This pick list highlights constituents of the Morningstar US Mid Cap Index that we believe offer investors the best risk-adjusted return prospects. The market capitalization range for U.S. mid-caps typically falls between $1 billion and $8 billion and represents 20% of the total capitalization of the U.S. equity market.

The 2Q reporting season is in full swing. Many companies have knocked it out of the park, delivering earnings and revenue numbers that were well over expectations. Meanwhile, we have been looking at the early trends and, as usual, there are companies increasing guidance. Raising guidance is one of our Investing Themes for the second half of 2026. We view management's ability to raise guidance consistently as a catalyst for possible market-beating returns in the quarters ahead. It's even harder for companies to lift guidance during uncertain economic times, as vision is murky. This is especially true now, as the war in the Middle East drags on. Wall Street is also pondering a new Federal Reserve chairman, one with a different view about forward-looking guidance (or in this case, a lack thereof). A good number of companies already have increased guidance in this earnings cycle, so we are putting out a first round of companies that are in Argus' Fundamental Universe of Coverage and that made the grade.

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Middle East Uncertainty, Chinese AI Holding Back Stocks In the trading week ended July 24, 2026, calendar 2Q26 earnings season kicked into a higher gear. The earnings news was positive pretty much across the board, but the overall stock market declined. Even oversold sectors that have rallied of late, including Healthcare and REITs, mainly paused if not backslid. The conspicuous culprit, of course, is the on-again, off-again war with Iran. A little more than a month after the war began, oil prices and bond yields came down and stocks rallied early in April at the first ceasefire. The memorandum of understanding signed in June sent crude oil and gasoline prices lower and stocks higher. Escalating missile and drone attacks in the middle weeks of July threatened to undo any fragile progress in the peace process. With both Iran and U.S. ceasing hostilities over the weekend of July 25 and 26, stocks perked up to open the final trading week of July but could not hold gains. The artificial intelligence (AI) standard-bearers that carried the market since fall 2022 remain mostly absent from any rally attempts. Inexpensive AI models from China threaten to wreck the economic foundations of AI infrastructure spending, including the eye-watering capital spending planned for this year and next by the hyperscalers. Investors still learning the difference between generative AI and agentic AI are finding they need to further add to their vocabulary, as they try to knowledgably discuss open-weight models and distillation. The AI trade, like other major technology transitions such as cloud and the Internet, has been predictably bumpy. That is unlikely to change anytime soon. Back and Forth in the War with Iran As the war with Iran moved into a hot phase during the middle weeks of July, it showed dangerous signs of broadening out. Iran's proxies in Yemen, Ansar Allah (commonly referred to as the Houthis), pledged to shut down the Bab-el-Mandeb Strait. Much as the Strait of Hormuz hugs the shore of Iran, the Bab-el-Mandeb is bordered by Yemen, and the Houthis control the corner of Yemen adjoining both Bab-el-Mandeb and the Red Sea. This strait, which connects the Red Sea to the Indian Ocean, has emerged as an alternative route for Saudi oil that has been rerouted from the Strait of Hormuz. The Houthis on July 22 fired on two Saudi tankers, causing them to turn back. The Saudi-backed government of Yemen and Saudi Arabia itself responded by attacking the Houthi-controlled port city of Hodeidah. In an escalating tit for tat, Houthi drones and missiles were then directed at Saudi oil production and refining facilities. Before the war with Iran began, military experts knew of Iran's expertise in drones. That's because Iran has been providing Russia with drones throughout its war with Ukraine. In an unexpected but ultimately not surprising link between the two wars, Ukraine attacked an Iranian vessel in the Caspian Sea. Ukrainian President Volodymyr Zelenskyy stated that Ukraine had carried out long-range strikes 'against vessels carrying military cargo.' Iran threatened retaliation, and neither side is backing down. The U.S. is simultaneously adding new military assets in the region, according to reports, and engaging in ongoing negotiations to end the war. The military and geopolitical permutations are proving to be difficult to predict, causing volatility in the U.S. financial markets. Bonds have weakened in July 2026, causing U.S. Treasury yields to spike to levels last seen in January 2025. That reflects war uncertainty, along with growing sentiment that the Federal Reserve may need to raise rates to combat resurgent inflation. Heading into the late-July meeting of the Federal Open Market Committee (FOMC), the CME FedWatch tool indicated a 34% probability that the Fed would raise rates. While two-thirds of investors continue to anticipate no change in rates at the July meeting, the probability of rate hike rises to 56% by the September 2026 FOMC meeting. And by year-end 2026, the CME FedWatch tool shows just an 8% probability that the Fed Funds rate will be at the current 3.50%-3.75% tendency and a more than 90% probability that the Fed Funds rate will be higher. The S&P 500 hit its all-time high in the beginning of June, days before the memorandum of understanding was signed. Since then, the index has declined about 2% in an uneven pattern, with spikes and dips mainly dictated by breaking war news. The S&P 500 is also down about 1% since the beginning of 3Q26. So far, 3Q trading at the sector level is less like 2Q26, when growth stocks were in charge, and more like 1Q26, when rotation beneficiaries in defensive, cyclical, and rate-sensitive categories were in the lead. For the quarter-to-date, Energy is in front, with a low-double-digit gain. Financial and REITs are both up in mid-single-digit percentages for the quarter, and single-digit gainers include Healthcare, Utilities, and Consumer Staples. The worst sectors have been Information Technology and Consumer Discretionary, both down more than 6% in 3Q26 to date. Other declining sectors for this quarter include Industrials, Materials, and Communication Services. Chinese AI Models: Attractively Cheap We have always regarded sector rotation as a positive and affirming signal of underlying bull market health. That's particularly true when economic cycle factors favor nontraditional sectors over the usual growth leaders. In this case, however, it is hard to argue that traditional growth leaders are flailing. Calendar 2Q26 earnings results for the Information Technology companies that have reported to date have been spectacular, driven by AI momentum. So why is the IT sector down 6%-plus in July? The simple answer is that investors are not responding to the near-term trend in AI but to the perceived long-term trend. They appear to be fearful that the entire domestic AI edifice may be overbuilt. The market, in a word, is having its second DeepSeek moment. Late in January 2025, stocks sold off (and, as noted above, bonds tanked) when the DeepSeek-R1 reasoning model was released. By the end of January 2025, DeepSeek-R1 was one of the most downloaded apps on the Apple App Store and Google Play. U.S. AI and information technology stocks regained their footing after Nvidia Corp. CEO Jensen Huang and other industry leaders welcomed the release of DeepSeek, indicating that technology advancement was good for the market overall and that there was plenty of room for more AI players in the pool. The release of DeepSeek was the most significant of several events to call into question the primacy and multigeneration lead of U.S.-developed AI models over those from China and elsewhere. The second major wake-up moment for U.S. AI investors is unfolding now. A Chinese company called Moonshot AI recently released an AI model called Kimi K3. It is regarded as the most capable of several inexpensive models to recently come out of China. AI output is expressed in token volume, and Chinese models such as Kimi K3 are generating tokens at less than half and sometimes up to 90% less than the cost of models from Open AI, Anthropic PBC, and other developers. U.S. companies are taking note. OpenRouter is a platform that enables developers to access a range of models. According to OpenRouter data, the share of tokens used by U.S. companies on Chinese AI models has averaged above 30% and been as high as the mid-40% range since 2Q26. That share was less than 5% in the first half of 2025. Technology investors are needing to learn new terms and concepts to fully appreciate the investing implications of competition in the AI space. Many of the Chinese frontier (i.e., reasoning) models are open weight in nature. These open weights are numerical values that enable developers to use or fine-tune a model without needing to retrain it all over again. These Chinese models may also have been born of distillation, wherein a large language model (LLM) with frontier characteristics, the 'teacher,' trains a smaller model. The resultant 'student' model may be less generally able, with a smaller set of capabilities and weaker latency, but it also offers lower computational costs and token usage. Hyperscalers making huge investments in AI have had a mixed response to development of open-weight models and distillation techniques. OpenAI offers distillation of its own most advanced models, although the output is into smaller OpenAI models. Another frequent claim is that Chinese model makers are pirating technologies and content from leading U.S. frontier models. But the U.S. giants are themselves subject to these claims. The Bartz v. Anthropic lawsuit successfully argued that Anthropic used pirated copies of published books to train its LLM, Claude. Argus has long predicted that the AI investment cycle would be turbulent, much as the Cloud and early Internet investment cycles were turbulent. We also believe the AI potential pool is vast, encompassing nearly all companies and enterprises, and that the AI investment cycle will be long. We also believe AI investing requires keeping up with fast-evolving trends in this dynamic space. Conclusion The calendar 2Q26 earnings season, with mid-20% growth so far, is providing a positive backdrop for stocks even as most investors remain in cautious profit-taking mode. Although investors are not showing their usual tendency to buy the dip in the formerly favored sectors of the market, they have been redeploying AI winnings into sectors (most notably Healthcare) that have long been out of favor. Nongrowth sectors, which led the market for much of 2H25 and all of 1Q26, appear to be back in vogue. We recommend that stock investors pay attention to this trend and look for value outside the headline leaders of recent years. We would also look for inflection points in areas where long-time winners turned recent losers, such as software, appear to represent attractive value.