Key Takeaways
The period of straightforward index gains has ended as three structural forces — geopolitical instability, frequent supply shocks and rising macro volatility — converge to reshape equity market dynamics, Charles Schwab's strategists warned Wednesday.
"The macro environment will continue to be unstable given policy crosscurrents and a wobbly labor market, but stocks can likely churn higher given a firmer earnings backdrop," said Liz Ann Sonders, chief investment strategist at the Schwab Center for Financial Research, and Kevin Gordon, head of macro research and strategy, in the firm's 2026 mid-year outlook published last month. "We think rebalancing based on volatility, as opposed to the calendar, makes sense."
The warning comes as the S&P 500 has continued grinding higher despite a backdrop that Schwab's analysts describe as increasingly fragile. The index has gained this year on the back of projected full-year earnings growth of 25%, according to LSEG I/B/E/S data — a pace that is rare outside of post-recession recoveries and is now in year seven of an economic expansion. Yet only about 17% of S&P 500 members have outperformed the index over the past month, one of the lowest readings in a decade, suggesting a market carried by a narrow cohort of AI-related and energy stocks.
The U.S.-Iran war and the effective closure of the Strait of Hormuz have pushed energy's contribution to headline inflation sharply higher, while core services inflation excluding housing — the so-called supercore measure — has settled above 3% year-over-year, reaching 3.5% in April. The University of Michigan Consumer Sentiment Index has plunged to a record low, below every recession trough in the survey's 75-year history, yet the S&P 500 has continued to rise — a divergence Schwab's strategists attribute to the K-shaped nature of the recovery, where equity ownership remains concentrated among higher-income households insulated from the inflation shock affecting lower-income consumers.
The 10-year Treasury yield recently jumped above 4.6% from sub-4% before the war with Iran began, driven by a combination of inflation risks and growing government debt issuance competing for capital. The equity risk premium has thinned to historically low levels, meaning stocks offer only a small return advantage over Treasuries. The correlation between equities and bond yields has turned deeply negative again, signaling that both asset classes are moving in the same direction — a pattern that historically precedes periods of elevated volatility.
Goldman Sachs' proprietary Risk Appetite Indicator now sits in the 99th percentile of all observations since 1991, suggesting markets are priced for continuation rather than disappointment. Meanwhile, the share of equities in household financial assets has reached more than 47%, nearly tripling from the 2008 financial crisis low, according to Federal Reserve data. At that level of exposure, any meaningful correction would likely transmit from portfolios into consumption through the wealth effect.
New Federal Reserve Chair Kevin Warsh may face his first formal market test. The selloff in U.S. Treasuries recently pushed the 30-year yield to its highest level in years, spurring a narrative that markets are testing the new chair's inflation credibility — a pattern that has historically greeted new Fed leaders. Warsh's known skepticism of the Fed's balance-sheet footprint and preference for tighter communication discipline could usher in more volatility than markets experienced under former Chair Jerome Powell.
Schwab's strategists identified additional risks that could drive volatility episodes: the high bar for forward earnings expectations, a longer-than-anticipated closure of the Strait of Hormuz that would further entrench inflation trends, private credit concerns spreading into public markets, the massive size of pending IPOs forcing passive funds to trim existing mega-cap holdings, and AI's productivity benefits undershooting expectations.
"The bull case has real substance," Sonders and Gordon wrote. "So does the case for managing it carefully."
This article is for informational purposes only and does not constitute investment advice.
