Q3 US stock market outlook: Investors face balanced risks, selective opportunities

Q3 2026 US stock market outlook key takeaways

• The US stock market is trading at an 8% discount to a composite of our valuations.
• Valuations and risks are more balanced today than at any time earlier this year.
• Remain overweight in small-cap stocks.
• Sector valuations trended toward fair value, and fewer dislocations exist.

Overall, the US stock market is trading at a slightly greater discount than at the beginning of the year, yet following significant rotations across style, capitalizations, and sectors, valuations have become more balanced. Based on a composite of our intrinsic valuations of the over 700 stocks we cover that trade on US exchanges, as of June 30, 2026, we calculated that the US equity market was trading at a price/fair value estimate of 0.92. This indicates that the market is trading at an 8% discount to our fair value estimates.

While the US equity market is attractively valued at an 8% discount to our valuations, we do not think that is enough margin of safety to overweight equities above an individual investor’s long-term asset-allocation targets.

Looking ahead, while many of the risks we identified at the beginning of the year remain outstanding, the trade-off between valuation versus risks appears more balanced heading into the second half.

On the macro-dynamic front, the market is pricing in at least one, if not two, hikes to the federal-funds rate by year-end, and headline inflation will likely remain elevated in the short term until subsiding oil prices flow through. Yet, the economy continues to plod along within a range of +2% +/- 0.5%, which we think is slightly below its long-term potential, and long-term interest rates appear range-bound for the second half of the year.

The greatest risk to the stock market remains the rate of spending on the artificial intelligence buildout boom. Yet, we also continue to monitor cracks in the private credit markets, which could spill over into the public markets. Internationally, we are keeping a close eye on the Chinese economy as well as the weakening of the Japanese yen.

Positioning for the second half of 2026

In our 2026 outlook, we noted numerous key reasons why we expected 2026 to be more volatile than 2025 and how investors should position their portfolio to take advantage of that volatility. We initially recommended a barbell-shaped portfolio, overweighting growth and value and underweighting core. Following a sharp selloff, we advised investors to take gains in value and reinvest those proceeds in deeply discounted growth stocks. Growth staged a quick comeback, and as valuations rose toward fair value, we advised locking in those gains and moving back to a barbell-shaped portfolio.

At this point, by category, valuations are broadly balanced, and we think investors should move to an equal weighting across value, core, and growth. By capitalization, even after registering their best first-half performance in more than three decades and well outperforming the broad market, small-cap stocks remain the most undervalued part of the market.

Where we see opportunity by sector

Over the past quarter, most sector valuations have trended toward fair value, and fewer dislocations exist as compared with last quarter or even the beginning of 2026.

At a 20% discount, the communications sector is the most undervalued. One of the greatest differentials between our view versus the market is Meta Platforms, which accounts for 19% of the sector market capitalization and trades at a 34% discount. Stocks of wireless providers AT&T T, T-Mobile TMUS, and Verizon VZ peaked at the end of March but have been on a downward trend since. We think the market is overly penalizing their valuations on concerns for slowing growth expectations and the possibility of new competition arising from satellite communications providers.

While the technology sector is the second-most undervalued, we caution investors to steer clear of overvalued commodity-oriented hardware. The rush to build AI data centers has led to shortages in the equipment needed to deploy AI chipsets, including memory semiconductors, networking gear, connectors, and even the CPUs to orchestrate AI workloads. These shortages have enabled manufacturers to raise prices substantially, driving record operating margins and earnings growth. Stocks such as Micron MU, SanDisk SNDK, and Seagate STX have risen to levels well in excess of our valuation. While we forecast substantial earnings growth this year and next, we expect new supply to come online in 2028, which will damp earnings growth thereafter. Within the sector, we see the most attractive valuations within the software sector.

Consumer cyclical is at a 9% discount, but that discount is skewed downward by Amazon AMZN, which constitutes 35% of the sector market cap and is trading at a 15% discount. Excluding Amazon, the sector only trades at a 4% discount.

In our last quarterly outlook, we noted that energy had swung too far to the upside and was the most overvalued sector. We stated it was an appropriate time to lock in profits. Since peaking at the end of March, the sector has slid throughout the second quarter and is now at a 7% discount. We think now is a good time to move back to a market-weight position. With its low-cost position, we continue to view Devon Energy DVN as one of the most attractive opportunities.

Real estate and financial services both remain slightly undervalued. Within the real estate sector, wireless cellphone towers are out of favor and offer attractive valuations and dividend yields. We also continue to prefer real estate whose tenants are defensive-oriented. Among the US megabanks, we think Bank of America BAC offers the best valuation, and we see significant value in LPL Financial LPLA, the largest US independent broker/dealer.

At a 14% premium, the industrials sector is the most overvalued. Where we see the most overvaluation is in those stocks that are tied to the construction of data centers and those that manufacture and supply electrical equipment. Transportation stocks, both trucking and airlines, are also overvalued. For investors looking for exposure to industrials, we see value among the defense contractors such as Lockheed Martin LMT and Northrop Grumman NOC. Defense stocks rallied from undervalued levels last fall, peaked this March at overvalued levels, and have now corrected too far to the downside and are once again back in the territory of a Morningstar Rating of 4 stars.

The consumer defensive sector is less overvalued than last quarter, as 1-star rated Walmart WMT and 2-star rated Costco COST have slid over the past quarter. These two stocks account for the preponderance of overvaluation. Excluding these two stocks from our valuation, the remainder of the sector is trading at a 4% discount.

The healthcare sector rose 9.47% last quarter. Whereas it was one of the more undervalued sectors last quarter, following this rally, the sector is now trading at a slight premium to fair value. Rounding out the other overvalued sectors, the basic materials and utilities sectors are both less overvalued than last quarter.