US Stock Market Outlook: What's Next for Stocks in the Second Half of 2026

The US stock market climbed more than 10% in the first half of 2026, but the ride was anything but smooth. Investors rotated across styles, market caps, and sectors as AI enthusiasm, tariff uncertainty, and a reignited Iran conflict all took turns driving headlines. 

In the Morningstar Q3 2026 US Stock Market Outlook webinar, Chief US Market Strategist Dave Sekera and Chief US Economist Preston Caldwell examined where valuations stand today, the biggest risks facing investors, and the opportunities that could shape the second half of the year. Here are some of the most common audience questions and our analysts’ perspective.  

It is still too early to assess how Federal Reserve Chair Kevin Warsh will shape monetary policy over the long haul. While his early hawkish statements during the nomination process prompted investors to reassess expectations for interest rates, the longer-term direction of policy remains uncertain. 

In the near term, Morningstar expects the Fed will have to hike interest rates once this year, in September, before returning to cutting rates next year and in 2028. This path is expected to take the target range of the federal funds rate from 3 1/2%–3 3/4% down to 2 1/2%–2 3/4% by the end of 2028, ultimately delivering a net 100 basis points in interest rate cuts. 

Warsh has proposed altering the Federal Reserve's communication strategy to reduce forward guidance. While this could enhance market volatility, historical precedent suggests that monetary policy can remain effective under less transparent frameworks.  

History suggests technological innovation is more likely to reshape the labor market than permanently reduce employment. Previous waves of automation shifted workers into new industries while increasing productivity and lowering costs for consumers. 

Early evidence points to a similar pattern with AI. The cost of AI services has fallen rapidly as competition has increased, suggesting productivity gains may become broadly distributed rather than concentrated. While some occupations will inevitably change, widespread long-term unemployment is not currently the base case. 

AI has the potential to boost long-term economic growth by improving productivity, much like previous technological advances. 

AI is already supporting economic activity on the demand side through increased business investment, but its supply-side productivity benefits remain difficult to measure. Current government data isn't granular enough to isolate AI's contribution to overall economic output, and broad productivity gains have yet to emerge. 

Many workforce reductions attributed to AI also appear to reflect post-pandemic restructuring and companies reallocating capital toward AI infrastructure rather than widespread automation replacing workers. 

For now, productivity trends, business investment, and real-world adoption remain the key indicators to watch. 

Higher inflation can temporarily reduce the debt-to-GDP ratio, as occurred following the inflation surge in 2021 and 2022. However, the strategy becomes self-defeating if markets begin expecting persistently higher inflation, since those expectations ultimately drive borrowing costs higher. 

Ultimately, a reduction in the primary deficit will be needed to put federal debt on a healthier trajectory. While political support for fiscal tightening remains limited, market pressure through higher bond yields or a weaker dollar could eventually force policy adjustments. 

Consumer defensive valuations reflect several years of margin pressure rather than a single catalyst. During the 2021-22 inflation surge, many food and packaged-goods companies couldn't raise prices quickly enough to offset rising costs. 

Although margins were expected to recover, lower- and middle-income consumers have remained under pressure, limiting companies' pricing power. 

More recently, higher oil prices have increased packaging, transportation, and fertilizer costs. Despite these headwinds, many companies in the sector continue to trade below Morningstar's estimates of fair value. 

At the same time, sector valuations are skewed by Walmart and Costco, which continue to trade at substantially higher valuations than Morningstar considers justified. 

Small-cap stocks posted their strongest first-half performance in roughly three decades as investors rotated away from crowded AI trades and toward more attractively valued parts of the market. 

Even after the rally, small caps continue to trade at roughly a 15% discount to fair value, making them one of the market's most attractive segments from a valuation perspective. While interest rates are no longer a significant headwind, Morningstar believes valuation, rather than macroeconomic conditions, remains the primary driver of the investment opportunity. 

Short-term market movements are inherently difficult to predict. Rather than attempting to time corrections, investors are generally better served by focusing on valuations and maintaining diversified portfolios. 

Morningstar currently favors a balanced allocation across value, core, and growth stocks, while maintaining an overweight position in small caps. If markets pull back, valuation-driven dislocations could create opportunities to selectively add exposure to companies whose prices fall more than their underlying fundamentals. 

The second half of 2026 begins with markets in a more balanced position than earlier this year. While AI continues to drive investment and influence both market performance and economic growth, valuation opportunities have broadened beyond the largest technology companies. 

Morningstar continues to see the strongest value among small-cap stocks while maintaining a balanced approach across value, core, and growth equities. Although questions remain around monetary policy, inflation, fiscal deficits, geopolitical risks, and AI adoption, a disciplined, valuation-driven investment approach remains more important than reacting to short-term headlines. 

Direct Advisory Suite gives investment professionals access to the underlying valuation models, fair value estimates, and analyst research behind this outlook—across equities, sectors, and asset classes. Request a free demo.