by AdvisorAnalyst.com Editorial Team
The U.S. economy entered the second half of 2026 not on the strength of a broad recovery, but on the back of a technology-driven investment boom that is overpowering nearly every other force in the macro environment. In their 2026 Mid-Year Investment Outlook1, J.P. Morgan Asset Management's Chief Global Strategist Dr. David Kelly and Chief Market Strategist for the Americas Gabriela Santos lay out a world of "crosscurrents and divergence" — where AI is simultaneously the tailwind, the concentration risk, the inflation insulator, and the dominant narrative across every asset class.
The Economy: Momentum With an Asterisk
After sluggish growth in late 2025 and early 2026, the authors note that real GDP is expected to accelerate from an average pace of 1.1% in the fourth and first quarters to "roughly 3% growth in the second and third quarters and then slow down to about 1.5% growth in late 2026." The drivers are narrow: upper-income wealth effects, AI-fueled capital expenditure, and large income tax refunds. Government cutbacks, weak demographics, and the drag from the Iran War — which disrupted oil flows through the Strait of Hormuz — are working in the opposite direction.
On jobs, payroll growth improved materially to 172,000 in May, with unemployment falling to 4.3%. Yet the authors caution that employment gains going forward are likely to land between 50,000 and 75,000 per month, as "solid GDP growth is largely achieved by productivity gains" — not labor expansion. With both legal and illegal immigration sharply reduced, the working-age population is now declining. Businesses are struggling to find qualified workers even as wages remain restrained, with average hourly earnings growing just 3.4% year-over-year in May.
Inflation: Peaking, Not Resolved
CPI hit a three-year high of 4.2% in May, driven primarily by energy prices tied to the Iran conflict. The authors are "cautiously optimistic" that inflation will drift lower, pointing to three disinflationary tailwinds: average tariff levels falling from 11% to an estimated 7.3% following a Supreme Court ruling against IEEPA tariffs; shelter inflation cooling as rental vacancy rates hit their highest level since 2017; and continued productivity gains — running at 2.5% output per hour this year — that are containing wage-price spiral risk. The authors note that "if wage growth remains relatively moderate in a tight labor market with strong productivity gains, the danger of sticky inflation is much reduced."
The Federal Reserve, now under Kevin Warsh, is expected to hold rates for the remainder of 2026 and potentially ease "modestly in 2027, if both economic growth and inflation fall below 2% year-over-year." Rate hike expectations have repriced sharply in futures markets, but the authors view actual hikes as unlikely — the Fed will be reluctant to tighten into an inflation problem that is likely to self-correct.
Equities: Follow the Capex, Not the Economy
U.S. stocks have registered 24 new all-time highs year-to-date — driven, the authors are emphatic, by earnings rather than economic acceleration. S&P 500 pro-forma earnings rose 27% year-over-year in Q1, with technology and communication services leading at roughly 50% earnings growth, while consumer staples and real estate mustered only 5% and 3%, respectively.
The authors identify three dynamics likely to persist: heightened scrutiny on hyperscaler return on AI investment; continued outperformance among AI capex dollar receivers — semiconductors, hardware, power equipment; and increasing differentiation within software, where business model uncertainty is driving a substantial sell-off despite unchanged near-term fundamentals. The authors offer one of the report's most striking statistics: "NVIDIA's suppliers have outperformed NVIDIA's customers by 186 percentage points year-to-date."
The biggest risk to equities, they argue, is not macro — it is a bad headline from a tech conference, model release, or funding round. "Any hint of a potential deceleration in AI-related capex can spell trouble for the concentrated U.S. equity market."
International: Secular Beats Cyclical
International equities are outperforming the U.S. for a second consecutive year — by 440 basis points in 2026, following 1,500 bps in 2025. Emerging markets are the standout, up 23%, with forward earnings expectations rising 36 percentage points. Technology now represents over 40% of the MSCI EM Index, and Korea and Taiwan are at the epicenter of the AI supply chain. However, the authors flag a concentration warning: just three semiconductor stocks represent roughly 25% of the EM index and 70% of this year's EM return.
Europe and Japan, net energy importers with limited tech exposure, have lagged. But the authors argue they offer genuine diversification through secular themes — defense spending, corporate governance reform, and the end of deflation — that favor the value style and can buffer AI-related equity corrections.
Fixed Income and Alternatives: Earn While You Wait, Diversify What You Can
With two-year yields now 60 basis points above the federal funds rate, the short end of the yield curve is compelling. The authors describe all-in yields across the fixed income universe as attractive — 5% in investment grade, 6% tax-equivalent in municipals, and 7% in high yield — while noting that AI concentration is now "creeping into the bond side of portfolios" as the technology sector's weighting in investment grade has increased fivefold since 2006.
On alternatives, the authors emphasize private equity's role on the "offense" side — particularly small and mid-cap PE with lower valuations and domestic focus — and real assets and hedge funds on the "defense" side, providing inflation diversification and non-correlated returns that core bonds increasingly cannot deliver alone.
Portfolio Construction: Back to the ABCDs
The authors close with a framework for navigating the remainder of 2026 — Appreciate fundamentals, Balance with expectations, Concentrate on concentration, and Diversify the diversifiers. The top 10 S&P 500 companies now represent 41% of the index; the U.S. represents 64% of global equities. Meanwhile, a 60/40 portfolio has historically recovered from a 20% drawdown in 11 months versus 24 months for equities alone. In an environment where bonds may maintain a positive correlation to stocks due to persistent inflation, the authors argue that the diversifier toolkit must expand: real assets, gold, absolute-return hedge funds, and international value are all on the table.
"Diversification is not about maximizing returns in any single regime," the authors write. "It is about increasing the probability of meeting objectives across regimes, especially when the future mix of shocks — growth, inflation, geopolitics and technological disruption — is unknowable."
Key Takeaways for Advisors
1. The AI capex cycle is the market — position accordingly, but know what you own. Earnings growth is not broad-based; it is concentrated in the AI supply chain. Semiconductors, hardware, power equipment, and hyperscalers are driving index-level returns while consumer staples and real estate contribute almost nothing. Advisors should audit client portfolios for how much AI exposure is already embedded — not just in equities, but increasingly in investment grade and high yield fixed income, where technology sector weightings have grown fivefold since 2006. Knowing what you own is the first step to managing the concentration risk that comes with it.
2. Inflation is likely peaking — but the path back to 2% is conditional, not guaranteed. The three disinflationary forces the authors identify — falling tariffs, cooling shelter costs, and productivity-contained wage growth — are real, but they depend on a durable resolution to the Strait of Hormuz crisis and continued restraint in wage demands despite a tightening labor market. Advisors should not position portfolios as if the inflation problem is already solved. The Fed is on hold, not easing, and the long end of the yield curve remains vulnerable to fiscal stimulus surprises ahead of the U.S. midterm elections. Inflation-sensitive diversifiers — real assets, infrastructure, gold — remain relevant in this environment.
3. The short end of the yield curve is where fixed income earns its keep right now. With two-year yields sitting 60 basis points above the federal funds rate, the authors make a clear case for stepping out of ultra-short cash instruments into short-duration fixed income. All-in yields across the fixed income universe — 5% in investment grade, 6% tax-equivalent in municipals, 7% in high yield — are genuinely attractive and supported by solid corporate, household, and municipal balance sheets. Advisors should be helping clients migrate idle cash into the yield curve while being selective about long-duration exposure, which remains susceptible to volatility as fiscal and inflation risks persist.
4. International diversification is not a consolation prize — it is a structural necessity. International equities have outperformed the U.S. for two consecutive years and the valuation gap versus U.S. equities remains wide. Emerging markets offer direct exposure to the global AI supply chain through Korea and Taiwan, while Europe and Japan offer something U.S. portfolios cannot easily replicate: genuine diversification from the AI theme through defense spending, corporate governance reform, and the end of negative rates. Advisors should resist the behavioral pull toward home-country concentration. The expected resumption of a weaker U.S. dollar adds a further tailwind for U.S.-dollar-based investors holding international positions.
5. Sitting on the sidelines is a decision too — and historically, the wrong one. The authors are unambiguous: cash has underperformed a diversified portfolio again in 2026. In an environment defined by crosscurrents — an AI boom, a geopolitical shock, elevated inflation, and a Fed on pause — the instinct to wait for clarity is understandable but costly. The prescription is not to chase performance; it is to return to portfolio basics. Rebalance into lagging asset classes, harvest tax losses where they exist, expand the diversifier toolkit beyond core bonds, and build portfolios designed to meet objectives across multiple regimes — not just the one that has dominated for the past three years. As the authors put it, portfolio balance should be the North Star, not the latest market move.
Footnote:
1 Kelly, David, and Gabriela Santos. 2026 Mid-Year Investment Outlook: Crosscurrents and Divergence Amidst an Increasing AI Surge. J.P. Morgan Asset Management, June 2026.
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