U.S. equities continued their upward momentum last week, with the S&P 500 rising 1.4%, the Nasdaq gaining 2.4%, and the Dow advancing 0.9%. The S&P 500 and Nasdaq both ended the week at fresh record highs, with the S&P 500 now up for a ninth straight week and the Nasdaq higher in eight of the past nine. The rally has been powerful as the S&P 500 gained a combined 16% across April and May, a two-month surge seen only a handful of times since 1950. Technology stocks remain the predominant drivers, with the Philadelphia Semiconductor Index up more than 80% year-to-date, the strongest first 100 trading days for the group on record.

While market leadership remained concentrated in technology and AI-related sectors, the week also brought some encouraging signs of broader participation. Beaten-down software stocks saw a reprieve, while airlines, cruise lines, homebuilders, trucking, logistics, and select industrial areas also participated in the rally. Falling bond yields and a sharp pullback in oil prices—WTI crude fell nearly 10% last week—also supported equity markets by easing inflation concerns and lowering pressure on interest rates.

That relief, however, has already started to look fragile. Oil prices and Treasury yields are both moving higher again in this week’s early trading after renewed Middle East tensions, underscoring a pattern we have seen several times this year: markets rally on signs of negotiation progress, only to confront another round of geopolitical stress or policy uncertainty. Negotiations between the U.S. and Iran remain active, and markets continue to assume that some form of settlement is still the most likely outcome. But recent reports that President Trump sent tougher terms back to Iran, alongside renewed military flare-ups, are a reminder that the path to settlement remains bumpy.

That volatile energy picture feeds directly into the inflation outlook. The Federal Reserve’s preferred measure, the PCE index, rose 3.8% year-over-year in April, well above the Fed’s 2% target, while core PCE rose 3.3%. The encouraging detail was that core prices rose a more moderate 0.2% month-over-month, and services inflation remains relatively contained. Still, higher energy prices can bleed into transportation, shipping, and goods prices, while higher electronics prices tied to supply chain and tariff pressures may keep core inflation close to 3% for much of the year.

Consumers are starting to feel the impact. Inflation-adjusted spending rose just 0.1% in April, and the savings rate has declined to approximately 2.6%, its lowest level since 2022 and well below its longer-term average. So households are still spending but with less cushion as higher gas prices and everyday expenses absorb more of disposable income. The U.S. economy continues to grow, though at a more modest pace. First-quarter GDP was revised down to 1.6% from 2.0%, reflecting slower consumer spending, weaker services activity, slower profit growth, and a larger-than-previously-estimated inventory drawdown.

The Federal Reserve continues to face a challenging environment. Inflation remains above target, while growth is slowing but still positive. Markets are now pricing in modest additional rate hikes through year-end, though those expectations eased last week as oil prices and bond yields fell. Several Fed officials have signaled they remain open to tightening if inflation pressures persist, while slower growth and calmer services inflation argue for patience. The bigger question for the Fed is not simply whether inflation is high today, but whether energy and goods-price shocks begin to seep into broader expectations.

Corporate earnings remain the most important offset to that macro uncertainty. According to FactSet, S&P 500 earnings estimates have unusually moved higher during the first two months of the quarter, bucking the normal pattern of downward revisions. Technology is doing much of the heavy lifting and is expected to drive roughly half of the S&P 500’s earnings growth in 2026 amid the AI infrastructure investment boom.

At the same time, the earnings backdrop outside of mega-cap technology remains stronger than the narrow market narrative suggests. Every S&P 500 sector is still expected to post positive earnings growth in 2026, and most sectors have seen estimates revised upward, with health care and staples the notable exceptions. Small-cap fundamentals also remain constructive, with S&P 600 earnings still expected to grow more than 12% this year, though that estimate has slipped from roughly 14% at the start of the year. That downward revision is worth watching, as smaller companies tend to have less direct benefit from the AI investment boom and more sensitivity to inflation, financing costs, and consumer pressure.

Looking ahead, investors will be focused on several key reports in the coming week, including manufacturing and services activity, job openings, and the monthly employment report. Expectations are for moderate job growth and an unemployment rate near 4.3%, indicating a labor market that remains healthy but is gradually cooling. The broader outlook remains balanced. Strong corporate earnings and continued AI infrastructure investment are supporting markets, while inflation, higher interest rates, geopolitical uncertainty, and pressure on consumers present ongoing risks.

2026 The Long View | First Merchants Bank