Ivanna Hampton: Welcome to Investing Insights. I’m your host, Ivanna Hampton. Market volatility tends to challenge investors’ willpower to stick to their plan. That’s understandable because it tends to be easier to say you will focus on the long term until uncertainty emerges. Geopolitics and artificial intelligence stirred up their share of highs and lows in 2026. What lessons can you learn from past market-moving events to stay invested, and where are the opportunities in the second half of the year? Dominic Pappalardo is the chief multi-asset strategist for Morningstar Wealth. It’s part of Registered Investment Advisor, Morningstar Investment Management.
Thanks for being here, Dom.
Dominic Pappalardo: Good to be here.
Hampton: How would you describe the first six months of 2026 regarding the stock market?
Pappalardo: I would say it was an interesting six-month period. We had a lot of news, we had geopolitical tensions, we had market dynamics that changed multiple times. We had a supply-side shock, and oil prices and other commodities pushed inflation higher. So, a lot of events taking place.
Hampton: Now we’re going to talk about three distinct events that the market experienced as of June 30, and I say June 30 because that’s the day we’re recording this episode. First up is the software selloff that happened earlier this year. Why was that significant, and where does the tech sector stand today?
Pappalardo: That’s very accurate. I like to think of the first half of the year as three different cycles that the market went through or three different sentiment shifts that occurred. So, as you said, January, February was a period where we saw a selloff in tech names, specifically software names. And it felt like the market finally realized like, “Hey, maybe AI isn’t actually great for every tech company out there.” And the fear or speculation that drove the selloff was that some of these software or other tool providers may lose pricing power or sell fewer seat licenses because of AI. So, it was kind of the downside of the AI boom that was taking place. That’s kind of ebbed and flowed since then. But for that first couple months of the year, that was the dominant theme across the market.
Hampton: The conflict in the Middle East triggered global market volatility in early March. How did different stock sectors fare?
Pappalardo: That was clearly the second phase of market sentiment shifts that occurred this year. And March was very much a traditional risk-off reaction to the conflict in the Middle East. You had a flight-to-quality mentality across markets. A few things transpired, as I already said, the price of oil spiked. Oil shipments that were going through the Strait of Hormuz from use were shut down, that represents a large percentage of global oil supply. That pushed the price much higher in a very quick manner. Second to that, you saw some more volatile or higher-beta segments of the market sell off more like emerging markets, for example. So, the US stock market held up better; even though it was still down, it performed better on a relative basis than some of those more volatile emerging markets.
And then finally, you saw a situation where energy companies were really the only segment of the US market that had a positive return for March. And that’s simply because the price of oil went up. Production costs are relatively fixed for energy companies. So if they could sell their product, i.e. oil, at a higher price, that increases margins, therefore pushes the stock prices higher.
Hampton: Another market cycle actually drove stocks higher in the spring. Ceasefire talks between the US and Iran helped fuel a so-called bounceback rally, but that wasn’t the only factor. Talk about what made Wall Street feel optimistic.
Pappalardo: That was clearly the third phase of the market cycles we saw this year. And it was a bounceback rally through April, May, and really all of June. It wasn’t a straight line up, but definitely markets moved higher. We set another series of new all-time highs. A couple of things drove that. Certainly, the ceasefire talks. It seems like progress has been made. To this point, nothing is officially final yet, but it seems like it’s going that direction, so that optimism is flowing through to markets. The other driving factor in the rally was the renewed AI trade. And that’s really what drove markets through 2024 and 2025. And we saw that continue through these last few months. It wasn’t quite as widespread as it was in ’24 and ’25. There were differences between subsectors of the tech market or even individual companies within the tech market. But nonetheless, those companies rallied so much that they pushed broad market indices to new all-time highs. So memory providers, semiconductor companies, really the leaders on the way up this time around.
Hampton: The market cycles we just discussed could have led to panic selling. What does history show us about how the market behaves during and after volatility?
Pappalardo: I think this year was really just a classic scenario where if investors tried to time their entry and exit into the market, they probably would’ve gotten it wrong. Those multiple sentiment shifts that we just talked about happened very, very quickly without warning; they’re almost impossible to predict. So, it’s just a good reminder that if you’re in the market, you should have a disciplined plan and be able to ride it out through those ups and downs. And the timelines may change, but usually the end result is the same, and that certainly was exactly what we experienced in 2026. If you had extra capital on the sidelines, if you were fortunate enough to do that, you would’ve had multiple opportunities to perhaps deploy more into the markets during the selloff, which, again, not everybody can do that, but if you can, those selloffs tend to be a good point to do that.
And really, the nuance of it is trying to decide, OK, are these headlines or are these situations really going to change the long-term fundamentals of the companies you’re investing in? And in most cases, they don’t. The surging oil prices, for example, didn’t really change the long-term prospects for energy companies. It just means the next quarter or two, they will produce higher profits because the price of oil went up. It doesn’t change their business over the next decade, for example. That will give a situation where perhaps you may have taken some profit as those companies rallied because you could see through and realize that the long-term position didn’t change. It’s just a temporary price movement.
Hampton: Part of being a long-term investor is accepting that drawdowns are normal. How do you do that?
Pappalardo: That’s the hard part. It’s difficult to see a statement balance go down and down and down in a relatively quick time period. It almost comes back to the planning phase. If you have a thoughtful, disciplined plan going into a market cycle like that, you should be able to trust that over the long term, you’re more likely to achieve your goals if you stick to that plan. That takes discipline. Perhaps for some people, the best thing to do is not watch it every day or every hour. Unfortunately, you and I have to watch it every day and every hour, so we don’t have that luxury. But it’s really coming back to the classic idea of focusing on the long-term horizon and trying to look past those short-term ups and downs.
Hampton: I think you just gave me the answer to this, but I’m going to ask anyway. What should investors do when market volatility occurs?
Pappalardo: Sometimes people say do nothing. I don’t necessarily think that’s the right answer. I would say don’t react emotionally is a much better answer or a much better approach to that situation. And what I mean by that is if you or your advisor or the investment firm you’re working with, if they believe some long-term fundamental shift is occurring because of those headlines, you should definitely change your portfolio mix, whether that’s reallocate among sectors or countries or asset class, whatever it might be. But if you don’t or your advisor doesn’t believe that long-term shift is occurring, then it’s probably best just to stick to your plan that’s already in place.
Hampton: What about the guidance that says do nothing and stick with the plan?
Pappalardo: It’s probably not fully accurate. There are times when you should reallocate, but again, you have to be able to look through the noise of the headlines and avoid the emotional reaction. So if you can take emotion out of it and make an analytical decision because of new information, then I think it’s OK to tweak your portfolio or your investment strategy, but just panic selling because things are going down is almost never the right answer.
Hampton: All right, we can pivot. Your team puts together a midyear outlook. What’s the forecast?
Pappalardo: The forecast is mixed, which I know is a terrible answer. Nobody wants to hear that. I think really what we’ve been thinking about is what we’ve seen year to date is very uneven impacts or responses to changing market dynamics. We think that will continue. The entire market won’t go up. The entire market won’t go down. There’ll be sectors that go up, sectors that go down. Individual companies do better, some will do worse. So, we’re really trying to highlight more specific exposures than we have been in the last couple of years, because the last couple of years were much more of a one-way trade, and we just don’t think that’s the case today. We could just talk about the tech sector, for example. We’ve added exposure in some of the software names because they’ve sold off quite a bit. They’re not better companies than they were six months ago. The price is just cheaper today. So to us, that’s a compelling opportunity.
We’re still underweight the US market, not as much as we were, but we’re still underweight the US market. To offset that, we’re overweight emerging markets. We talked a little bit about how emerging markets sold off in March more than some of the developed markets did. That was an entry point that we found attractive. We specifically focused some of our exposure in Latin America, and the emerging markets within Latin America are interesting because, as I said, they sold off more, but one of the benefits to those countries is most of them, many of them are oil exporters. So you have this scenario where the prices went down by more than some of the developed markets, but the number-one export for their local economies went up in price, and we already talked about how that can lead to more profits. So, you have a situation where there’s potentially an economic tailwind, and you can get a lower-priced point of entry into those markets. Those are a couple of things we’ve talked about. And we’re still overweight healthcare. We like the healthcare sector within the US. Fundamentals are holding up quite well, and performance has really lagged the broad US market. We think that gap could narrow, and we’ve been overweight healthcare as a result of that.
Hampton: I like how you connect the dots throughout our conversation. In a January episode, we talked on Investing Insights about opportunities in fixed income. What’s the update?
Pappalardo: Not much has changed, quite honestly, since the beginning of the year there. There’s been some volatility, but not really enough to change our strategy or our portfolio positioning. We still think government bonds in the US are more attractive than corporate credit in the US just because the yield premium you get for adding corporate exposure is very, very narrow, historically narrow. We don’t think that risk/reward trade-off is appealing today. We’d rather own the government bonds as opposed to taking on the extra credit risk of the corporations. We have diversified our government-bond exposure globally. We’ve added some global sovereign debt. So basically, that’s foreign government Treasury bonds. Not necessarily because we have concerns about the US, but you could pick up yield and generate more income in your fixed-income allocation by broadening out your treasury holdings across the globe. So, countries like Japan, the UK, France all offer higher yields in US-dollar terms than US Treasuries. We think that’s appealing from an income benefit perspective as well as just diversifying your portfolio, which generally is always a good idea.
Hampton: Which equity sectors do Morningstar analysts believe are worth a look?
Pappalardo: Well, I mentioned healthcare already. That’s probably our number-one sector overweight. I like to think about this question more as market segments than just sectors. So, healthcare is a sector. We’re overweight there. We’re also overweight small-cap stocks, which we haven’t talked about yet today. Small-cap stocks are having a very strong start to the year, which is a big reversal from what we’ve seen in the previous few years. Small caps have lagged large caps by quite a bit over recent history. Small caps are outperforming large caps year to date as well as the broad US market year to date. So again, quite a reversal from what we’ve seen. We like the fundamentals. We think fundamentals are favorable for small caps, and the discounted prices are really appealing, in our view. And then I would say the third segment that we like gets back to that emerging-market exposure. And we kind of talked through that already. But if you think about it in terms of segments, not just sectors, it would be healthcare overweight, small-cap overweight, which has done quite well, and then kind of that emerging-market non-US exposure that we’ve been holding for a while.
Hampton: What are the takeaways to prepare for the second half of 2026?
Pappalardo: I think it starts with the macro headlines. Certainly, a more final resolution to the conflict in the Middle East would be favorable and received well by markets. I would argue most of that’s probably priced in already. I think there’s reversal risk, meaning that if a deal doesn’t happen, you could see markets retreat and sell off a little bit. I think that’s the overarching theme to watch for.
I think interest rates and Fed activity are another important piece of the macro conversation. The view of what the Fed’s going to do with interest rates has shifted a lot this year. If you go back to the beginning of 2026, futures markets were pricing in two rate cuts this year. If you looked at it last week, there was a 65% chance of a rate hike by the end of this year. So, a very large reversal and forecast there. That’s being driven by two factors. One is inflation, and two is the labor market. Inflation was running really, really hot, particularly in the second quarter of this year, much of which was fueled by the higher energy prices. That’s an input into almost every good and service we consume, so that pushes prices higher. Not to mention what everybody was paying for fuel directly at the pump.
The other side of the equation, as I said, is labor markets. Three of the last four employment reports have surprised to the upside. They’ve been more positive than expected. That was not the case coming into the year. 2025 employment reports were pretty weak. So you have these competing forces where inflation’s higher than the Fed’s target. The last print was just over 4%; the Fed’s targeting 2%. That wouldn’t mean they want to hike rates to fight inflation, but that theoretically will put more downward pressure on the labor market, which they don’t want to do. But since we’ve seen some strength in job reports, the market is leaning more toward hikes than cuts because the risk/reward has shifted a little bit. So I think that’s the second dynamic. And then the third is just going to be the continued AI capital investment cycle. That’s really what drove the bounceback rally that we talked about.
Budgets for investment in AI keep coming in higher and higher than expected. Those cannot grow indefinitely. Corporations have a cap for how much they can spend, and there’s speculation that we may be reaching that cap. So, if we start to see a pullback in capital investment toward AI, that may kind of take some of the steam out of that AI trade and maybe not cause a dramatic selloff, but probably keep some of those names from rallying beyond the current price points.
Hampton: We have plenty to watch.
Pappalardo: Yes.
Hampton: Thank you, Dom, for coming to the table and sharing your market insights.
Pappalardo: Thanks for having me.
Hampton: That wraps up this week’s episode. Thanks for making this show part of your day. A couple of reminders: Give Investing Insights five stars on Apple Podcasts to help others find the work we’re producing for you, and subscribe to Morningstar’s YouTube channel to watch new videos from our team. Thanks to senior video producer Jake VanKersen and associate multimedia editor Jess Bebel. I’m Ivanna Hampton, editorial multimedia manager, Morningstar. Take care.
