Update on the Economy and Markets: August 2026

Phillip Williams, Jr., CFA
Director, Investments

Overview

The month of July was yet another rollercoaster for the investment markets.  On the one hand we enjoyed cooler inflation numbers (at least temporarily), and strong corporate earnings.  On the other hand, we endured a broken ceasefire in Iran, renewed trade wars, and a Fed that is projecting a potential rate hike at its next meeting.  And let’s not forget the collapse of a leveraged hedge fund.  Despite these crosswinds, the U.S. equity markets ended the month flat.  Strong corporate earnings were essentially offset by increased geopolitical uncertainty and rising bond yields. 

Unsurprisingly, volatility increased during the second half of July as fighting in Iran intensified, tariff policy re-entered the narrative, and the Fed’s hawkish rhetoric created concern regarding looming rate hikes and rising treasury yields for the remainder of 2026.  The Trump administration announced a new round of tariffs on Canada (50% on certain goods), Brazil (25%), and another sixty trading partners (10%-12%).  Canada and Brazil were targeted as a result of perceived discriminatory treatment of American products while the others were targeted utilizing Section 301 of the Trade Act of 1974 alleging “their failure to impose and effectively enforce a prohibition on the importation of goods produced with forced labor” ¹ according to the Office of the United States Trade Representative.

Renewed fighting with Iran in early July sent oil prices higher, but early August began with a downtrend in oil after President Trump called off a planned attack on Iran at the urging of his Middle East allies. Despite a very strong corporate earnings season, the direction of the war in Iran could have a major effect on equity performance leading into the September Fed meeting, especially if the conflict expands into the Red Sea.

Inflation, Interest Rates and the Fed

June inflation, both headline and core, came in cooler than expected with headline CPI falling to 3.5% year-over-year (YoY) and core to 2.6%.  The temporary ceasefire with Iran slowed down the increase in energy prices while a moderate easing in shelter costs supported the slowdown in core inflation. 

While inflation slowed a little in June, it remains well above the Fed’s 2% target.  Also, during July, oil prices soared, increasing 20% to around $85 per barrel of crude.  This surge was driven by the broken ceasefire and escalating tensions in the Middle East with the Red Sea becoming another flashpoint as the Houthis, a terrorist group sponsored by Iran, attacked merchant ships. 

Surging oil prices, solid economic data, and a stubborn inflation rate above hovering well above the Fed’s target were all on the table for the Federal Reserve to consider when it met last week.  Prior to the meeting, longer-term rates were rising in the U.S., and the Fed’s decision and comments did nothing to alter the trend.  The Fed decided in a 9-3 decision to hold rates steady, with three members in favor of increasing rates. This is the first time since 2016 that three members dissented. According to Neel Kashkari, one of the dissenters (and the Minneapolis Fed President), “To manage against the risk that high inflation could become entrenched, I would rather tighten policy incrementally as we gather more data on the path of inflation and employment.  If inflation remains elevated, in my view, a potential series of small policy moves would be better than waiting and eventually concluding that even bolder actions were necessary.” ²  This shows the difficult predicament that new Fed Chairman Warsh has before him.  The market is now expecting a Fed rate hike at its September meeting. 

Higher rates are generally not good for growth stocks as the higher discount rates used to value future earnings for these companies lowers their modeled value.  Beyond being a potential headwind for stocks, higher rates will also dampen the broader economy.  Elevated mortgage rates, for example, are a headwind for housing activity but also can have a negative impact on consumer spending if a larger portion of monthly income is going to housing. 

The largest impact, however, may be observed in government finance.  This country, sadly, has a debt problem that neither political party has the will nor the votes to rectify, especially during a mid-term election year.  Higher short and long-term rates increase the interest costs for the U.S.  Annual interest payments on our debt already exceed $1 trillion dollars per year.  Rising yields are pushing our cost of borrowing even higher at the same time that we have a trillion-dollar plus government deficit.

The U.S. can continue to manage its balance sheet like this because of the current strength of its currency, though the U.S. dollar has declined in recent years relative to other currencies.  Ironically, President Trump prefers a weaker U.S. dollar as it supports his protectionist trade policies. Strong corporate earnings and consumer spending alongside a solid job market are able to provide some distraction for many, though the growing debt problem will ultimately need to be addressed.

U.S. Corporate Earnings

According to FactSet, as of July 31, “For Q2 2026 (with 61% of S&P 500 companies reporting actual results), 86% of S&P 500 companies have reported a positive EPS surprise and 77% of S&P 500 companies have reported a positive revenue surprise… For Q2 2026, the blended (year-over-year) earnings growth rate for the S&P 500 is 47.4%. If 47.4% is the actual growth rate for the quarter, it will mark the highest earnings growth rate reported by the index since Q2 2021 (91.6%). It will also mark the 2nd consecutive quarter of year-over-year earnings growth above 20% and the 7th consecutive quarter of double-digit growth for the index.” ³  Corporate earnings are having a great 2026 following strong growth during the previous years. 

What this creates is a scenario where the S&P 500 has more than doubled since February 2020, but valuations are essentially unchanged.  The chart below shows that the forward price-to-earnings ratio for the index in February 2020 just prior to the COVID drawdown was 19.2x vs. the current forward P/E ratio of 19.3x.  Strong corporate earnings growth can continue to support the market at current valuations.

Leverage is Risky, Kids

Leverage has made some people incredibly rich over the decades, but it has also taken down some of the smartest people alongside retail investors.  From the Great Depression to Long-Term Capital Management to Lehman Brothers, leverage has caused the collapse of some once-renowned entities.  If you are interested in learning more about these events, I would recommend the books 1929: Inside the Greatest Crash in Wall Street History – And How It Shattered a Nation, When Genius Failed: The Rise and Fall of Long-Term Capital Management, and The Big Short.

Leverage is the use of borrowed money to increase the size of your assets exposed to the market with the goal of increasing returns.  July brought two more examples of the risks involved with utilizing leverage in your investment portfolio.  A hedge fund run by a 24-year old with little trading experience blew up as a result of too much leverage with concentrated AI investments, and South Korean retail investors experienced margin calls at an exceptionally high rate.  The dramatic unwind of the AI-focused hedge fund, Situational Awareness (the irony of its name is not lost on anyone), was one of the major events of the month.  It highlighted the risk of concentrated, leveraged investing.  After rapid gains driven by AI-related holdings, the fund was forced to unwind much of its portfolio following sharp declines in AI stocks and margin calls.  The forced liquidation of a large portion of Situational Awareness’ portfolio added to selling pressure across the AI sector.  In fairness to Situational Awareness, it has been reported that despite the incredible deleveraging, the fund survived and has still posted strong YTD returns given just how large the gains had been during the first six months of the year.

The South Korea story is sadder on the surface since it involves retail investors and not a multi-billion-dollar hedge fund.  The South Korean stock market was up over 100% YTD through June before falling more than 20% during July as the parts of the AI-trade unwound.  The run-up had in part been fueled by retail traders with access to margin.  Many of these retail investors had heavily leveraged positions in AI-linked semiconductor stocks.  The ensuing wave of margin calls and forced selling amplified market volatility, although the clearing of these leveraged positions helped stabilize sentiment.  From a MarketWatch article on July 17, “It was a bad week for “the ants,” as South Korea’s army of retail traders are known colloquially, as 1.2 million of them were clobbered with margin calls. That’s more than 3% of the country’s adult population, illustrating the feverish extent of stock-market speculation and the danger of leverage.  Those stats were provided in a desk note to clients Thursday by Goldman Sachs trader Loannis Blekos, who added that, this week alone, around 350,000 retail accounts were liquidated amid the Korean market collapse.” ⁴

Geopolitics

The war with Iran continues to evolve with both sides looking for offramps that are justifiable to their own constituencies.  Iran’s control over the Strait of Hormuz remains an important sticking point for the U.S.  Following the calling off of strikes last weekend, it is expected that the U.S. and Iran will have direct or indirect talks this week in hopes of finding common ground for a ceasefire and, ultimately, a peace deal. [See this month’s FAQ (LINK HERE) for more scenario discussion around the Strait of Hormuz.]

Separately, President Trump last week hosted Ukraine’s President Zelensky in the Oval Office.  The two appeared to be on better terms compared to previous visits while Ukraine’s ability to hold off Russia and inflict pain inside its territory has changed at least some perceptions of the war here in the U.S.  At a July 2026 NATO summit meeting, Trump went as far as to suggest that the U.S. would give Ukraine a license to build Patriot systems to defend its country.   However, Trump backed away from the offer just as a massive missile attack last week on Kyiv showed Ukraine’s ongoing need for patriot missiles.  

Markets

• U.S. equities were flat during July as the market faced headwinds from rising oil prices and bond yields. The S&P 500 fell 0.1% during the month, bringing its year-to-date (YTD) return to 10.1%. International stocks were down 1.8% during the month but were up 11.6% YTD through July.

• The yield on a 10-year treasury spiked during the month as rising oil prices and a hawkish Fed (who may increase interest rates in the near future) concerned investors. The 10-year yield closed July at 4.74% while the 30-year hit 5.28%. This was the first time the 30-year had exceeded 5.2% since 2007 prior to the 2008/09 Great Recession financial crisis.

Economic Trends

• In the advanced reading of Q2 U.S. GDP growth, real GDP grew at only 1.5%. This was below the consensus forecast of 2.1% along with Q1 growth which was also 2.1%.  Imports were a headwind to growth as the trade deficit widened; however, consumer spending and AI infrastructure buildout continued to show strong domestic demand.

• Headline inflation cooled during June as oil prices fell during the ceasefire with Iran. The June CPI print came in at 3.5%, falling from 4.2% in May. Energy prices were the main driver of this decrease. Core inflation, which excludes energy and food, also cooled. June core inflation came in at 2.6% YoY compared to 2.9% during May. As mentioned above, July’s readings on inflation are likely to be higher.

Our Team’s Take

Federal Reserve interest rate decisions during the second half of 2026 will be a focus for investors along with the trajectory of the war in Iran and its impact on gasoline prices.  Investors received more guidance from the Fed following their July meeting as the three dissenting votes showed a growing belief amongst voting members that the Fed needs to increase rates.

We continue to focus on diversification across asset classes, including private alternatives such as infrastructure, real estate, private equity, and private credit. Public stock valuations are elevated relative to history, but strong earnings growth, positive investor sentiment and a decent economy continue to provide support for stock markets. Eventually, AI productivity growth should help maintain strong profit margins,– however, markets continue to punish stocks that fall short of lofty expectations. Continued turbulence is likely.

As we have discussed repeatedly, it is imperative that investors be in the correct risk tolerance for their own personal situations. If you have concerns, please do not hesitate to reach out to your wealth advisor.

Sources:

¹ Office of the United States Trade Representative Press Release, July 23, 2026.
² https://www.minneapolisfed.org/article/2026/statement-on-my-fomc-dissent, July 31, 2026.
³https://advantage.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_073126.pdf, July 31, 2026.
⁴ https://www.marketwatch.com/story/bad-week-for-the-ants-as-ripple-effects-of-korean-crash-spread-out-across-asia-8a5e4a43, July 17, 2026.