2026 Q3
July 1st 2026
Our quarterly S&P 500 forecast for 2026 Q3 (average price returns) is a 4.5 percent growth over the second quarter of 2026. Our monthly forecast for July is only slightly higher than June’s average.
Volatility concerning frequent changes in tariff rates and timings, and geopolitical conflicts, cannot be captured in a forecast model. Thus, any uncertainty concerning these issues makes the 95 % confidence interval around the point forecast rather wide.
Q2 ends 14.9% higher than Q1
The war in the Middle East was the main driver of the poor stock market performance in the first quarter of 2026. Surging oil prices and rising inflation spooked investors. The S&P index was down 4.81 % in 2026 Q1 over the end of 2025 Q4.
The S&P 500 had a turnaround in Q2. There was a strong rally in April and May. In mid-June, the US and Iran signed an interim framework agreement, establishing a 60-day ceasefire. Although the truce is fragile, it raised hopes for an end to the war in the Middle East. The S&P 500 index was 14.9% higher at the end of Q2 than the end of Q1. This was the best quarterly performance since 2020 Q2.
A broader-based market rally
Another reason for the stock market rally in Q2 was the surprisingly robust earnings of the S&P 500 companies in 2026 Q1. The forthcoming $750 billion capital spending on AI infrastructure has broad market implications. From Semiconductors to Electricity utilities, the AI boom is lifting demand for many companies in the S&P 500 index. Semiconductor and hardware stocks currently make up almost 20% of the S&P index. S&P 500 company earnings expectations exceeded the analysts’ expectations at the end of March.
The US economy and labor market remain resilient despite the higher inflation. The big dip in GDP growth in 2025 Q4 due to the government shutdown was reversed in 2026 Q1, calming any recession fears.
Kevin Warsh replaced Jerome Powell, whose term as Fed Chair had ended on May 15, 2026. The first Fed meeting under Kevin Warsh took place on June 17, 2026. Warsh’s hawkish stance and the changes in the Fed’s communication style initially caused a sell-off in stock markets. Some investors realised that a rate hike rather than a cut is more likely given the new Fed Chair’s determination to keep inflation close to the target level. The 10-Year Treasury yield ended June at 4.44%.
Fed Policy without ‘Forward Guidance’
The new Fed Chairman, Kevin Warsh, abandoned the Fed’s ‘forward guidance’ policy, i.e., hints of future interest rate changes. He justified the policy change, arguing that it locks the Fed into certain policy paths.
Although the death of ‘forward guidance’ came as a shock to market analysts, there is indeed not much statistical evidence supporting that ‘forward guidance’ was a successful policy instrument.
The graph below shows the dates of ‘forward guidance’ announcements alongside the stock market performance. The impact of these announcements on the stock market was generally negative but not statistically significant.
The second graph shows the timing of ‘forward guidance’ in relation to the CBOE Volatility Index (VIX). There doesn’t seem to be any statistical evidence for a reduction in market volatility following a ‘forward guidance’ announcement.
Based on econometric evidence, we agree that the new Fed Chairman Kevin Warsh’s decision to scrap the ‘forward guidance’ policy is the right decision. It reduces the Fed’s flexibility in reacting to changes in market conditions, especially when geopolitical instability creates ‘known unknowns’.
U.S. Q1 GDP growth is revised up in the final estimate
The 2026 Q1 third and final estimate was 2.1%, revised up from the previous estimate of 1.6%. (Source: Bureau of Economic Analysis (BEA)). The main reason for higher GDP growth in Q1 was the downward revision in imports, which were cut from 21.1% to 11.8%. In addition, gross private domestic investment increased 7.9%, higher than the previous estimate of 7%. However, consumer spending was revised down to 0.5% from 1.4%. The consensus was for GDP to hold at the earlier 1.6% estimate.
Although US economic growth appears respectable, deteriorating inflation prospects stemming from the war threaten household budgets. Moreover, consumer spending growth in Q1 was the weakest since 2022 Q1.
Consumer spending is related to job creation. Nonfarm payrolls increased by 172K jobs in May 2026, well above forecasts of 85K. Job gains occurred in health care, retail trade, leisure, hospitality, local government, and manufacturing.
The unemployment rate remained unchanged at 4.3% in May, in line with expectations. The latest job market signals seem to vouch for labor market resilience.
Both retail sales and home sales recovered in May
Starting with the economic data, retail sales rose in May. Home sales also continued to recover.
The advance estimate of U.S. retail and food services sales was up 0.9% in May and up 6.9 percent from May 2025.
The National Association of Realtors’ index of pending home sales rose 3.8% in May (m-o-m). The Pending Home Sales Index typically lags existing home sales by one to two months. Higher inflation is likely to keep mortgage rates elevated. That said, contract signings continued to recover in May. Home sales increased 4.8% (y-o-y) despite higher mortgage rates, indicating a strong recovery in housing demand.
The labor market remains resilient
In the week ending June 20, the advance figure for seasonally adjusted initial claims was 215,000, a decrease of 12,000 from the previous week’s revised level. The 4-week moving average was 224,250, an increase of 750 from the previous week’s revised average. The advance seasonally adjusted insured unemployment rate was 1.2 percent for the week ending June 13, unchanged from the previous week’s unrevised rate (Source: US Department of Labor).
Initial jobless claims remain well below the 250,000 mark. The expression ‘low-hire, low-fire’ describes a market where companies are reluctant to lay off workers despite labor-saving AI technology. As the latest job creation numbers are on the healthy side, it is too soon to judge if this trend is reversed.
So far, the backdrop of a resilient labor market is maintained. The Fed is to remain restrictive, as the unemployment rate remains below the critical value of 4.5% to warrant a rate cut. Even if this benchmark is reached, higher consumer prices make a rate cut very unlikely any time soon.
PMI deteriorates, and consumer confidence slightly improves
The Chicago Purchasing Managers’ Index (PMI) fell to 56.7 in June from 62.7 in May. The index averaged 54.25 between 1967 and 2026. The contraction in business activity has been a theme over the last two years. The latest dip in the data was caused by the fall in new orders.
The Conference Board’s consumer confidence index ticked up by 0.6 points to 91.2 (1985=100) in June, up from a downwardly revised 90.6 in May. The Present Situation Index—based on consumers’ assessment of current business and labor market conditions—fell by 3.0 points to 116.4. The Expectations Index—based on consumers’ short-term outlook for income, business, and labor market conditions—rose by 3.0 points to 74.4. The survey period for this month’s preliminary results was June 1–23. The US-Iran ceasefire agreement and falling oil prices have eased future inflation worries. However, consumers are feeling less optimistic about the prospects of getting a job.
Inflation soars to 4.2%
The annual inflation rate in the US increased to 4.2% in May from 3.8% in April 2026, in line with market expectations. This was the highest rate since April 2023. The war in the Middle East was the main cause of the sharp increase in inflation, followed by increases in materials prices caused by the disruption in the Strait of Hormuz, including fertilizers, aluminum, and helium.
The personal consumption expenditures (PCE) index, a key barometer of inflation and consumer spending, rose at a 4.1% annual pace in May, up from 3.8% in April, in line with the consensus estimate. Core PCE, which excludes the more volatile food and energy categories, ticked up to 3.8% in May from 3.3% in April, also in line with market forecasts.
US inflation is at a three-year high. Being above the target inflation rate (2%) for five years is a concern for the Fed. At the end of April, both WTI Crude and Brent Crude were trading above the $100 mark. After the peace deal between the US and Iran, the oil price dipped sharply. At the end of June, the WTI Crude price is hovering around the $70 mark. The inflation rate is expected to come down in the coming months. That said, given the lagged effects, production costs and consumer inflation may remain elevated in Q3. We don’t expect the inflation picture to improve any time soon.
A rate hike in September?
Since the cut in December 2025, the federal funds rate’s range has been 3.5 % to 3.75%. The Fed held the rates unchanged for a fourth straight meeting in June. The next Fed meeting is in July. We believe a rate cut is unlikely, given that inflation is at its highest in three years. In fact, given the resilience of the labor market and the economy, the appropriate course of action for the Fed would be to increase the interest rates.
As long as inflation remains near the 4% mark, we believe the prospect of any rate cuts in 2026 can be ruled out. In fact, we see the probability of a 25bp rate hike in September more than 50%.
Surprisingly robust Q1 corporate earnings
The US corporate earnings with inventory valuation and capital consumption adjustments (domestic industries) were up 2.7 percent in 2026 Q1 from the previous quarter. The Earnings were up a whopping 11.3 percent over 2025 Q1. The AI boom is the main driver of this jump, followed by companies in Consumer Discretionary sectors such as Autos, which benefited from tariff refunds and improving supply chains. Furthermore, some outlier gains related to AI investments distorted the overall figure (e.g., Amazon’s stake in Anthropic)
Our consumer sentiment indicators are based on our ‘keyword’ algorithm related to ‘Google Trends’. Accordingly, these indicators are among the explanatory variables that predict US corporate profits. In 2026 Q2, we expect the company’s earnings to be 9.6% higher than in 2026 Q1 and 21.3% higher than in 2025 Q2. US corporate earnings encompass a broader range of companies than the S&P 500. That said, lately the AI boom has made the earnings impact of the ‘Magnificent 7’ more dominant. This inevitably blurs the more representative picture of the health of the US economy.
The historical data from June 30th 2025
The S&P 500 is close to fair value
According to FactSet Insights from June 26, the forward 12-month P/E ratio for the S&P 500 is 20.1. This P/E ratio is above the 5-year average (19.9) and above the 10-year average (19.0). For 2026 Q2 reports that the blended (year-over-year) earnings growth rate for the S&P 500 is 23.1%. If 23.1% is the actual growth rate for the quarter, it will mark the second-straight quarter of earnings growth above 20%.
Overall, the index is close to fair valuation, owing to high earnings forecasts, driven by the AI revolution.
For Q1 2026, 85% of S&P 500 companies reported a positive EPS surprise, and 81% of S&P 500 companies reported a positive revenue surprise. Moreover, the latest forward 12-month P/E ratio is well below the P/E values before the dotcom bust (over 25).