Mosaic Quarterly Review and Outlook

The compute phenomenon wasn’t restricted to just the US market. The MSCI Emerging Markets Index surpassed the S&P 500 Index by a wide margin, gaining +24.1% for the quarter, boosted by compute stocks in Korea (MSCI Korea Index +88%) and Taiwan (MSCI Taiwan Index +49%). Much has been made of the S&P 500 Index’s market concentration, where the top 10 holdings have approached 40% of the index; however, this dynamic is no longer unique to the U.S. stock market. Post this quarter’s rally, the top three holdings of the MSCI Emerging Market Index sit near 30% of total capitalization. The developed international markets also had a fantastic quarter, with the MSCI EAFE Index up +10.8%.

Interest rates pushed higher over the quarter as investors continued pricing in the possibility of interest rate hikes later in the year. Kevin Warsh presided over his first meeting as Chair of the Federal Reserve in June. He made it abundantly clear during his press conference that the Fed intends to achieve their 2% price stability target, forward guidance is a thing of the past, and that the Fed will be scrutinizing all its various data sources and how they are used to formulate policy decisions moving forward. Coupon income was offset by the increase in yields, resulting in a +0.7% 2Q return for the Bloomberg US Aggregate Bond Index. Given the risk-on dynamic, corporate bonds outperformed both US Treasuries and mortgage-backed securities.

Outlook

It certainly appears that both sides would like to see a permanent resolution to this year’s hostilities. However, many questions remain as the United States and Iran work toward cementing June’s memorandum of understanding, as each side seems to have their own interpretation of pieces of the agreement. While we allow for the possibility that a hot war could be rekindled, it is not our base case.

Instead, we believe it’s more likely that the markets will continue to focus on the positives that were in place before the war: a stable labor market, an ongoing upswing in manufacturing, the continued tailwind of heavy AI spending, outsized fiscal support, and even stronger earnings growth emanating from corporate America. The last point is crucial as it’s helped keep valuations in check despite the steady rise in stock prices during the quarter. Typically, earnings growth estimates decline throughout the year as analysts revise their previously optimistic expectations lower. Instead, we’ve seen steady upward revisions taking 2026 full-year expectations to 24% from 15% on 12/31/2025.

Further, it’s not just large cap tech stocks seeing higher earnings revisions, small cap stocks (S&P Small Cap 600 Index) have seen a markup for 2026 growth estimates from 16% to 21% since the start of the year. The S&P Mid Cap 400 Index has seen its 2026 projection move up to 22%. Small and mid cap stocks are more sensitive to interest rates and the domestic economy, so we find both the increased earnings estimates and year-to-date outperformance over large caps (S&P Mid Cap 400 Index +17.3% and S&P Small Cap 600 Index +23.9% vs. the S&P 500 Index at 10.2%) especially encouraging. As markets continue to broaden out, diversification is once again enhancing portfolio returns after being deadweight for much of the past several years.

Although the factors above create a positive backdrop, we’d be remiss not to address the remaining risks to the outlook. Inflation is a problem, not just its reacceleration this year, but the cumulative price change since pre-COVID. Consumer prices growing by 4.2% year-over-year (May’s CPI figure) is disheartening for consumers, but the 29% cumulative rise in prices since February 2020 is downright depressing, and this is clearly behind the dour state of consumer confidence. Yes, spending continues to appear buoyant, but spending is reported in nominal terms, adjusting for inflation shows consumers have largely been paying more for the same amount of goods and services. The labor market is stable, but also relatively stagnant. It’s a low-hire, low-fire economy, leaving the jobs picture tenuous. A turn in the labor market would undoubtedly hit consumer spending and weaken our economic footing.

The composition of economic growth has also become a concern as nonresidential fixed investment (read AI datacenter buildout spending) has overtaken consumer consumption as the biggest driver of growth. So, the economy and markets have become increasingly levered to AI spending at the same time the market has punished several of the spendthrift hyperscalers. A pullback in capital expenditures would likely induce market and economic volatility.

Increased equity issuance is another cautionary sign. June brought us history’s largest initial public offering (IPO) with SpaceX raising $75 billion, simply remarkable, especially on the heels of Alphabet issuing $85 billion in new equity the week prior. Anthropic and OpenAI wait in the wings with anticipated IPO valuations close to $1 trillion each.

Putting it all together, we see the positives outweighing the potential risks and remain fully allocated to stocks relative to neutral benchmarks, but seeking to avoid high beta and momentum, both of which appear highly susceptible to the burden of excessively high expectations.