Fall 2026 Investment Directions

• We believe the macro backdrop is healthy and supports staying invested in equities, despite ongoing geopolitical tension, concerns about inflation and uncertainty stemming from the reduction of guidance from the Fed.
• We remain convicted in AI equities, while diversifying around AI portfolio concentration. Strong Q2 earnings reinforced the long-term AI opportunity, with clear evidence that capex is translating to returns.
• Outside the U.S., we prefer emerging over developed international markets, with our strongest conviction in Asia. Taiwan and South Korea remain central to the AI buildout, while opportunities are broadening across China, India and Japan.
• We look beyond stocks and bonds for new sources of diversification. The orientation of the economy and markets along the AI axis potentially creates risk from a whole portfolio perspective, raising the importance of looking beyond traditional asset classes for diversification. We favor alternative and market-neutral strategies.

The U.S. economy continues to defy expectations for a downturn and remains in fine health from a macro perspective. That said, we’re mindful of the challenges to our optimistic view:

• Growth is increasingly driven by business investment rather than consumer strength.
• Labor market growth has slowed substantially and is concentrated in a narrow group of industries. The labor force participation rate fell to 61.4% in July, its lowest in more than five years.¹
• Five years (and counting) of inflation above the Fed’s 2% target has weighed on consumer goods production and consumption.²
• There’s a malaise visible in consumer sentiment data, elevated policy uncertainty, and even in fund flow data that has favored conservative exposures such as bonds and cash.³

That said, at the same time, corporate profits have rarely looked better: second-quarter earnings for the S&P 500 were near the best on record and, encouragingly, broad-based; 8 of 11 S&P sectors reported double-digit year-over-year earnings growth in Q2.⁴

Artificial Intelligence is unmistakably a driver of growth — and occasionally angst — across the economy. The rapid advancements in technology and equally rapid proliferation have pushed productivity higher and created a generational boom in manufacturing and the infrastructure needed to support it. Companies that have plowed money into AI-related capital expenditure over the last three years have begun to see meaningful returns on those investments, validating money already spent and motivating further capital allocations.

AI has created winners and losers, but we contend the theme is not zero-sum. AI investment creates competition for capital, pushing longer-term interest rates higher and creating new income opportunities for investors. As AI has moved from predominantly a U.S. equity story to one that touches nearly every part of a portfolio, it has also shifted the relationships between asset classes.

While we continue to have confidence in the long-term growth prospects of AI investing, we acknowledge that the orientation of the economy and markets along a single axis also potentially creates risk at the whole portfolio level. We see further reason to look beyond traditional asset classes for diversification and increasingly favor strategies that can benefit from dispersion and volatility rather than purely directional bets. For more about the portfolio implications of potential economic outcomes, read the BlackRock Investment Institute’s latest Outlook.

Based on feedback from our readers, we have adopted a streamlined format to address the top questions we’ve received from investors about macro, markets and portfolio construction. To submit a question for future publications, please email us directly or visit r/iShares on Reddit.

Downside volatility is not abnormal for tech stocks, but there were some intense bouts this summer.⁵ July 27-29 was the third-largest three-day hedge fund reduction of leverage on record, trailing only the 2020 COVID drawdown and 2021 meme-stock mania.⁶

In June and July, the PHLX Semiconductor Sector Index (SOX) had a daily return of greater than +5% or worse than -5% on 33% of all trading days vs. just 3% of all trading days in the prior 10 years.⁷

Leverage, crowded positioning, and profit taking may have been amplifying stock moves. In the first seven months of 2026, over $8 billion flowed to leveraged ETF products tied to South Korean equities, particularly Samsung and SK Hynix, far above the $540 million in total flows these products had seen in the previous five years.⁸

The impact of excess leverage from hedge funds was made apparent on July 30, when it was reported that AI-focused hedge fund Situational Awareness faced acute margin call pressure and sold off most of its liquid assets at a discount.⁹ That event appeared to mark the low point of the sell-off (semis fell 29% from June 22 to July 29).¹⁰

In our view, this summer’s sell-off was not based on any deterioration of fundamentals. The earnings landscape for AI and semis stocks continues to improve. S&P 500 semiconductor firms are now expected to grow earnings 144% year-over-year in the second quarter, versus the 126% expected on June 15.¹¹ (See more on the earnings from AI stocks in Question 4.)

Amid the decline in semis and AI stocks, other areas of the market rallied. An equal-weighted basket of S&P 500 stocks was only 1% away from all-time highs in mid-August.¹² That resilience came from parts of the market that are not associated with AI, like dividend-paying stocks, quality stocks, or software stocks, which reversed course after selling off sharply in late 2025 and early 2026.

We believe this summer’s AI sell-off was temporary rather than the start of a downward trend, but we also brace for likely elevated volatility as a lasting feature of the AI theme. The excess leverage deployed this summer has decreased — leveraged ETF assets have declined more than $60 billion from their June peak — but is not gone.¹³

Uncertainty surrounding AI will likely remain, but we see the long-term opportunity and continue to refute comparisons between AI and the late 1990s dot-com bubble. The recent sell-off may provide those with long-term time horizons and high tolerance for risk an attractive entry point and lessons to apply for the next AI drawdown.

Federal Reserve Chair Kevin Warsh struck a hawkish tone in his Jackson Hole speech, but we still see room for the Fed to hold rates steady in September rather than hike aggressively into year end. This means higher rates could persist, while resilient growth and rising AI-related corporate bond issuance could pressure longer-term yields, reinforcing our preference for front- and intermediate-term Treasuries, aka the “belly” of the yield curve.

We believe U.S. inflation likely peaked in May, as gasoline and jet fuel price inflation have declined since, easing some of the energy-related pressure on inflation.¹⁴ The three-month average of so-called super-core inflation (core services ex-housing) has fallen to 0.09% month-over-month growth vs. the 12-month average of 0.28%.¹⁵

Additionally, we estimate upcoming methodology changes to Personal Consumption Expenditures (PCE) could reduce measured year-over-year inflation by approximately 0.3%.¹⁶ Effective September 30, the changes are intended to better reflect household consumption patterns, including improved measurement of portfolio management fees, legal services, and software prices.

The labor market also appears stable, if unimpressive. While job growth has come from a narrow subset of sectors, the unemployment rate has remained contained, with lower job creation offsetting a shrinking work force. Payroll revisions have also been consistently negative, with three-month average job growth slowing to 20,000.¹⁷

Since becoming Chair in May, Kevin Warsh has begun reshaping how the Fed communicates with markets and approaches policy — yielding fewer details for Fed watchers. He shortened the FOMC statement and largely stepped away from forward guidance, emphasizing that markets should "play the ball, not the referee," i.e. responding to economic data rather than Fed projections. Warsh also established five task forces, including one focused on communications and one looking at the Fed’s inflation framework — potentially signaling more formal changes to come.

We believe this is likely to result in increased volatility in rates and a steepening of the yield curve. As investors reassess the outlook after each economic release, markets can reprice the expected path of monetary policy, tightening or loosening financial conditions without a change in the federal funds rate. Options-based strategies may offer a way to harvest the elevated rate volatility on the long-end of the yield curve and provide income.

Markets continue to price a greater likelihood of additional Fed hikes than we expect, creating room for front and intermediate yields to fall. Meanwhile, resilient economic growth, rising competition for capital to finance AI investment, elevated Treasury issuance, fiscal uncertainty, and questions around Fed credibility could keep upward pressure on longer-term yields, making curve positioning ever more important.

There is likely to be no shortage of headline risk through year-end, from fragile geopolitical developments in the Middle East to discussions over AI data centers and other focal points of domestic politics ahead of the November midterms.

Even as we have seen stronger-than-expected performance in 2026 to date, investors should be aware of the patterns surrounding key events:

• Historically, midterm election years have delivered weaker-than-average returns of 7.5% vs. 12.4% in all years.¹⁸
• Since 1970, the market has started to rally on average around a month (22 trading days) before a midterm election, as polling data provides clearer indications of results.
• Regardless of the outcome, midterms can help reduce uncertainty, with markets often rallying after the event. As event risk passes post-election, equities have historically experienced tailwinds, with an average return of 14.1% in the following six months compared to 5.7% in non-midterm years.¹⁹

The conflict in the Middle East remains a key risk, with traffic severely curtailed through the Strait of Hormuz, a critical thoroughfare through which about 20% of global oil supplies have historically passed.²⁰ Shifting expectations around ceasefire negotiations and the reopening of the Strait have meant sharp energy market swings: Brent crude has traded between $69 and $128 per barrel since the conflict began in March.²¹ Shipping remains severely constrained: recent traffic has averaged 6 vessels per day vs. about 140 pre-conflict.²²

Continued disruption to a main energy corridor leaves oil prices — and inflation and broader markets — sensitive to every development in the conflict. While headlines are likely to remain a source of near-term volatility, the key for investors is to stay disciplined and consider staying invested. It’s important to remember that the core driver of markets remains solid fundamentals, even in years dominated by headlines.

AI remains our highest conviction theme within U.S. equities. Evidence from corporate earnings showed us that the AI opportunity is becoming broader, not more zero-sum. The AI economy continues to expand as providers of frontier models grow revenue, AI adoption spreads, and an increasing share of compute shifts from training toward inference and real-world usage.

But the clearest earnings evidence in the second quarter came from compute infrastructure: cloud growth accelerated strongly across the hyperscalers (Google Cloud +82%, Azure +43%, and AWS +37%), as these companies reaped the rewards of previous years’ investments.²³ Just as importantly, these companies drew a much more explicit link between AI investment and potential future returns.

Further, the infrastructure layer is also less dependent on which individual AI model ultimately wins. Open- and closed-weight models are proliferating, becoming more capable and being used for a growing range of tasks.²⁴ More models and more use cases ultimately mean more inference and more tokens generated — and therefore more demand for the compute, networking, power, and cloud capacity beneath them. That makes the infrastructure layer one of the broadest ways to participate in likely continued growth of the AI ecosystem.

That conviction also guides our factor style view. We opened the year with a more balanced view between Growth and Value, as detailed in our 2026 Outlook. We now tilt further into Growth.

In its June index reconstitution, FTSE Russell moved many of the market’s AI and semiconductor momentum leaders more squarely into Growth, making the style a cleaner expression of the AI earnings story.²⁵ Shifting momentum and style leadership this year underwrites our preference for dynamic allocation strategies rather than static holdings. Active ETFs may offer a tax-efficient way to rotate holdings with evolving macro and micro dynamics without the need for frequent portfolio rebalancing.

AI stocks make up nearly half the market capitalization of U.S. equities, meaning investors are increasingly exposed not only to the AI opportunity and the volatility that comes with it, but also to macro risks that could challenge the trade.²⁶

Higher real rates make future earnings worth less today and can increase financing costs across an increasingly capital-intensive AI buildout. For portfolios in today’s AI era, diversification might mean new considerations: companies with characteristics and revenue drivers that are independent of the AI theme can lower portfolio risk.

If AI can generate outsized returns (our base case), AI leaders may reinvest aggressively. Lower free cash flow today may not be inherently a concern if that spending is building a potentially much larger profit pool tomorrow. But that trade-off has come under greater scrutiny in recent weeks.

Investors who are less convicted about future returns, or simply looking to diversify from AI concentration, could prioritize near-term cash flows, such as those provided by high-quality dividend exposures. While AI leaders have been reinvesting cash to fund future growth, dividend payers have been returning more cash to shareholders, giving investors the flexibility to redeploy it elsewhere and making them a natural counterweight if returns on AI investment come under pressure.

That ballast was on display in recent months: dividend-paying stocks were up 8% in the July AI sell-off, as shown in Figure 6.

Not only have dividend-paying stocks been increasingly negatively correlated with the AI trade, but they also operate in sectors that are likely safe from AI disruption: gasoline, tobacco, and beverages are likely not getting replaced by AI agents.²⁷ Global healthcare offers another source of diversification: over the last five years, it has outperformed the broad market in 71% of the weeks semiconductors fell — a hit rate that climbs to 81% over the past year as the sector’s more defensive nature leaves it less tethered to the AI investment cycle.²⁸

The quality factor offers a complementary approach: quality strategies tilt toward companies with high return on equity, low leverage, and low earnings variability. Strong balance sheets can provide greater resilience if real rates remain high or financing conditions tighten, without abandoning the long-term AI opportunity.

As detailed in our Year Ahead and Spring Investment Directions, we continue to prefer emerging markets (EM) over developed international markets and view the strongest opportunities in Asia.

Overall, international equities have continued to attract investor interest in 2026, despite a marked pickup in volatility. Market participation remains broad, with 86% of country ETFs trading above their 50-day moving averages.²⁹ At the same time, international and global strategies are on pace for record annual ETF inflows, underscoring continued investor demand for non-U.S. exposure.³⁰

In Asia, while concentration and volatility have increased notably, the fundamental backdrop remains supportive. Taiwan and South Korea remain central to the semiconductor and memory supply chains powering AI, contributing to strong expected EM earnings of approximately 20% growth in the next 12 months.³¹
Read more about our outlook for international stocks.

While the recent pullback has made valuations more attractive in AI-focused names, higher volatility and sensitivity to leverage warrant consideration of more thoughtful portfolio sizing and hedging strategies.

Importantly, the Asia AI opportunity has broadened beyond the traditional semiconductor and memory story:

• In China, we favor a selective approach focused on innovation, automation and industrial upgrading, even as the domestic property market and consumer consumption remain challenged.³² Advanced manufacturing and technology continue to be bright spots, with integrated-circuit exports rising 89% year-over-year in the first half of 2026 amid strong global AI demand.³³
• India offers a different source of opportunity and potential diversification from AI-heavy markets, with selective opportunities across its more domestically oriented financial and consumer sectors.
• Japan also offers meaningful exposure to robotics and the semiconductor supply chain, providing another way to participate in AI beyond the memory and chip manufacturers that dominate North Asia.

We believe elevated risk-free rates and real yields provide an attractive starting point for forward returns within fixed income. As spreads to Treasuries remain historically tight for both investment grade and high yield corporate bonds,³⁴ we favor clipping coupons while remaining selective about where credit risk is deployed. This approach favors higher-quality bonds, focusing on investment-grade credit and highly rated speculative grade bonds, rather than taking broad credit-market risk.

Securitized and real asset-backed credit may offer attractive income with resilient cash flows and lower exposure to potential AI-driven obsolescence. Emerging market debt continues to benefit from supportive carry, resilient growth, and improving flows.³⁵

We see potential for further yield curve steepening given the competition for capital from record corporate bond issuance and heavy Treasury issuance. Furthermore, risk premia could rise as new FOMC Chair Kevin Warsh works to establish credibility.³⁶ Navigating elevated duration risk will likely require a nimble approach.³⁷

That’s not to say that there are no tactical opportunities further out the curve. With 30-year TIPS yielding over 3% for the first time since the Global Financial Crisis of 2008 and real yields elevated across all maturities, we view TIPS exposures as providing meaningful income opportunity and a potential cushion against growth deterioration.³⁸ Despite strong inflows since 2025, positioning in inflation-mitigating investments remains relatively light and we see potential for further inflows through the end of the year and into next.

AI has moved beyond an equity story and into core fixed income holdings — an evolution that may put upward pressure on the yield curve and ultimately could make U.S. investment-grade (IG) credit a less effective portfolio diversifier.

As the data center buildout consumes ever more internally generated cash, AI adopters have increasingly turned to debt financing, which creates competition for capital.⁴⁰ The five hyperscalers (Amazon, Microsoft, Alphabet, Meta and Oracle) collectively issued approximately $200 billion of investment-grade debt in the first half of 2026, almost double the issuance during all of 2025.⁴¹ Technology sector borrowing has accounted for 20% of the total amount of new U.S. investment-grade debt issued so far this year,⁴² and over 30% of new long-duration supply.⁴³

This elevated issuance is changing the investment grade market’s composition. Technology’s share within the investment grade universe has risen from 9.3% in January 2025 to 11.6% today.⁴⁴ With over $1 trillion in par outstanding, tech now has a higher weight in the iBoxx USD Liquid Investment Grade Total Return Index than banks.⁴⁵

As technology’s share of investment-grade indices grows, correlation between IG bonds and technology stocks has also moved higher, reaching ~0.45 in August, up from ~0.05 in November 2025.⁴⁶

Unique sources of return are even more important for a market with narrow drivers. With the corporate bond market’s rising exposure and correlation to technology, we believe investors could consider including alternative sources of diversification. Liquid alternative strategies such as equity market neutral can provide diversification from technology, delivering positive returns when U.S. equities are negative.⁴⁷

Recent market stress reinforced the importance of portfolio diversification, especially when AI exposures have further reduced the diversification benefits from core fixed income. The total risk of an average moderate financial advisor portfolio has increased from 10.8% to 11.3% since the beginning of the year, and a broader increase in market risks has added to potential portfolio volatility.⁴⁸

Investors are paying more attention to AI as it encompasses a growing share of traditional asset classes in their portfolios. Within equity sleeves, dividends and quality stocks can prove useful diversifiers, while looking beyond IG credit can limit a bond allocation’s correlation to equities. Investors may look outside of stocks and bonds to alternatives or commodity strategies that historically have been negatively correlated with equities to seek additional diversification.
Explore more in “Re-Underwriting Bitcoin: Still a Portfolio Diversifier”.

We believe investors should consider hedge fund style strategies as an additional source of diversification, alongside bonds and alternative asset classes like gold and cryptocurrencies.

We remain constructive on gold structurally, with central bank demand providing an important source of support. And bitcoin has exhibited positive recent momentum in flows and performance amid supportive policy comments from the White House and government regulators. Tactically, however, stronger AI-driven productivity could translate into higher real yields, posing a near-term risk to performance for non-yielding assets.

While volatility across traditional equity and fixed income markets has increased in the AI era, average hedge fund strategies have exhibited comparatively lower volatility with more differentiated return drivers as shown in Figure 10. Their ability to manage market exposure dynamically, invest long and short, and pursue relative-value opportunities can provide sources of return that are less dependent on broad market direction.

The opportunity set has become increasingly compelling in 2026, supported by higher equity dispersion and a broadening of market leadership across sectors, countries and factors. Dispersion within the S&P 500 has reached its highest level since 2010, creating greater scope to generate alpha from winners and losers.⁴⁹ Historically, periods of elevated dispersion have also been associated with stronger hedge fund performance.⁵⁰

Fund flows and investor sentiment are showing a diverging story: investors are allocating into bond funds and money markets, while identifying as bullish on equities in our polling.

We believe this disconnect is one of this year’s more striking market developments. U.S. stocks continue to climb to new highs, with the S&P 500 up over 10% year-to-date through July and with gains extending across international, emerging market, and small-cap equities.⁵¹

Yet flows show caution as investors seem to favor bond and money market funds, indicating a desire to capture yields and prepare for an uncertain economic and political backdrop.

• Even with bond performance largely flat, bond mutual funds and ETFs have attracted about $912 billion in the past 12 months, approaching the all-time record of $959 billion from 2021.⁵²
• Intermediate core bonds and ultrashort bonds have seen the strongest inflows, suggesting investors are prioritizing income, stability, and capital preservation over equity upside.⁵³

On the other end of the risk spectrum is the rise of levered exposures and narrowly focused semiconductor ETFs, which have seen $21 billion of inflows YTD.⁵⁴ Even with recent volatility, investors have indicated a “buy the dip” attitude: in weeks following negative semiconductor performance, flows into the top seven semiconductor ETFs increased by 14%.⁵⁵
Read our H1 ETF and ETP flows report for more.

BlackRock polling also reveals that advisor sentiment has rebounded. Since the March lows, sentiment has steadily recovered, with the percentage of respondents expressing bullish sentiment nearly doubling, while the percentage of those expressing a bearish view halved.⁵⁶

The dichotomy between flows and sentiment is evident in investors’ forward intentions. Since mid-May, the top two asset classes investors have indicated they’re looking to add to have been U.S. equities and liquid alternatives, suggesting investors are both leaning into risk and getting more deliberate about portfolio diversification.

With earnings remaining strong, market leadership broadening, and investors still favoring defensive allocations, the current environment suggests the equity rally may have more room to run.