than 50% year-to-date, compared to just six down more than 50%; 29 stocks have gained over 75%; and 22 have risen more than 100%.
From a style perspective, small-cap stocks have been particularly strong and are on track for their largest annual outperformance versus the S&P 500 since 2003. Pasquariello attributes this to a cyclical growth environment, some small-caps' exposure to biotech and AI infrastructure, and a short squeeze effect from previously record-high short positioning in Russell 2000 futures.
AI Theme Drives Markets, North Asia Outperforms Globally
The acceleration in AI infrastructure build-out has been the most distinct structural theme of the first half.
Goldman Sachs custom basket data clearly illustrates this trend: the memory sector is up 250%, data centers 115%, and AI semiconductors 101%. The Philadelphia Semiconductor Index has gained 102% year-to-date and recently posted its best-ever quarterly performance.
North Asian markets were the biggest winners in global equities for the first half, with the three major markets all highly linked to AI infrastructure investment. Japan's Nikkei 225 surged 37% in the second quarter alone, its largest quarterly gain since data began in 1970. While delivering impressive returns, South Korea's KOSPI has experienced five intraday trading halts this year, nearing half the total number of such halts since the turn of the century, exhibiting a classic pattern of "spot up, volatility up."
It is notable that Asian markets also occupy the bottom of the global performance rankings: India's NIFTY is down 7%, Hong Kong's Hang Seng Index has fallen 10%, and Indonesia's JCI Index has declined 33%.
Within the US tech sector, a divergence has emerged that Pasquariello admits he did not anticipate: the "Magnificent Seven" are flat year-to-date, while the other 493 S&P 500 constituents are up 16%.
Macro Path Proves Bumpy, with Sharp Reversals in Dollar and Rate Expectations
Despite the overall positive equity performance, the evolution of the macro environment has been uneven.
Interest rate expectations have undergone a significant shift: market expectations for Federal Reserve policy in 2026 have swung from pricing in about 50 basis points of cuts at the start of the year to now pricing in roughly 37 basis points of hikes. The US dollar's trajectory has similarly reversed 180 degrees from broadly bearish sentiment in March to broadly bullish sentiment currently.
In commodities, crude oil, after a period of being range-bound, has given back the bulk of its earlier gains. Gold and silver climbed persistently to record highs before peaking and trending lower following news of a key appointment to a Federal Reserve role. Pasquariello suggests the final leg of that decline may be more fundamentally meaningful—perhaps signaling the end of an era where the Fed responded to every major issue with massive monetary easing.
The momentum factor has continued to perform strongly in a highly dispersed, low-correlation market environment. A flagship long/short pair-trading strategy at Goldman Sachs, after gaining 48% in 2024 and 30% in 2025, is up another 57% year-to-date.
Hedge Funds Perform Well, but Second-Half Risks Loom
The hedge fund industry has continued to deliver positive returns in the first half, building on the strong momentum from 2025, which was its best year since 2009. All nine hedge fund sub-categories tracked by Goldman Sachs are positive year-to-date, with fundamental long/short and macro strategies standing out. The Goldman Sachs Hedge Fund VIP basket is up 22%.
Looking to the second half, Pasquariello expects the global equity uptrend to persist, a view underpinned by Goldman Sachs forecasts for S&P 500 earnings growth to continue at a double-digit pace through 2027.
However, the macro strategy team at Goldman Sachs also highlights potential risks: matching the valuations of AI-related stocks to AI's potential macroeconomic contribution requires increasingly optimistic assumptions. The risk of the market overestimating the persistence of above-average profitability is rising, particularly for profits driven by the investment boom itself.
Pasquariello further notes that multiple factors are pushing overall market exposure higher: record fiscal deficit spending in G3 nations, continued heavy AI capital expenditure by hyperscale cloud companies, and a global leveraged ETF exposure that has reached $570 billion. He states he will maintain a "long delta, long volatility" positioning for the second half.
AI regulation is also flagged as an emerging variable to watch. Pasquariello cites a recent commentary: "Today's AI industry is the only one in America with less regulation than a sandwich shop." He believes the political narrative around AI will become a more significant market storyline in the coming months.
Comments