Market Commentary, Q2 2026

June 30, 2026

Two forces defined global markets in the second quarter. The first was the war in Iran, which remained an active driver of energy, commodity and inflation dynamics throughout the period. A ceasefire announced on April 7 lifted sentiment sharply, and as the immediate risk of escalation eased, investors rotated firmly back into equities and markets rallied. However, the effectiveness of the ceasefire was called into question given the truce was breached repeatedly. The Strait of Hormuz remained effectively closed, and the resulting supply disruption continued to feed higher and more persistent inflation expectations. That backdrop kept central banks in a hawkish posture. Some members of the US Federal Reserve favoured a rate increase, though the Fed ultimately held, while both the European Central Bank and the Bank of Japan moved to 25 bps hikes in June, shortly after the quarter closed.

The second force was the continued expansion of AI infrastructure, underpinned by substantial capital spending from the largest US hyperscalers, which lifted global manufacturing activity to its highest level in four years in the first half. The scale of spend is considerable with the top five hyperscalers having committed roughly $780 billion to AI capex in 2026, rising toward $1 trillion in 2027, while AI related capital spending across the economy has grown from near zero in 2021 to approximately 2% of US GDP, ranking among the largest single contributors to US growth this cycle. That spending was matched by a wave of capital raising, including more than $200 billion from Meta, Amazon, Anthropic, and Google alone, alongside the largest IPO in history, SpaceX, which raised roughly $75 billion at a $1.8 trillion valuation, with SK Hynix's $29 billion Nasdaq ADR following shortly after the quarter closed. For many investors, the AI boom is at once an investable shift in digital and physical infrastructure but also a growing source of concentration risk, one this commentary quantifies across asset classes in the sections that follow. In private markets in particular, the discipline in diligence is to test whether the benefits companies claim are genuinely additional and broadly shared, and to treat power demand, water use, data governance, workforce effects and valuation itself as material risks rather than afterthoughts. Renewed energy-security concerns also strengthen the case for clean energy investment, as reducing reliance on fossil fuels increasingly serves both an impact objective and a source of long-term portfolio resilience.

MACRO

The second quarter carried forward many of the themes from Q1, but with a more difficult combination of slowing growth and renewed inflation pressure from the war in Iran. In the United States, real GDP growth moderated to an annualized 1.5% from 2.1% in the first quarter, as higher energy prices weighed on household consumption, business confidence and broader economic activity. The labour market also softened meaningfully over the period, with non-farm payroll gains slowing sharply by June. While unemployment edged down to 4.2%, this was accompanied by weaker labour-force participation, indicating that the lower unemployment rate partly reflected fewer people actively looking for work rather than stronger hiring conditions.

Canada presented a somewhat different picture. Real GDP rebounded 0.8% in the second quarter, or roughly 3.3% annualized, following a near-flat first quarter, supported by stronger exports, household spending and business investment. Inflation remained volatile as higher energy prices pushed headline CPI higher during the quarter, while the labour market continued to resemble a “low-hire, low-fire” environment: unemployment rose to 6.9% in April before easing to 6.5% by June but remained elevated relative to recent history. Faced with inflation pressure on one side and a still-soft labour market on the other, the Bank of Canada held its policy rate at 2.25%, effectively waiting for greater clarity before changing course. For impact portfolios, this environment reinforces the relevance of businesses addressing affordability, access to essential services and household financial resilience, particularly where headline economic growth does not translate evenly across workers and communities.

The Eurozone faced a more acute version of the same trade-off. Annualized GDP growth improved to 1% in Q2, but inflation rose to 3% from 2.1% in the prior quarter as the region’s heavy reliance on imported energy left it particularly exposed to disruptions from the war in Iran. With inflation moving further above target, the European Central Bank raised rates by 25 bps despite a softening growth outlook. The policy trade-off is increasingly difficult: unlike the U.S. Federal Reserve, which has a dual mandate to balance price stability and employment, the ECB’s primary mandate is price stability, giving it less flexibility to support weaker growth while inflation remains elevated. Labour conditions also softened, with unemployment drifting higher and France reaching a five-year high above 8%. The result is a challenging backdrop in which higher energy costs and tighter monetary policy are weighing on households and businesses at the same time.

PUBLIC EQUITIES

Global equities rebounded sharply in the second quarter following the April ceasefire between Iran and the US and a strong corporate reporting season, with both revenues and earnings generally exceeding expectations. Gains were led by technology companies exposed to the AI investment cycle, many of which had underperformed in Q1, as well as financials which were supported by resilient earnings, healthy credit conditions and the broader improvement in risk sentiment. Against this backdrop, the MSCI ACWI returned 17.5%, with technology and financials accounting for more than three quarters of the gain, while the technology-heavy NASDAQ rose 30%. MSCI Europe and MSCI Japan also gained 12.7% and 16.5%, respectively. Importantly, the rally was supported by fundamentals: MSCI ACWI companies reported revenue 2.7% above consensus expectations and earnings 18.3% above estimates, with every sector other than Utilities exceeding expectations. By comparison, the S&P/TSX returned 7%, with energy giving back some of its strong first-quarter performance. The S&P/TSX’s relative underperformance, driven in part by a reversal in energy, also highlights how concentrated Canadian benchmark returns can be in a small number of resource-heavy sectors. For impact portfolios, this reinforces the importance of understanding benchmark concentration without allowing the benchmark’s composition to dictate where capital is allocated.

Valuations nevertheless became more demanding as share prices rose alongside higher earnings expectations. The S&P 500’s next-twelve-month P/E increased to 20.4x from 19.4x, while MSCI ACWI rose to 17.5x from 16.5x. Technology saw the strongest analyst revisions, with forward EPS expectations rising 35.5%. One way to frame current valuation risk is through the spread between the S&P 500’s forward earnings yield and the US 10-year Treasury yield, which stands at only around 44 bps versus a 20-year average of roughly 336 bps. In simple terms, investors are receiving relatively little additional earnings yield for taking equity risk. For that spread to return to its historical average while equity prices continue to rise at their long-term rate of roughly 11.2% annually, S&P 500 earnings would need to grow at about 22% per year over the next five years. Even with a 10-year Treasury yield of 3.0%, the required earnings growth rate would still be about 17%. Current valuations leave markets increasingly dependent on sustained, outsized earnings growth, particularly from AI-related companies. For private market portfolios, public market exuberance can flow through to higher entry valuations and more optimistic exit assumptions. As in prior quarters, we believe impact investors should apply the same valuation discipline to richly valued companies exposed to the AI theme, as genuine impact credentials do not provide immunity from a repricing if earnings growth fails to keep pace with elevated expectations.

PUBLIC FIXED INCOME
Bond markets were generally positive in the second quarter, with the Bloomberg Corporate Investment Grade Bond Index returning 1.5%. Canadian and European investment grade corporate bonds gained approximately 2.0% and 2.35%, respectively, while US investment grade bonds lagged with a return of roughly 0.7%. The April ceasefire helped ease some of the immediate inflation concerns associated with the Iran conflict, but US government bond yields nevertheless moved higher as investors remained focused on tariffs, fiscal policy and the implications of Kevin Warsh’s (an interest rate hawk by reputation) appointment as Federal Reserve Chair in May. The increase was concentrated at the short end of the yield curve, with the US 2-year Treasury yield rising roughly 40 bps compared with a 15 bp increase in the 10-year yield. This resulted in a flatter yield curve, meaning the gap between short- and long-term interest rates narrowed. At the same time, US corporate credit spreads tightened, helping offset some of the impact of higher government yields on corporate bond returns. In Canada, 2 year and 10-year Government of Canada yields declined modestly by approximately 7 bps and 10 bps, respectively, reflecting relatively resilient demand for Canadian government debt despite continued uncertainty around US trade policy. For impact portfolios, a higher rate environment can widen financing gaps for lower income communities, smaller issuers and mission driven projects, increasing the importance of directing capital toward borrowers and structures that preserve affordability, access and essential services without compromising credit quality.

PRIVATE MARKETS

Global private equity fundraising totalled approximately $136 billion in Q2, putting the industry on pace for its weakest annual total since 2016. Capital remained concentrated among larger established managers and specialized technology strategies as weak distributions, higher borrowing costs and geopolitical uncertainty reduced appetite for leveraged strategies and emerging funds. US deal count improved, although aggregate value fell 37% from Q1, while the change in European activity relative to Q1 outperformed the US in terms of both deal count and value due to the appeal of lower relative valuations to investors. Software remained a notable weak spot, with deal activity down 66% from Q2 2025 as investors reassessed businesses most exposed to AI disruption. For impact LPs, scarce capital creates both a risk and an opportunity, as financing gaps may deepen for smaller, locally rooted managers, while investors with dry powder may secure better entry terms and stronger impact governance, reporting, and mission protection. This concentration is a further headwind for emerging and diverse-led managers, who are disproportionately responsible for bringing new impact strategies to market, reinforcing the case for LPs willing to provide patient, catalytic capital to first- and second-time funds.

Venture capital remained heavily concentrated in AI, which accounted for approximately 86% of global VC deal value in the first half of 2026. Average AI deal size more than doubled from 2025 levels as capital flowed to a smaller number of large financings (such as Anthropic’s $65bn series H which was completed in May). This concentration leaves many essential but less fashionable sectors comparatively underfunded, creating opportunities for impact investors in areas such as health, affordability, financial inclusion and community infrastructure.

In Canada, private equity deal value fell to $12.7 billion in the first half of 2026, down 59% year over year, while venture capital investment rose 16% to $2.7 billion. Roughly 80% of PE and VC dollars were concentrated in Ontario and Quebec, highlighting persistent regional gaps in access to growth capital. Cleantech investment also moderated, although new and expanded federal tax incentives introduced in the Spring Economic Update 2026 should improve project economics and help crowd private capital into clean electricity, hydrogen, carbon capture and related technologies. Forestry investment remained weak, potentially creating opportunities in restoration, wildfire resilience, sustainable forest management and Indigenous led land stewardship.

Private credit fundraising remained healthy during the quarter, but defaults rose to their highest level since 2021. Stress was most evident in healthcare companies facing revenue pressure following the One Big Beautiful Bill Act, as well as in businesses whose margins were weakened by higher energy costs. Investors also became more cautious around highly leveraged software companies, where concerns about AI disruption have raised questions around the durability of future cash flows and contributed to higher redemption pressure in some private credit funds. To date, however, credit deterioration in software has remained relatively contained outside of more exposed subsectors. For impact credit investors, the healthcare stress is particularly important because weaker financial performance can directly affect service continuity, affordability and access. This makes covenant protection, capital structure and borrower resilience especially important in sectors where preserving the impact outcome depends on the underlying business remaining financially viable. At the fund level, rising redemption pressure also reinforces the need to ensure that investor liquidity terms are appropriately matched to the liquidity of the underlying loans.

OUTLOOK

Against this backdrop, the continued build-out of AI infrastructure, including the power generation required to support it, together with supply disruptions stemming from the war in Iran should sustain demand for alternative energy sources, greater technology processing power and substitute sources of key commodities. We also expect businesses to place greater emphasis on protecting margins through efficiency, waste reduction and circularity, including the use of more sustainable inputs and feedstocks such as alternatives to conventional plastics. We believe that the war has created a significant and potentially long-term tailwind for Canada to become a trusted low-risk supplier to much of the world and we anticipate increasing interest in domestic private investment by international investors in areas such as infrastructure as a result. While some of this investment will focus on the extraction, production, and delivery of fossil fuels (for example, LNG to European customers) we note that there is also increased investment in clean energy, energy efficiency, and decarbonization technologies such as renewable infrastructure and energy storage.

The common thread is a repricing of resilience, with energy security, supply chain diversification and access to critical inputs becoming more important considerations in capital allocation. We also see increasing potential investment opportunities that intersect with Indigenous rights and local communities who can benefit from meaningful partnerships to develop and steward natural resources such as land and water. Set against these opportunities is a still challenging risk environment. The escalation in trade tensions through August underscores the continued uncertainty surrounding global and Canadian trade relationships, particularly the impact of US tariffs on export-oriented industries, which has already weighed on investment in areas such as auto manufacturing, consumer businesses and retail.

DISCLAIMER

Rally Assets considers third-party information and data presented herein to be reliable but because it was prepared by a third-party, Rally Assets may have had to rely upon the work product of the third party to some extent, without being able to verify the accuracy of the information. Opinions expressed herein are current as of the date appearing at the top of this page and are subject to change without notice.

The information provided on this page is provided as a general source of information. While the information is considered to be true and correct at the date of publication, change in circumstances after the time of publication may impact the accuracy of the information. Rally Assets reserves the right to add, remove, vary or alter the information and materials contained in this document in its discretion.

This document may contain "forward-looking information" as defined in Canadian securities regulations. Forward-looking information involves estimates, projections and known and unknown risks. The actual performance may be materially different from those expressed or implied in the forward-looking information. Wherever possible, words such as "anticipate", "believe", "expect", "intend" and similar expressions have been used to identify these forward-looking statements. For greater certainty, information regarding a security’s or a firm’s past performance, whether that information is actual or simulated, is not a reliable indicator of future performance and should not be relied upon as a basis for an investment decision.

There are risks associated with investing in securities. The security described herein may be subject to considerable fluctuations in value and the loss of principal is possible.