The Market Feels Fragile—But This Isn’t the Moment to Panic

Markets didn’t ease into 2026 particularly smoothly. A sharp rotation out of AI‑exposed stocks, an oil price shock tied to the Iran conflict, and renewed debate about inflation and interest rates are testing investor confidence.  

During Morningstar’s Q2 2026 US Market Outlook webinar, Chief US Market Strategist Dave Sekera, CFA, and Chief US Economist Preston Caldwell responded to those concerns directly, breaking down how they’re assessing today’s market risks and opportunities.

A: Morningstar’s base case still assumes no rate cuts in 2026, but Caldwell outlined several scenarios that could shift that view. The most important factors: a sustained drop in inflation and a sharper‑than‑expected weakening in growth or labor markets. 

“If everything goes perfectly—if the ceasefire holds, traffic resumes through the Strait of Hormuz immediately, and oil prices move lower—we could see PCE inflation average a little under 3% this year,” Caldwell said. 

Additional downside risks could also push the Fed to act earlier, including a sudden deterioration in financial conditions if the market suddenly lost confidence in the AI story and valuations collapse. 

A: Caldwell emphasized that the biggest risk isn’t temporary shipping disruption, it’s lasting damage to energy infrastructure that keeps oil prices elevated for years, not months.

In that scenario, inflation expectations could become “unanchored,” forcing the Fed back into tightening mode. Caldwell warned that sustained higher rates could eventually “put recession risk in a serious way back into play.” For advisors, this frames geopolitical risk as a duration problem, not just a headline shock.

A: We see continued deterioration in private credit fundamentals, with more stress likely ahead. “We’re definitely seeing ongoing deterioration in the credit quality of the companies that we cover in the private credit market,” Sekera said.

He highlighted rising covenant breaches, distressed exchanges, and defaults—especially among smaller, leveraged companies. Importantly for diversified portfolios, Sekera warned these problems could spread.

“That then is going to cause contagion across all the rest of the credit markets,” he said, starting with high yield and working into investment grade.

A: Defense stocks have largely done what we expected them to do—and Sekera believes much of the upside is now reflected in prices.

“With as much as they’ve rallied…a lot of them are getting to the point where they’re overvalued, and now is a good time to be taking profits,” he said.

The original catalysts—higher global defense spending commitments—are no longer underappreciated by the market. Advisors may want to trim positions and redeploy capital where valuations better reflect current risks.

A: Sekera argued that, in many cases, yes—especially for high‑quality software firms with durable competitive advantages. Generally, we think these companies are utilizing AI themselves. They're improving the products and services they sell to their clients, charging more for those products, and they'll continue to be consumers of those products.

“We’re not looking for AI to wipe out entire companies,” he said. “In a lot of areas, AI actually ends up making the software companies more valuable.”

He pointed to cybersecurity as a clear example, noting that AI increases both attack surfaces and the need for sophisticated, network‑based defenses. For advisors, the selloff has created selective opportunities in wide‑moat software names rather than reasons to avoid the space entirely.

A: Sekera framed this as a valuation reset rather than a fundamental shift away from value.

“Value was doing pretty well…because it was very attractively valued compared to the growth category,” he said. That gap has now largely closed. Meanwhile, growth—especially technology and AI‑related stocks—has been hit hard enough to look more attractive on a forward basis.

“That’s now where we see the best valuation,” Sekera explained, reinforcing the message to readjust rather than retreat.

This quarter’s outlook reinforced that markets are volatile and risks are real, but discipline matters more than timing. For advisors, the task is to help clients stay invested and diversified instead of trying to predict the next headline.