Heating Up
Summer has arrived — and so has the heat. Inflation is running at its fastest pace in three years, energy prices have surged 23.5% over the past twelve months, geopolitical tensions continue to simmer following the outbreak of conflict in Iran, and volatility across interest rates and currencies remains firmly elevated. Yet just as a scorching day rarely slows a determined market, financial markets have largely shrugged off any discomfort. U.S. equities powered higher in May, with the S&P 500 posting a gain of 5.3% on the month and 29.8% over the trailing one-year period. These returns were fueled by a first-quarter earnings season that delivered a stunning 28.8% growth rate for the index — more than double what analysts had anticipated.
While corporate America has had a strong start to 2026, the global growth picture is more uneven. The eurozone’s composite PMI sank to a 31-month low in May and economists are forecasting a 0.2% contraction in Q2, as rising prices weigh on production, hiring, and consumer confidence across France and Germany. Japan, by contrast, is finding its footing, with Q1 GDP expanding at an annualized 2.1% on the back of stronger consumption and an 11.5% surge in exports. However, higher energy costs tied to the Iran conflict remain a meaningful headwind for the country’s corporate sector.
Elsewhere in emerging markets, India delivered a standout 7.8% GDP growth print in Q1, well ahead of forecasts, while Brazil posted a solid rebound driven by stronger investment and consumer spending. Both nations are demonstrating that the EM growth engine still has plenty of heat left in it, even as inflation keeps central banks on their toes. The economy, the markets, and the geopolitical backdrop are all heating up in their own ways and navigating that heat with patience and strategic diversification remains our guiding principle.
Economic Backdrop Remains Solid Despite Higher Inflation & Geopolitical Uncertainty
The May employment report beat expectations with upward revisions to the prior months’ reports. The headline reading of 172,000 new jobs was well ahead of the 80,000 expectation, and the March and April reports saw total upward revisions of 93,000. The unemployment rate held steady at 4.3% and the broader U6 unemployment rate declined to 8.1%. Average hourly earnings increased 0.3% month-over-month (M/M) and 3.4% year-over-year (Y/Y). Leisure and hospitality led all sectors with 70,000 jobs, well above the 14,000 per month average over the past year. Healthcare contributed 35,000 new hires, in line with its average. Local government added 55,000 and social assistance added 12,000. Broader economic growth has been solid with 3% growth expected in Q2.
U.S. GDP expanded at an annualized clip of 1.6% in Q1 based on the second reading from the Bureau of Economic Analysis. This was down from the initial reading of 2.0%, but up from Q4’s 0.5% pace. Gross private domestic investment surged, bolstered by an unrevised 17.2% jump in equipment spending. This continued capital influx was heavily anchored in AI-related infrastructure and software. Personal consumption expanded at a revised 1.4% rate, a deceleration from previous quarters as elevated gas prices and lower savings rates squeezed household budgets. The initial reading was cut because of downward revisions to consumer spending and investment.
U.S. consumer prices rose at their fastest pace in 3 years based on the May CPI report. Headline inflation increased 0.5% M/M or 4.2% Y/Y while Core CPI registered a gain of 0.2% M/M or 2.9% Y/Y. Most of the inflation surge came from a 3.9% jump in energy prices, putting the 12-month increase at 23.5%. Food costs accelerated just 0.2% and shelter costs rose 0.3%, half the gain of April. The Fed’s preferred PCE Index showed headline inflation of 3.8% in April with core inflation at 3.3%.
Consumers & Businesses Are Holding Up Well
U.S. retail sales rose 0.5% M/M in April, following an upwardly revised 1.6% gain in March. Retail spending was up across most categories last month, but sales at gas stations rose just 2.8% in April, down sharply from March’s steep 13.7% increase. Overall, we believe U.S. consumers remain resilient despite soaring gas prices. Core retail sales, which exclude food and energy, increased 0.5% M/M in April.
April durable goods orders surged 7.9%, chalking up the largest increase in nearly a year. The result outpaced expectations for a 4% rise, and March orders were revised higher. Transportation orders jumped 21.5%, led by a 166% rise in civilian aircraft orders. Boeing booked orders of 136 new planes in April, a sharp increase from 33 in the prior month. Gains in durable goods orders were broad-based as nearly all industries booked increases. The one exception was computers and electronic product orders, which declined 0.7% after seven straight months of gains. Nondefense capital goods orders excluding aircraft, a proxy for capital spending, fell 1.1%, after rising 3.9% in March and 1.6% in February.
Eurozone Economy Shows Weakness While Japan Posts Growth in Q1!
The eurozone flash composite PMI fell to its lowest level in 31 months with a reading of 47.5 in May (down from 48.8 in April); figures below 50 indicate contraction. Services activity dropped to a 63-month low in May and the rebound in manufacturing activity weakened a bit to a three-month low. Prices rose at their quickest pace in 3.5 years and this led to weakness in production, new orders and employment. Both France and Germany reported declines in business activity last month. Based on May’s PMI data, economists believe the eurozone economy should contract 0.2% in Q2.
Japan’s economy grew at an annualized 2.1% in Q1 of 2026, beating expectations on the back of improved consumption and strong exports. Japan’s exports grew by a better-than-expected 11.5% Y/Y in March, partly powered by a 29.3% jump in shipments of semiconductor equipment. The BOJ recently cut its GDP growth forecast for 2026 and raised its outlook for inflation. As a major energy importer, the Iran war is having a large impact on corporate profits and household incomes.
India & Brazil Are Driving EM Growth
India’s economic growth surged 7.8% in Q1, well ahead of the 7.2% forecast. India benefited from trade deals with the eurozone in Q1 along with some easing of tariffs by the U.S. As a major energy importer, India’s economy is expected to feel the pain of higher oil prices resulting from the war in Iran. While inflation currently remains below the Indian central bank’s target of 4%, the central bank recently raised its inflation forecast and lowered their GDP growth forecast. Brazil’s economy rebounded in Q1 with GDP growth of 1.1% quarter-over-quarter (Q/Q), supported by stronger investment and consumer spending. Consumer spending rose 1% while investment increased 3.5%. Brazil’s economy is forecast to grow 2–2.5% this year, but like most countries, inflation remains above the central bank’s 3% target, creating a challenge for future monetary policy.
How Much Longer Will Private Credit Stress Last?
Perceived stress in private credit markets continued into Q2 with notable interval funds and BDCs reporting redemption queues above the stated 5% quarterly requirement. Blackstone’s BCRED reported redemptions of 10% ($4.4B) for Q2 but the firm restricted redemptions to just 5%, meaning exiting investors will receive a pro-rata redemption. Cliffwater’s flagship Corporate Lending Fund incurred redemptions of 17% of NAV, higher than the 14% rate reported in Q1. Cliffwater also capped redemptions at 5% in Q2. While other notable firms are still compiling their redemption data, similar figures have been reported by Partners Group and Blue Owl. Blackstone said that BCRED remains well-capitalized, with more than $15B in available liquidity and repayments exceeding shares repurchased. Loan repayments of $2.6B received in the first quarter and about $1B of inflows in the second quarter have more than outpaced share repurchases.
Various rating agencies and investment banks have very different estimates of what a stressed credit environment may mean for private credit. Common risk factors include software / technology borrowers who may be impacted negatively by AI.
We continue to stress diversification within private credit portfolios, including the usage of asset backed lending, and note that not all private credit funds are created equal.
Earnings, Earnings, Earnings!
Corporate America has ignored the geopolitical noise that often impacts financial markets and risk assets. Q1 earnings in the U.S. were nothing short of spectacular with growth coming in at 28.8% for the S&P 500. This was more than double analyst expectations and driven by huge earnings beats from the AI/disruptive technology theme. Analysts project 22.8% earnings growth in 2026 with all four quarters expected to top 20%. In addition to the strong results expected this year from communication services and technology, the S&P 500 should get a boost from energy and materials because of higher energy/commodity prices. Earnings have provided substantial support for current valuations, and we think the ingredients are in place for further gains in risk assets assuming there are no additional unanticipated shocks.
Volatility Remains High
Volatility across interest rates and currencies continued in May and early June with the 10-year Treasury crossing 4.5% and the USD strengthening as a result versus most major currencies. We expect volatility to remain elevated globally as a result of geopolitical uncertainty and contrasting statements from the Trump administration. This dynamic has presented significant challenges for active management.
