Signals & Noise: U.S. Equity Mid-Year Outlook 2026 — Buy Stocks, Not the Index

Hello and welcome to Signal vs. Noise, where strategists and economists from around the globe offer a shorter take on market and economic matters as part of Global Research Unlocked. I'm Savita Subramanian, Head of US Equity and Quantitative Strategy at BofA Global Research, and we're recording this episode on Wednesday, July 1st, 2026.

As we head into the second half of 2026, we take stock of what happened this year. Interestingly, instead of an administration focused on affordability and domestic policy, we got war and inflation. But our expectations for strong earnings growth and multiple contraction were delivered.

In fact, we got more earnings growth than we were expecting at the beginning of the year, despite the fact that we were well above consensus in expecting about 15 percent growth. We're clocking something closer to 20 percent at this point. Analysts revised earnings up a lot, nine percentage points.

Markets returned close to 10 percentage points, so multiples actually expanded for the year. But we did see very different trends than what we've seen in the last couple of years. The average stock outperformed the index, so the equal weighted S&P outperformed the cap weighted S&P by about a percentage point.

Analysts revised up earnings the most in three areas that are different from last year's mega cap hyperscaler dominance. We saw big upward revisions in energy, semiconductors, and materials. Commodities and semis, which are much more GDP sensitive segment of the tech sector.

Meanwhile, Magnificent 7 stocks dropped about five percent despite reasonably strong revisions. And we think it's just a classic case of expectations are now too high, crowding is too extreme, the bar is too high for a lot of these mega cap tech stocks. So what's in store for the second half?

Well, we maintain our initially launched S&P 500 year-end target of 7,100, which suggests a little bit of downside from current levels for the overall index. Within the index, there are a lot of areas that we are bullish on, and I'll get to those in a moment. But on the target itself, the index target is based on five models that we update on a regular basis.

And the expected range of these models is pretty wide. Our most bearish model is spitting out about 6,000. Our most bullish model is spitting out about 8,000.

And our official year-end target is 7,100. We think investors should take profits in the index and in the AI hyperscalers, and instead buy large cap value manufacturing beneficiaries. So this would include energy, materials, parts of industrials, financials, real estate.

This is an environment where you really want to go heavy on CapEx takers that generally do well during a manufacturing pickup. When it comes to the consumer, we're a little more defensive, and we think investors should stick with staples over discretionary. We're overweight consumer staples, we're underweight consumer discretionary.

This positioning has already delivered about nine percentage points of alpha in the first half, and we think there is more to go. Why are we less enthusiastic about the consumer? Well, AI is posing risks to job security for a higher paying income cohort, white collar professional services, undergrads, recent graduates, which have been the engine of consumption growth for the last 20 or so years, are now suffering the highest unemployment rate we've seen since prior recessions.

And the trade down from wants to needs is alive and well in our credit card data. We're seeing inflation hit even middle income consumers. Our economists are now calling for three Fed rate hikes or a 75 basis point increase in the Fed funds rate.

Now this isn't enough to derail markets, but it is a reversal of the rampant central bank liquidity we saw in 2025. This suggests to us that the economy is fine, earnings are gonna be fine, but inflation and rates have upside risk. The liquidity spigot from central banks across the globe that we enjoyed for the last few years is drying up.

On top of that, equity supply demand dynamics are worsening. So when you think about last year, we had very limited IPO activity, very limited equity issuance, and we had a lot of privatizations, a lot of buybacks, accelerating buybacks. This year we're seeing buybacks slow down.

We're seeing equity issuance increase. So those are potentially a reversal of the bullish shrinkage theme that we've seen for the last decade or more. We still like stocks more than cash, especially with inflation running hotter.

Cash might be a worse asset class to be in than equities that keep up with inflation. We emphasize large value stocks that would benefit from a CapEx boom. It's interesting because a flatter curve and lower oil prices don't seem bullish for value stocks, but we are in a CapEx boom, which suggests you wanna buy CapEx takers in cyclical manufacturing sectors that are sources of cash that are throwing off a lot of capital, not the AI spenders that are now raising capital.

Right now, investors are paying a very high premium for the last cycle's top line growth stories. But sales revisions this year have shifted from just thematic AI spenders to commodities, tech hardware, semiconductors, more GDP sensitive companies. And we think that's where the leadership is really shifting to.

Companies that benefit from a cyclical recovery that are generally cheaper than some of the secular growth plays and are relatively neglected and have less crowding risk or less sell-off risk than some of the more crowded AI investment theme names. We think the big areas of the S&P 500 can withstand higher short and long rates, but TMT and the big mega cap tech companies might not be as nimble as they were back in 2023 when they embarked on a lot of moves to adapt to a higher rates environment. If you recall in 2022 and 23, the big tech companies cut capex, cut costs, and did very large buybacks to support their stock prices and bring a little bit of that cashflow forward, essentially reduce their duration risk.

Today, they can't really do that unless they're willing to drop out of the AI race. And that is the big difference in terms of tech optionality. In contrast, we think that energy, financials, materials, old value, cyclical sectors are now disciplined, lean, and unlevered.

They sport the highest shareholder yield. And those are the areas that we're really bullish on for the second half of the year. So wrapping it up, buy stocks, not the index.

Buy cyclical companies, not thematic growth themes into the second half of this year. Large cap value, full stop. Thanks for listening.

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