The earnings story remains strong, but uncertainty surrounding the path of Fed policy and worries about excessive leverage propping up the market are near the top of the list of concerns
Stock returns have been so strong in the second quarter of the year that even bullish investors are worried about a pullback.
The first half of 2026 comes to a close on Tuesday, and with it, another rollicking stretch for the U.S. equity market.
The first quarter was a tough one for U.S. investors, marred by the start of a war with Iran and a rolling panic triggered by fears that accelerating disruptions from artificial intelligence could harm the business models of many software and professional-services firms.
The second quarter has been far kinder. Cash poured into shares of companies expected to benefit from bottlenecks in the AI supply chain. Shares of hot memory names like Micron Technology $(MU)$ soared.
As of Monday's close, the S&P 500 SPX had risen 14% since the beginning of April - the best performance during a calendar quarter since June 2020, FactSet data showed. The Nasdaq composite COMP is on track to tally a nearly 20% quarterly gain, the best in just as long - even though the tech-heavy index has actually fallen during the month of June.
A look beyond the major indexes offers more clues about what really drove the hot returns in stocks over the past three months. The PHLX Semiconductor Index SOX, which offers investors exposure to semiconductor names, has been the star of the show, having gained more than 80% in the second quarter.
That marks the best quarterly performance on record, according to Dow Jones Market Data. But it doesn't fully capture the intensity of the rally in the semiconductor space: The two Korean semiconductor giants, Samsung Electronics (KR:005930) and SK Hynix (KR:000660), have performed even better, up 93% and 225.7%, respectively. Neither company's shares are included in SOX index.
Wall Street strategists chalked up much of this quarter's strong performance to a couple of key drivers. As supply bottlenecks worsened and oil prices soared, analysts dramatically revised up their expectations for near-term profit growth.
Expectations for second-quarter earnings rose as the quarter progressed, an unusual pattern, according to FactSet's John Butters. He told MarketWatch that analysts typically lower their profit forecasts for the current quarter as the quarter-end approaches.
Not this time. For the second quarter, the estimated earnings growth rate for the S&P 500 recently stood at 23.1%. If companies can clear this bar, it would mark the second straight quarter of earnings growth greater than 20%, FactSet data showed.
Mark Hackett, chief market strategist at Nationwide, said earnings have helped to justify the rapid repricing higher of stocks. The foundation of the rally looks strong, and he remains bullish, Hackett said. However, he does see a few things that could trigger a pullback.
"On balance, there are more tailwinds than headwinds," Hackett said. "But there are some technical things."
Quarter-end rebalancing, the beginning of the corporate-buyback blackout period and high levels of leverage supporting a frothy stock market come to mind, he said.
Not everybody is quite as sanguine as Hackett. Some investors worry the taste of volatility seen in June might be the beginning of a bigger pullback.
"We believe the market volatility seen so far in June is the tip of the iceberg, which could turn into a 10%-20% correction in the broader markets, as it's been well over a year since we have seen a double-digit pullback," said David Laut, chief investment officer at Kerux Financial.
Even strategists who've been raising their S&P 500 price targets expect a bumpy ride. When RBC's Lori Calvasina raised her target this week, she advised clients to brace for drawdowns of between 5% and 10% over the next year.
"[W]e continue to believe that the path higher for stocks in the year ahead will not necessarily be a linear one," Calvasina said in written commentary shared with MarketWatch.
Here are a few things investors are watching as talk of a third-quarter "summer squall" picks up.
Earnings
In a couple of weeks, the second-quarter earnings reporting season will swing into gear.
Over the past 12 months, upward revisions to earnings estimates have driven all of the returns for the S&P 500. Based on its forward price-to-earnings ratio, which compares the price of the index against expected earnings per share for its member companies, the index has actually gotten cheaper over the past year.
That puts the onus on earnings to keep on surpassing Wall Street's already high bar, according to Ben Snider, chief U.S. equity strategist at Goldman Sachs Research, who shared his views in a June 26 client note.
Investors are increasingly looking beyond the so-called hyperscalers - the companies spending the most money to build the data centers needed to power AI. Lately, investors have been trying to gauge just how much money companies are willing to spend on AI products, along with where within the ecosystem that spending will be concentrated - and, most important, whether that spending will generate a suitable return for the companies providing these services.
Rebalancing
Part of the recent pressure on stocks also appears technical, according to Paisley Nardini, managing director and head of multiasset solutions at Simplify Asset Management. Quarter-end portfolio rebalancing might be leading some large asset owners, including sovereign-wealth funds and pensions, to sell equities and buy bonds after stocks outperformed bonds by a pretty wide margin over the past quarter, Nardini noted.
The iShares 20+ Year Treasury Bond ETF TLT, an exchange-traded fund that invests mostly in 30-year Treasury bonds, has gained less than 1%.
Fed uncertainty
Federal Reserve Chair Kevin Warsh shook things up when he stepped up the lectern at the Eccles Building on June 17 for his first press conference as head of the central bank.
His endorsement of a more tight-lipped approach from the central bank is already leading some investors to fear the worst. Futures traders ratcheted up expectations for a 2026 rate hike following Warsh's first press briefing. On Wall Street, expectations are hardly uniform. Some firms say they expect zero hikes between now and the end of the year.
Meanwhile, economists at Bank of America have been the most aggressive, penciling in three interest-rate hikes before year's end.
"I think that's why we're seeing the market cautiously price in a couple of rate hikes, because it's just not clear how decisions are going to be made in the future," said Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management
Leverage
Leverage is another worry.
Options trading volume has soared, investors have taken out more margin debt in their brokerage accounts, and assets managed by risky leveraged ETFs have also shot higher as investors piled into these products, seeking to maximize their gains from soaring semiconductor stocks.
Charlie McElligott at Nomura has warned clients that leveraged products could make the U.S. equity market more volatile. Others have also flagged them for contributing to some of the recent wild swings at the index level. On June 5, the Nasdaq fell by more than 4%, its biggest daily drop in more than a year, FactSet data showed.
"Usually when there's volatility like this, it's a shot over the bow. There's a lot of speculation in the market, and these names are in the hands of weak players," Chris Galipeau, head market strategist at the Franklin Templeton Institute, said in an interview with MarketWatch.
The Direxion Daily Semiconductor Bull 3X ETF SOXL, which aims to amplify daily swings in SOX, has seen its assets under management more than double over the past year, rising from $14.1 billion as of June 1, 2025, to nearly $34 billion at its peak on June 23, according to Dow Jones Market Data. The ETF is the most popular leveraged semiconductor fund that trades in the U.S.
U.S. stocks were on track to finish the quarter on a positive note on Tuesday, with the S&P 500, Nasdaq and Dow Jones Industrial Average DJIA all sitting in positive territory in late morning trading, FactSet data showed.
Joy Wiltermuth, Ken Jimenez and Michael DeStefano contributed.
-Joseph Adinolfi -Frances Yue
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(END) Dow Jones Newswires
June 30, 2026 11:50 ET (15:50 GMT)
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