Fundamental Backdrop Strong. Watch for Pullbacks.

Macro

Our real gross domestic product (GDP) growth forecast for 2026 is 2.5% (based on Franklin Templeton Institute’s Global Investment Management Survey), versus the Federal Reserve’s (Fed’s) forecast of 2.3% and the Wall Street consensus of around 2%. The main drivers of our GDP forecast are the continued capital expenditures (capex) spend by big technology companies to build out artificial intelligence (AI) infrastructure, the resilient consumer, and fiscal stimulus connected to the One Big Beautiful Bill Act. The duration of the Middle East conflict is the primary risk to our forecast. Higher oil prices are a tax on the consumer, and the negative impacts of higher oil/gas prices will likely broaden over time. To that point, this past week we heard from Walmart (WMT) and Home Depot (HD), and both management teams said consumer spending is tepid, especially the low-end consumer. Walmart also said it is absorbing higher fuel costs, and those costs are impacting the bottom line.
We expect the Fed to stand pat on interest rates as the conflict continues. The relationship of two-year Treasury yields relative to the federal funds (FF) rate supports this view. Two-year yields historically lead the Fed’s rate decisions, and currently the two-year yield is 4.10%, above the FF rate. FF futures are now pricing in a rate hike by next March. The last tick for core Personal Consumption Expenditures (PCE) data came in at 3.2%, the highest reading since November of 2023. Higher oil prices will bleed through to core PCE if oil prices stay elevated. The combination of higher oil prices and higher-than-expected inflation prints are serving to push interest rates up. The unemployment rate (U-3) is 4.3%, just off the recent high in November of 4.5% and essentially flat for the trailing 12-month period. The labor market is holding up, but real wages are starting to come under pressure.
Inflation expectations were up a touch last week. One-year breakeven rates are currently at 2.91%, down 21 basis points (bps) on the week and have effectively been tracking oil prices. This is also the lowest level for one-year breakeven rates since January 21 of this year. Two-year breakeven rates are 2.77%, down 12 bps on the week. Finally, five-year breakeven rates are 2.62%, down 8 bps on the week, and they have been hovering between 2.60% and 2.70% for the last three months. These numbers represent the bond market’s pricing of annualized inflation out one, two and five years.
On the currency front, we are expecting the US dollar to be essentially flat for the year despite the recent volatility. The US Dollar Index (DXY) is trading at US$99.44, near the highs of its 12-month range, defined as US$96‒US$100.

Read more: The Cost of Being Too Liquid

Equities

We are constructive on US equities and have established a target range of 7,000‒7,400 for the S&P 500 (based on Franklin Templeton Institute’s Global Investment Management Survey) driven by 8%-13% year-over-year (Y/Y) earnings-per-share (EPS) growth. We are reviewing that target now as earnings came in significantly stronger than expectations. I have been expecting some consolidation of this move either in terms of price, time or both, and that seems to be occurring now. I think that’s good news—and would suggest buying on pullbacks. We expect volatility to persist until the Strait of Hormuz is fully open.
We reiterate our “broadening” call on equities and emphasize our bullish call on US small- and mid-cap stocks and continue to favor emerging market equities and Japan. Additionally, risk/reward in the Magnificent 7 names looks more appealing today versus the start of the year. The earnings estimate for the S&P 500 Index is currently at US$337.76, up another dollar on the week, and represents Y/Y EPS growth of 15%, above the high end of our forecast. The tape is now 22x 2026 estimates, cheaper than at the start of the year. Earnings estimates have steadily ticked up all year and in the long term, earnings drive stock prices—not geopolitics.
Speaking of earnings, and our bullish view of US small caps in general, have a listen to our latest “Talking Markets” podcast. This episode features Frank Gannon, Chief Investment Officer of Royce Investment Partners. Royce is a legendary small-cap manager, and Frank gives compelling reasons to own small caps.
Let’s look at year-to-date performance in the United States: As of this writing, the Russell 2000 Value Index is leading the charge, up 15.51%; the S&P MidCap 400 Growth Index is up 14.38%; the Russell 2000 Index is up 14.29%; the Russell 2000 Growth Index is up 13.16%; the Russell 1000 Value Index is up 11.42%; the S&P MidCap 400 Index is up 9.92%; the S&P 500 Index is up 9.05%; the Russell 1000 Index is up 8.56%; the S&P 500 Equal Weight Index (our indicator of the “average stock”) is up 6.95; the S&P MidCap 400 Value Index is up 5.89%; the Mag 7 stocks are up 5.97%; and the Russell 1000 Growth Index is up 5.55%.
Outside the United States, the MSCI Emerging Markets Index is up 17.42%; the MSCI Latin America Index is up 14.32; the MSCI Japan Index is up 11.22%; the MSCI Europe Index is up 5.74%; and the MSCI India Index is up 12.64% (total returns are in US dollars).
A lot of questions have come up in the last few weeks on the old Wall Street adage, “sell in May and go away.” Does it work? It has not worked in nine of the last 10 years. Over the last 10 years, from May 1 through to December 31, the S&P 500 Index has a mean return of 7%, with a 90% hit rate. The one down period from May 1 to December 31 was in 2022, with a 6% loss.
Midterm election years have historically been volatile with sub-standard returns. According to analysis by Franklin Templeton Institute Strategist Lukasz Kalwak, the average peak to trough decline in the S&P 500 Index in midterm years was about 18%. What you might not know is that in the third year of the presidential cycle, the market has bounced back. The average S&P 500 rally from the midterm lows was about 32%. The hit rate of positive returns is 100%. Ergo, I would buy any significant drawdowns, similar to our call in March. See our paper, “From US concentration to global opportunity,” and exhibits 11-13 for historical midterm data.
Bottom line: We believe it’s prudent to have a diversified equity playbook that includes US large-, mid- and small-cap exposure, with a balance of growth and value. The same can be said for ex-US equity exposure, with a mix of emerging markets and developed international markets. Reduce concentration and diversify. Use consolidation to your advantage.

Fixed income

We expect 10-year US Treasury bond to yield in a range of 4.0% and 4.25% for the year. The market traded through the high end of our range, with yields now at 4.59%. Much like we have the S&P 500 target under review, we also are reviewing our 10-year yield call. I have been stating that investors should consider adding duration risk north of 4.50%—well, here it is.
The US yield curve has flattened recently, with the 2-year/10-year spread at 50 bps, pretty much unchanged for the last six weeks. We expect bull steepening in 2026, but are on the wrong side of that call at the moment.
We expect short duration fixed income mandates and corporate credit to outperform cash again this year. Considering our views on US 10-year yields, we do not expect duration to be a significant driver of total return this year. Rather, all-in yield capture seems to be the play, although recent spread widening might create an opportunity for additional total return. Our approach would be to clip coupons.
Credit spreads have made big moves (tightening) in the last two months. Investment-grade (IG) spreads (one-year/three-year option-adjusted spreads, or OAS) are now only 74 bps over Treasuries, and high-yield (HY) spreads, as proxied by the Bloomberg US Corporate HY OAS, are now 268 bps over.
Historically, when IG credit spreads have traded 200 bps over, forward returns for the Bloomberg US Aggregate Bond Index have been positive. According to analysis by Rick Polsinello, Franklin Templeton Institute Senior Market Strategist-Fixed Income, the US Aggregate Index has median forward returns out three months of 1.92%, out six months of 4.19%, out nine months of 4.75% and out 12 months of 3.97%. The market is not there obviously, but if it trades there, we would consider buying.
Similarly, when HY credit spreads have traded 600 bps over Treasuries, forward returns have been positive out three months, with a median return of 12.82%, out six months 22.35%, out nine months 26.75%, and out 12 months 29.98%. Again, the market is not there yet, but we would be ready to act if it trades there.
We are bullish on municipal bonds and find taxable-equivalent yields to be attractive, along with robust fundamentals. Importantly, municipal bonds can offer diversification benefits relative to most taxable fixed income mandates. Consider using some cash to add muni exposure in taxable accounts. Have a read of our latest piece on municipal bonds here “Municipal bonds are back.”

Sentiment

The percentage of bullish investors in the latest AAII Investor Sentiment survey stood at 32%. The percentage of bearish investors in the survey stood at 44%. As I see it, there’s no signal here; it’s more like a swing back to the wall of worry.
Bull markets typically peak on euphoria. We are a long way from that.

I will continue to analyze the markets and will offer insights again next week.

Source of data (except where noted) is Bloomberg and Franklin Templeton Institute, as of May 22, 2026. Important data provider notices and terms available at www.franklintempletondatasources.com.

The Franklin Templeton Institute Global Investment Management Survey is a biannual outlook survey designed to give a view across our investment teams. The Franklin Templeton Institute identifies the median across the survey answers and develops the outlook. The survey received responses from around 200 portfolio managers, directors of research and chief investment officers, representing participation across equity, private equity, fixed income, private debt, real estate, digital assets, hedge funds and secondary private markets. Each of our investment teams is independent and has its own views.

Glossary of terms

The AAII (American Association of Individual Investors) Sentiment Survey: This survey offers insight into the opinions of individual investors by asking them their thoughts on where the market is heading in the next six months.

Breakeven rates: The difference between yields of Treasury bonds and TIPS for issues of the same tenor/maturity, calculated by subtracting TIPS yields from Treasuries; a measure of inflation.

Capital expenditure (capex): Funds that companies spend to acquire, upgrade or maintain physical assets, such as buildings, technology or equipment, with the purpose of maintaining or growing future operations.

Duration: A measure of how much a bond’s price changes relative to changes in interest rates.

Federal funds (FF) rate: The interest rate that depository institutions such as banks charge other institutions for holding overnight reserves.

Hit rate: The percentage of positive positions or returns over a specific period.

Magnificent Seven: Refers to shares of Apple, Microsoft, Amazon, Alphabet, Meta Platforms, Nvidia, and Tesla.

Option-adjusted spread (OAS): Measures the spread between a bond's interest rate and the risk-free rate, while adjusting for any embedded options like callables or mortgage-backed securities.

Personal Consumption Expenditures (PCE) and core PCE: Measures the price changes in goods and services purchased by US households; core PCE excludes food and energy prices. Both are measures of inflation.

Relative Strength Index (RSI): A momentum indicator that measures the speed and magnitude of recent security price changes, used in technical stock market analysis.

Tape: A reference to broad market performance, based on the ticker tape that transmitted stock prices during the 19th and 20th centuries.

Taxable-equivalent yield: The yield of a municipal bond investment calculated to reflect the benefits of income tax exemption and to be comparable to the yield of a taxable bond.

U-3 unemployment rate: The official measure used by the US Bureau of Labor Statistics (BLS) to report the percentage of the labor force that is unemployed and actively seeking work.

Yield spreads/tights: Spreads are the difference between yields on differing debt instruments of varying maturities, credit ratings, issuers or risk levels. “Tight” in reference to spreads indicates small differences in yields.

Indexes

Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator of future results.

Bloomberg US Aggregate Bond Index: The Barclays U.S. Aggregate Index is a broad-based bond index comprised of government, corporate, mortgage and asset-backed issues, rated investment grade or higher, and having at least one year to maturity.

Bloomberg US Corporate High Yield Index: Tracks the performance of the USD-denominated, high yield, fixed-rate corporate bond market.

MSCI Emerging Markets Index: A free float-adjusted, market capitalization-weighted index designed to measure the equity market performance of global emerging markets.

MSCI Europe Index: A free float-adjusted, market capitalization index that is designed to measure developed market equity performance in Europe: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

MSCI India Index: This index is designed to measure the performance of the large- and mid-cap segments of the Indian market. With 64 constituents, the index covers approximately 85% of the Indian equity universe.

MSCI Latin America Index: This index captures large and mid-cap representation across 5 Emerging Markets (EM) countries in Latin America.

Russell 1000® Index: A market capitalization-weighted that measures the performance of the 1,000 largest companies in the Russell 3000® Index, which represents the majority of total US market capitalization.

Russell 1000® Growth Index: A market capitalization-weighted index that measures the performance of Russell 1000® Index companies with relatively higher price-to-book ratios and higher forecasted growth rates.

Russell 1000® Value Index: A market capitalization-weighted index that measures the performance of Russell 1000® Index companies with relatively lower price-to-book ratios and lower forecasted growth rates.

Russell 2000® Index: A market capitalization-weighted index that measures the performance of the 2,000 smallest companies in the Russell 3000 Index.

Russell 2000® Growth Index: A market capitalization-weighted index that measures the performance of the 2,000 smallest companies in the Russell 3000 Index with relatively higher price-to-book ratios and higher forecasted growth rates.

Russell 2000® Value Index: A market capitalization-weighted index that measures the performance of the 2,000 smallest companies in the Russell 3000 Index with relatively lower price-to-book ratios and lower forecasted growth rates.

S&P 500® Index (SPX): A market capitalization-weighted index of 500 stocks, a measure of broad US equity market performance.

S&P 500 Equal Weight Index (EWI): The equal-weight version of the S&P 500 Index. The index includes the same constituents as the capitalization weighted S&P 500, but each company is allocated a fixed weight, or 0.2% of the index total, at each quarterly rebalance.

S&P MidCap 400® Index: A market capitalization-weighted index of 400 stocks of mid-size companies, distinct from the large-cap S&P 500.

The S&P MidCap® 400 Growth Index: An unmanaged, float-adjusted market capitalization-weighted index comprised of stocks from the S&P MidCap 400 that are classified as growth stocks based on three factors: sales growth, the ratio of earnings change to price, and momentum.

The S&P MidCap® 400 Value Index: An unmanaged, float-adjusted market capitalization-weighted index comprised of stocks from the S&P MidCap 400 that are classified as value stocks based on three factors: the ratios of book value, earnings and sales to price.

US Dollar Index: A basket of six foreign currencies (euro, Japanese yen, UK pound sterling, Canadian dollar, Swedish krona, and Swiss franc) used to track the relative strength of the US dollar, with a higher index value representing US dollar strength.

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX): A measure of market expectations of near-term volatility as conveyed by S&P 500 stock index option prices.

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The allocation of assets among different strategies, asset classes and investments may not prove beneficial or produce desired results. Diversification does not guarantee a profit or protect against a loss.

Equity securities are subject to price fluctuation and possible loss of principal.

Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.

International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The investment style may become out of favor, which may have a negative impact on performance.

Large-capitalization companies may fall out of favor with investors based on market and economic conditions.

Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

Commodity-related investments are subject to additional risks such as commodity index volatility, investor speculation, interest rates, weather, tax and regulatory developments.

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