Mid-Year Review & Outlook: A Resilient Economy Continues to Push Through Headwinds

Key Takeaways

Economic growth is stronger than headline GDP suggests. Private sector activity currently outpaces GDP, which has been dragged down by net exports.
The labor market is tight, not strong. Worker scarcity should keep jobs growth cooling and unemployment low. » Inflation likely peaked in May. Led by fading energy costs and cooling housing inflation, current levels support a pause by the U.S. Federal Reserve.
Weak inflation-adjusted income growth remains the key risk flag. Though not enough to turn our outlook cautious, income growth is a concern.
Corporate earnings are a bright spot. With 2026 S&P 500 Index earnings growth tracking above 24% and estimates being revised up, corporate earnings are solid.
Our positioning remains overweight equities and emphasizing the U.S. Our equity tilts include health care services, industrials, regional banks, and AI infrastructure. Within fixed income we favor highquality ABS/MBS. Regarding our alternative allocations, we continue to focus on multi-asset real return and equity options overlay strategies for income, diversification, and risk management.

A Sample of Recent Additions

We added a healthcare service providers ETF to our Growth, Moderate Growth, and Conservative Growth Strategies to better participate in a broadening equity market after years of narrow, tech-driven leadership. Healthcare service provider valuations appear unusually attractive, while the fundamental outlook is improving as pricing, utilization, and earnings trends stabilize. The addition may enhance portfolio resilience by adding exposure to an industry supported by durable healthcare demand, with return drivers that are less dependent on the market’s recent AI-investment theme.

The first half of 2026 has been defined by crosscurrents with a geopolitical shock in the energy market, a labor market that keeps surprising to the upside even as its underlying capacity shrinks, and a corporate earnings environment that continues to ride the wave of economic growth and infrastructure investments. U.S. economic momentum, as quantified by GDP, has moderated from the robust pace set in mid-2025, but the composition remains encouraging with business investment, consumer spending, and government outlays still contributing. Importantly, private sector economic activity, as measured by Real Final Sales to Private Domestic Purchasers, appears to be stronger than overall GDP growth, which has been negatively impacted by net-exports (exhibit 1). Our work continues to suggest that current GDP growth underestimates the strength of the private sector even as inflation adjusted income has weakened and remains the primary risk factor according to our Recession Tracker framework.

The labor market reaccelerated this past quarter and defied expectations of a slowdown. However, we anticipate slowing jobs creation based primarily on the lack of available workers rather than businesses being more cautious. The official unemployment rate (U-3) ignores individuals that are not looking for work. In contrast, we prefer a broader measure using all Americans that are 16 years or older. Using this larger population set, the unemployment rate is near an all-time low (exhibit 2). Whether in high school, a retirement home, or somewhere in between, the U.S does not have much slack in our potential labor force. Importantly, this scarcity of available workers should keep the unemployment rate low even as jobs growth cools toward a more modest pace into next year.

Additionally, the much-discussed inflation story seems to have turned a corner. This past May probably marked the high point for the cycle as energy driven price spikes continue to fade and shelter costs, which are by far the largest and stickiest component of the inflation basket, have waned to their slowest pace since before the pandemic (exhibit 3). Our base case scenario suggests that inflation should weaken more throughout this year and into the next, which will likely keep the U.S. Federal Reserve (Fed) on hold rather than tightening further. Meanwhile, corporate earnings have been a genuine bright spot as growth estimates for the most recent quarter have been revised up rather than down, as is usually the case.

According to FactSet, 2026 S&P 500 Index earnings are now expected to be up more than 24% over last year. While we foresee episodes of volatility, with some periods that might even feel like a bear market, we think that earnings growth in this range can continue to support higher equity market prices over time.

Investment Implications

Against this backdrop, our overall positioning remains overweight equities compared to fixed income with an emphasis on U.S. equities over foreign.

Equities: We maintain targeted overweights to the areas of the market that are most directly tied to productivity-enhancing technological investments, while also leaning into a broadening of market participation beyond the largest-capitalization names. These areas include the health care sector via service providers, the industrials sector, and regional banks, as well as semiconductors and electronic equipment. We remain underweight non-U.S. equities overall, primarily due to reduced exposure to Europe and China.
Fixed Income: We continue to favor high quality asset-backed and mortgage-backed securities in the belly of the curve. This year’s rise in yields has meaningfully improved our expected forward returns for fixed income, and we view the current levels as attractive relative to recent history. Across the fixed income sleeve, we are deliberately focused on intermediate maturities (2031 to 2032), where we believe the risk-toreward tradeoff is the most attractive. This range allows us to be long enough to benefit from an eventual decline in rates without taking on the interest rate risk that comes with longer-term bonds.
Alternatives: We maintain a meaningful allocation to multi-asset, real-return-oriented strategies and options-based equity overlay strategies. These exposures are used to diversify the sources of return, help manage risk, and potentially generate income alongside our traditional stock and bond holdings.

The Cash Indicator

Our Cash Indicator (CI) monitors market stress in real time using signals that can alert us that a 25% or 50% cash position might be beneficial under certain conditions in an attempt to protect principal and preserve liquidity for redeployment at more attractive valuations.

While low by historical norms, the current CI level is not signaling a defensive posture and we are fully invested. Credit spreads remain contained and reflect underlying confidence in fixed income markets, while equity markets continue to indicate a healthy degree of skepticism rather than outright fear.

We publish the CI level twice each month through our Monthly Dashboard and Monthly Commentary. These reports are available in our weekly email and at sheltoncap.com/active-allocation-solutions.

Shelton Capital Management is an investment adviser in Denver, CO. Shelton Capital Management is registered with the Securities and Exchange Commission (SEC). Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. Shelton Capital Management only transacts business in states in which it is properly registered or is excluded or exempted from registration. Some of the firm’s strategies allocate client’s investment management assets among exchange-traded funds (“ETFs”). A GIPS Report along with a complete list and description of all composites is available by calling (800) 955-9988. A copy of Shelton Capital Management’s current written disclosure brochure filed with the SEC which discusses among other things, Shelton Capital Management’s business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. INVESTMENTS ARE NOT FDIC INSURED OR BANK GUARANTEED AND MAY LOSE VALUE. The views contained herein are not be taken as an advice or a recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested.

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Index Definitions:

S&P 500 Index – This Index is a capitalization-weighted index of 500 stocks. The Index is designed to measure performance of a broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.