The second quarter of 2026 saw a sharp reversal in energy markets and investor sentiment. The quarter began with markets still absorbing the economic consequences of the conflict with Iran and the disruption to global oil supplies. Temporary ceasefires, progress toward negotiations, and a gradual reopening of the Strait of Hormuz reduced the risk of a prolonged energy shock. Brent crude, which had reached approximately $126 per barrel in April, fell nearly 40% during the quarter. As energy prices fell, strong corporate earnings and continued AI infrastructure investment helped drive a broad recovery in risk assets.
Economic data remained resilient, though growth continued to moderate.
First-quarter real Gross Domestic Product was revised higher to an annualized rate of 2.1%, while the current consensus for the full-year 2026 is also 2.1%. The labor market cooled, but did not materially weaken. Employers added 57,000 jobs in June, and the unemployment rate declined to 4.2%, although prior-month payroll gains were revised lower and labor-force participation fell. Manufacturing remained in expansion, with the Institute for Supply Management index at 53.3 in June, its sixth consecutive month above 50. The services index at 54 is similarly supportive of economic growth.
Inflation remained the main complication.
The Consumer Price Index (CPI) rose 4.2% over the twelve months through May, driven largely by a strong increase in energy prices, while core CPI was a more moderate 2.9%. The Federal Reserve’s preferred Personal Consumption Expenditures (PCE) index increased 4.1%, with core PCE at 3.4%. In response, the FOMC held the federal funds rate at 3.50%–3.75% in June, while it raised its inflation forecast and projected a year-end policy rate of approximately 3.8%. This marked a meaningful shift from the rate-cut expectations that prevailed at the start of the year. Monetary policy now depends in part on whether lower oil prices flow through to broader inflation.
Equity markets looked past much of this uncertainty. Technology and semiconductor stocks led the initial rebound as earnings expectations increased and spending on AI infrastructure remained strong, exemplified by the Philadelphia Semiconductor Index, which gained nearly 88% during the quarter. Importantly, participation broadened beyond the largest technology companies.
For the second quarter, major indices delivered strong results.
The S&P 500® posted a total return of 15.20%, while the Russell 2000® gained 21.49%. The S&P SmallCap 600® advanced 19.69%. Against this backdrop, our portfolio delivered solid absolute performance though below the benchmark.
Our top three contributors to performance for the quarter were as follows:
Sterling Infrastructure (STRL), a large civil and commercial construction company, again led performance for the quarter. The company continues to benefit from infrastructure demand tied to data centers and semiconductor manufacturing. Management continued to beat and raise guidance, supported by larger projects and visibility into 2028. Our positive outlook continues to be supported by a strong backlog, hyperscale company activity, and on-shoring trends.
Semtech (SMTC), an analog and mixed-signal semiconductor company, also led performance. The company reported record first-quarter results, and management pointed to increasing momentum in data centers and LoRa solutions, a networking ecosystem that enables inexpensive, long-range connectivity for battery-powered Internet-of-Things (IoT) devices. The hyperscale investment cycle and the company’s product roadmap continue to support strong fundamental growth.
Power Integrations (POWI), an analog semiconductor device manufacturer, rounded out our top performers, as it did last quarter. Its products manage high-voltage power conversion across consumer appliances, industrial applications, electric vehicles, and emerging data center applications. A focused management team, new design wins, and its gallium nitride (GaN) platform for high-power applications should support continued bottom-line strength.
The largest negative contributors were as follows:
Artivion (AORT), a medical device company addressing cardiovascular disease, underperformed our expectations during the quarter. Management reported mixed results in sales and profitability, partially driven by the events in the Middle East, and slightly lowered guidance for the year. The stock was punished severely despite what we view as manageable issues. We remain constructive on company prospects given a strong management team, continued market share gains, and positive clinical studies supporting their new products.
Calix (CALX), a provider of broadband products and software, also weighed on performance. For the first quarter, management reported results above estimates, raised current-year guidance, and provided a baseline for next year’s revenue above Street estimates. Despite this positive backdrop, markets focused on margin pressure from memory prices (though elevated costs are incorporated into their raised guidance) and a perceived threat from satellite connectivity to broadband providers. We expect to maintain our position. The company is enabling agentic AI solutions for broadband providers, using its tools internally to improve efficiency, and we believe the satellite threat is overblown for the foreseeable future.
Matador Resources (MTDR), an independent energy company, rounded out our largest negative contributors for the quarter. Impacted by the swings in oil prices, this holding declined on lower commodity prices. We see this holding as a core position for the portfolio as the company has driven good well productivity, methodically built its acreage for drilling, maintained a solid balance sheet, and is expanding its midstream (pipeline) assets. We also believe the founder-led management team has depth and has historically delivered solid results.
During the quarter, we exited Simply Good Foods (SMPL), Trupanion (TRUP), and Prestige Consumer Healthcare (PBH). We also locked in gains with trims around Zeta Global (ZETA), Calix (CALX), Power Integrations (POWI), Albany International (AIN), Sterling Infrastructure (STRL), and Ameresco (AMRC).
Proceeds were allocated to existing holdings of UMH Properties (UMH), Euronet Worldwide (EEFT), Aerovironment (AVAV), Matador Resources (MTDR), Artivion (AORT) and Tecnoglass (TGLS). New positions included specialty chemical company Sensient Technologies (SXT), flow control equipment manufacturer Franklin Electric (FELE), biotech-focused Ligand Pharmaceuticals (LGND), IP licensing company Adeia (ADEA), and pet food provider Freshpet (FRPT). All considered, our turnover during the quarter was approximately 13%.
We begin the second half overweight Industrials, Technology, Utilities, and Consumer Discretionary. We are underweight Financials, Healthcare, Real Estate, Energy, and Consumer Staples; equal-weight Materials; and have no exposure to Communication Services.
We remain positive on economic growth for the rest of the year. Economic growth appears likely to remain near 2% or slightly better. Inflation should moderate if the cessation of hostilities in the Middle East holds, while employment remains steady in a low-hire, low-fire environment. Steady employment, wage growth of slightly over 3%, and productivity of over 2% should support healthy consumer spending. Also, although consumer sentiment is at low levels relative to the past five years, lower gas prices, larger tax refunds, and moderating inflation may support improvement. In fact, since the war began, retail same-store sales have been trending higher.
As discussed last quarter, expectations for Federal Reserve policy had shifted from rate cuts to patience, with possibly only a single 25-basis-point cut. Now under the leadership of Kevin Warsh, given a stable employment backdrop, growing economy, and an uptick in inflationary pressures, the policy stance has moved further towards a higher rate environment with a possible 25-basis-point increase prior to the end of the year. This is more consistent with our long-held ‘higher for longer’ view.
Our positive economic view is also supported by the large capital expenditure cycle tied to Artificial Intelligence (AI). This is driving data center construction and investment in energy infrastructure. Industrial capex is another growth driver, as policy and corporate strategy increasingly support domestic production in semiconductors, pharmaceuticals, and defense. The One Big Beautiful Bill and the 21st Century ROAD to Housing Act are further examples which should support economic growth.
There are risks to this outlook. As we write, the Iran ceasefire may be in jeopardy, and oil prices are once again increasing with interest rates rising in sympathy. Some economists also point to the ‘K’ shaped economy where higher income households are driving spending while lower income groups struggle with higher prices. Higher rates are also a potential brake on the speed of our economy. This is not driven solely by Fed guidance. Persistent inflation, large corporate bond issuance for AI investment, and rising U.S. government debt tied to fiscal deficits are all putting upward pressure on interest rates across maturities.
Though there are many cross-currents, our constructive view is further bolstered by continued corporate earnings growth and a general trend of rising estimates across all sizes of companies.
Within the portfolio, we remain focused on quality, cash flow, solid balance sheets, and future sales and profit growth. The challenges in software continued into the second quarter, but each of our names are outperforming the broader universe. After first-quarter earnings and subsequent events, we remain positive on this group’s ability to benefit from and enable AI. We are also monitoring the software narrative for opportunities to potentially increase our weightings. Our semiconductor holdings have also outperformed the broader industry. We have maintained a modest overweight while locking in some profits.
We are also positioned to continue to benefit from the capex cycle both directly with equipment for AI but also from an industrial sector perspective in infrastructure construction and energy grid investment. Balancing our cyclical, growth-focused holdings, we also hold defensive positions that should perform well should the economic narrative shift. Our team is also evaluating our AI investment exposure across sectors while monitoring for meaningful changes to the narrative given increasing local community push-back on data centers.
Valuations for companies tied to the capex buildout are elevated, and we expect more volatility in the second half after the strength of the first half. While index-level volatility remains low, individual-stock volatility is elevated, as shown by the CBOE S&P 500 Constituent Volatility Index (VIXEQ). Though no formal index captures this for small-cap stocks, our own analysis of benchmark constituents and experience indicate more dramatic moves in both directions, often on what should be considered, in our opinion, minor news or small changes in outlook.
In addition to our focus on quality companies, we are developing AI-based screening techniques to
monitor existing holdings and identify new candidates for due diligence. With price momentum
driving much of this year’s returns, our initial focus has been on that factor, overlaid on our bottom-
up fundamental process.
We remain focused on companies we believe are of high quality with solid balance sheets, niche products and services, and good management teams. The portfolio has a structurally solid
fundamental profile with higher return on equity (ROE) and margins, lower debt, and better growth.
When viewed at the total portfolio level, results from our companies during the quarter were
positive relative to the broader small-cap universe. In several instances, performance did not match
results or guidance. However, we believe that reported results and our continuing work on existing
holdings support a positive outlook.
Thank you, and as always, we are available to discuss the portfolio and our outlook in more detail.
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