Q2 2026 US stock market outlook: Don’t panic, readjust

2Q 2026 stock market outlook key takeaways

• US stock market is trading at a 12% discount to composite of our valuations.
• Stocks are undervalued, but for a reason—an especially cloudy future and weakening macrodynamics are on the horizon.
• This volatility provides opportunities to take profits and reallocate to undervalued sectors and stocks.

In our 2026 Outlook, we noted numerous key reasons why we expected 2026 to be more volatile than 2025. Little did we know how quickly that would come to fruition. While the broad stock market has traded within less than a 7% range, this range masks significant sector‑level rotation occurring beneath the surface.

Based on a composite of our intrinsic valuations of the more than 700 stocks we cover that trade on US exchanges, as of March 23, 2026, we calculated that the US equity market was trading at a price/fair value estimate of 0.88. This represents that the market is trading at a 12% discount to our fair value estimates.

US stock market undervalued--but for a reason

The US equity market is attractively valued at a 12% discount to our valuations and repeatedly shows signs of wanting to move higher whenever steps are taken toward a moderation in the conflict with Iran. However, until there is a public signal from Iran that it is open to negotiations, we think these rallies will be limited.

While the artificial intelligence investment boom has been a significant tailwind the past two years, much of that optimism is already reflected in prices. To take the next leg up in these stocks, we think investors are looking for better visibility into how AI capital spending translates into new revenue growth and greater efficiency to drive operating margin expansion.

Looking ahead, the first‑quarter earnings season begins the week of April 13. If oil prices remain elevated, management teams may issue more conservative guidance to build in a cushion amid rising uncertainty. At the same time, macro conditions are weakening: Growth is slowing, inflation pressures are resurfacing, and interest rates are edging higher. This leaves the Fed cornered, unable to cut without fueling inflation or hike without risking economic slowdown.

By capitalization, large-cap stocks have become much more attractive following their selloff during the first quarter and are now at a 13% discount to fair value. Mid-cap stocks held their value and are at only a 6% discount. Small-cap stocks remain the most attractive, trading at a 17% discount to our fair value estimate.

By style, growth stocks have become much more attractive. Growth has been hit the hardest thus far this year, yet we increased our valuations on several growth stocks; thus, the sector has become more undervalued as compared with last quarter. At the current 21% discount, growth stocks have only traded at this much of a discount less than 5% of the time since 2011. Similarly, a selloff among core stocks in conjunction with a few fair value increases has brought core stocks to a 10% discount from fairly valued last quarter. The valuation for value stocks has held steady as our valuation increases matched the category return.

Where we see value by sector

Technology stocks, especially software, were hit hard for the quarter to date, yet we increased several of our fair values as the hyperscalers released even greater than expected capital-expenditure plans for 2026, propelling the AI buildout boom even higher. The combination of lower prices and higher valuations has brought the sector to a 23% discount. Since 2011, the technology sector has only traded at this much of a discount when the market bottomed out in 2022 and at the height of the sovereign debt and European banking crisis in 2011.

Throughout 2025, investors had little interest in the energy sector, yet we recommended that investors overweight it, as it was one of the most undervalued, provided an attractive dividend yield, and would act as a natural hedge against inflation and/or geopolitical issues. The sector has lived up to that reputation and has risen 34% this year. Following this surge, it is now the most overvalued sector. We have recently begun to recommend harvesting profits.

Last quarter, financials were the most overvalued, but after plummeting the most, the sector is now at a slight discount. Similarly, overvalued consumer cyclicals were the second-worst-performing sector and are now attractively valued.

Value stocks benefit from flight to safety, whereas core and growth contract

The Morningstar US Market Index fell 3.49% through March 23, 2026.

The value category dodged the market downdraft as the over 34% return in the energy sector was more than enough to offset losses elsewhere in the value category.

The core category was dragged down by its high weightings in technology, consumer cyclical, and financials, the three worst-performing sectors. Among individual holdings, the downdraft in Microsoft MSFT alone accounted for 38% of the category loss.

The technology sector accounts for 42% of the growth category and was the greatest detractor to return. Losses in Nvidia NVDA, Meta Platforms META, Broadcom AVGO, and Oracle ORCL, as well as former overvalued highflyer Eli Lilly LLY accounted for the greatest losses, yet losses were widespread across the growth category.

Just as mega-cap stocks had an outsize impact to the upside the past few years, losses in these same stocks this year skewed large caps lower. The greatest detractors included Microsoft, Apple AAPL, Nvidia, Amazon AMZN, and Tesla TSLA.

Mid-caps bucked the trend to the upside as a combination of their exposure to energy and AI hardware stocks was more than enough to offset losses elsewhere.

It was not surprising that small caps held their own with only a minimal loss, as, according to our valuations, this was the most attractively priced part of the market coming into the year.

Rotation into energy and defensive stocks drives especially wide range of sector returns

Energy stocks soared as oil prices spiked following the US bombing campaign in Iran. Industrial stocks tied to defense and the AI buildout boom performed well.

The risk-off sentiment also drove a rotation into defensive stocks, leading to gains in the consumer defensive and utility sectors. Healthcare dropped, yet one-third of the decline was directly attributable to the loss in overvalued Eli Lilly.

With oil supply constrained in the Middle East, companies whose feedstock comes from onshore sources such as US chemical and fertilizer companies stand to benefit at their international competitors’ detriment, leading the basic materials sector higher.

Last quarter, we noted that financials were the second most overvalued sector as the market overestimated net interest income growth. With the Fed on hold for the foreseeable future, bank stocks sank.

Higher oil prices and higher interest rates will constrict discretionary spending--thus, the retreat in consumer cyclicals.

More volatility ahead-reallocations to consider and key risks to monitor

We suspect that even after the conflict in Iran moderates, volatility will remain elevated as there are several key risks that could play out.

These include:

• High oil prices lead to stagflation:
• • Slowing rate of economic growth
  • Hotter-than-expected inflation
• AI stocks require even greater growth to support high valuations
• New chair will take the reins at the Fed
• Impending midterm elections
• Resumption of trade and tariff negotiations
• Weakening fundamentals in private credit markets
• Chinese economy weaker than expected/deceleration accelerating
• Japanese government bonds are suffering losses as yields rise and the yen weakens

So that raises the question, how can investors position themselves to take advantage of volatility?

Based on the market and sector movement, we see a number of opportunities to readjust portfolios to take advantage of valuation changes.

For example, in 2025, we recommended investors to overweight the energy sector, as it was undervalued, had a high dividend yield, and would act as a natural portfolio hedge against higher-than-expected inflation or geopolitical issues. That hedge worked, and now is a good time to take at least some of that profit and reallocate to other sectors that have been hit too hard.

Last quarter, we also recommended a barbell-shaped portfolio in order to retain the further upside potential we see in technology and AI stocks, yet to use high-quality value stocks to balance those positions against the potential for elevated volatility in 2026. As value stocks have traded higher and AI and technology stocks have sold off, now is a good time to lock in some profit on those value stocks and reallocate into undervalued and oversold growth stocks.