12 minute read
The start of 2026 served as a reminder that markets do not move in a linear fashion. While economic fundamentals remained largely intact, global political events began to exert a stronger influence on sentiment and asset prices. Against this backdrop, geopolitical news moved to the forefront of market activity.
Geopolitical news dominated the first quarter. The year kicked off with the capture and extradition of Venezuela’s then President Nicholas Maduro. And as the first quarter ended, the Iranian war and middle east conflict dominate the news and is impacting financial and energy markets.
In the first quarter, the S&P 500 fell 4.3%. US equities were marginally positive on the year until the conflict with Iran commenced in late February. The bar chart below shows how different asset classes have performed since the onset of the war at the end of February. Foreign equity markets have suffered worse than domestic markets. A stronger US dollar in March contributed to some of the underperformance and higher energy prices have more of a negative impact on countries that import much of their energy. The US has become a net exporter of oil in recent years and is much less reliant on the Middle East for energy. Other nations, particularly many in Asia, import much of their energy through the Persian Gulf.
Energy stocks were top performer, up 38.2% within the S&P during the quarter. More defensive sectors such as utilities also did well. Mega-cap tech stocks were the laggards during the first two months of 2026 as fears around elevated AI spend and a growing concern that many software stocks could see their moats weakened by AI agents. The Software Index has already fallen more than 24% this year and is now down in-excess of 30% from its high last September.
After delivering another rate cut last December, the Fed held rates steady at their two meetings in 2026. The Fed funds rate remains at 3.5%-3.75%. Since the onset of the war, the market has priced out any additional rate cuts this year. The implied number of cuts for 2026 was about two cuts at then end of February – however, the market is now pricing a Fed that will hold rates at current levels. At one point in March, the market started pricing in Fed rate hikes in 2026, however we believe this was an overreaction and that central banks around the world are unlikely to hike rates this year. US rates have moved higher of fears higher inflation stemming the spike in energy prices. After closing below 4% at the end of February, the 10-year Treasury rate has jumped to nearly 4.4% in recent days. The two-year Treasury, which is often cited as a good proxy for the Fed Funds rate, has increased nearly 50 basis points to 3.9%.
Despite all the events of the quarter, the S&P 500 is only 6% off the all-time high it reached in January. Broadly, the global economy is still expanding, and inflation continues to moderate despite all the negative headlines. S&P 500 earnings growth grew at a 14% clip last year and is expected to grow 13.2% year over year in the first quarter. For now, corporate profits and broader economy continue to show resiliency despite all the gloom.
While geopolitical shocks can trigger sharp drawdown, history suggests the impact is typically short-lived. Markets tend to reprice uncertainty quickly with most of the reaction happening over days and weeks rather than quarters or years. Unless the event materially changes the path of the economy, inflation, or policy, risk assets can remain supported. The table below from Ned Davis Research shows the market reaction to military events since World War II. The current conflict in Middle East has certainly resulted in negative equity returns, but within historical norms.
The conflicts duration will largely determine the impact on the global economy. With the Strait of Hormuz effectively shut, 20 million barrels of oil that transit the Strait daily are stranded. This accounts for roughly 20% of daily global oil demand. Liquified natural gas (LNG) is also heavily impacted by events in the Middle East. Qatar is responsible for 20% of global LNG supply and at the moment 100% of this offline due to the war. It has been reported the Iran targeted and damaged a portion of Qatar’s Ras Laffan LNG complex, resulting in roughly 17% of their capacity to be taken out and that it could be years to repair and bring back production to normal levels. Any escalation that results in additional energy infrastructure being damaged will have lasting effects on the energy markets. The longer the Strait of Hormuz remains closed, the worse it will be for the global economy.
Inflation is Back in Focus
The conflict in Iran has sent oil prices higher and is stirring memories of the inflationary spike of 2022 following the start of the Ukraine/Russia war. Broadly speaking, the current facts lead us to believe that today’s environment is different than from a few years ago. Back in 2022, inflation was driven by multiple forces that all came together at the same time – massive fiscal stimulus, ultra-accommodative monetary policy, a surge in money supply, pent-up demand from the pandemic, and disruption to supply chains. Higher energy costs certainly played a role in the inflation spike; however, it was far from the only factor. Today, many of these factors are not in play. Rates are significantly higher, liquidity is being pulled from the system, the labor market has cooled down, and wage growth has decelerated. For the moment, any increase in inflation in the coming months or quarters will be driven by supply constraints rather than excess consumer demand.
The Fed estimates that the oil price spikes added roughly half a percentage point to overall inflation during 2022. Inflation has certainly cooled down in recent years; however, it remains above the Fed’s 2% target. Central Banks tend to focus on core inflation readings – those that exclude the more volatile food and energy prices. Given this, the Fed is more likely to respond to higher oil prices by holding rates where they are instead of hiking them. We are seeing this in the futures market where further rate cuts this year are being priced out of expectations. For now, our current base case is that the current oil shock is far more likely to produce a temporary bump in headline inflation rather than a repeat of the broad and persistent inflation cycle experienced a few years ago. Prior to the war, US inflation was expected to be 3% in 2026, however, higher energy costs have increased the OECD inflation estimates to 4.2% for this year. Their 2027 estimate of inflation, however, is lower than their previous estimate of 1.6%. This signals an expectation that the oil shock will be temporary.
Source: OECD Economic Outlook, Interim Report March 2026
Equity Markets
After peaking in late February, global equities (MSCI ACWI) have fallen 7.6% from that high. Global equities finished the quarter with a negative return of 3.2%. US stocks underperformed international stocks over the full quarter – S&P 500 fell 4.3% compared to a modest .7% loss for MSCI ACWI excluding US Index. However, since the onset of the Iran conflict, US stocks have outperformed. This is partly due to a strengthening US dollar in March and the fact that the United States stands in a better position relative to most developed countries when it comes to higher oil prices given it’s a net exporter of oil and Europe and Asia are importers and are more exposed to Middle East supply disruptions.
While the S&P 500 is off roughly 6% from its high, the index is flat since last summer. However, unlike the last few years, more than half of the S&P 500 stocks are outperforming the broader index return so far in 2026. Dispersion across sectors have increased as well – with the energy sector up over 38% this year while the financials and tech sectors have fallen by 9%. A historically large number of S&P 500 stocks are setting 52-week highs and 52-week lows at the same time. We expected market leadership to broaden as the outsized performance of large-cap stocks begins to moderate. Smaller-cap and value-oriented segments supported by earnings recovery, operating leverage, and more attractive valuations could attract interest as the economic growth story remains intact and financial conditions ease.
So far the drawdown has mainly been through a repricing of the market’s lofty valuation. The forward P/E of the S&P 500 has contracted nearly 12% this year, while earnings expectations have not come down meaningfully at this point. It is sentiment and uncertainty about the future that has compressed multiples. Fundamentals remain largely intact with double-digit earnings expected for this calendar year.
Fixed Income
After a quiet start to the year, the threat of energy driven inflation unsettled global fixed income markets, with US interest rates rising between 35-45 basis points in March, with larger reactions from European markets who have greater exposure to oil & gas produced in the Persian Gulf.
At the same time, markets have dramatically revised their expectations for central bank policy. Investors now anticipate that the Federal Reserve will deliver no rate cuts for the rest of the year (compared with expectations of two cuts at the end of February).
We are skeptical of the scale of this repricing. The recent rise in yields may represent an attractive entry point for yield seeking investors, particularly as both a rapid resolution and a more prolonged conflict in the Persian Gulf could results in the need for interest rate cuts.
In the shorter-duration scenario, the recent increase in energy prices driven by the disruption to supply is likely to be short lived. Central banks tend to focus on core measures of inflation which exclude energy. As such we find it unlikely that a shorter duration shock causing higher inflation which is excluded from their core focus would result in interest rate hikes.
A more prolonged conflict and higher energy prices would likely weigh on economic activity via higher input costs and weaker demand. In such an environment it seems hard to see that central banks would raise rates to fight an inflationary force they cannot control and are much more likely to lower rates to stimulate a weakening economy. Our base case is for mid to upper single digit returns for fixed income.
Alternatives
Alternatives provide powerful long-term portfolio benefits and non-correlated returns to traditional stock and bond holdings and improve risk-adjusted returns of balanced portfolios. Given the current volatility in public equity markets, alternative investments have delivered good relative returns with low volatility just as we would have expected.
We favor private real estate investment allocations to multi-family, industrial, and self-storage, and selected grocery-anchored centers. We expect equity like long-term returns from these investments with built in inflation protection and tax efficient income generation. Our real estate investments will also benefit significantly as the Fed cuts interest rates. We also favor private equity but have sold our remaining private credit investments as they no longer offer good risk/reward characteristics. We believe alternatives tend to follow public markets and offer meaningful upside. We will continue to add alternatives to our diversified balanced portfolios and expect solid returns.
Closing Thoughts
The conflict in Iran has introduced a number of unknown variables into the 2026 outlook. So far markets have largely overlooked the clash; however, if the duration of the conflict continues to increase the impact on the global economy becomes greater. Energy prices have risen quickly – with Asian and European economies having more exposure than the US. We do not believe central banks will react to an energy price spike, however if the conflict drags on and energy prices remain elevated it is likely that other aspects of inflation will increase, pushing on living standards and forcing the central bank’s hand.
Absent the conflict in Iran, our outlook remains positive, with real GDP growth and supportive consumer spending and ongoing investment in infrastructure, energy and Artificial Intelligence all expected to enhance productivity.
Despite recent weakness, equity market fundamentals remain strong. We have to see market leadership broaden away from mega-cap technology stocks to smaller and more value orientated companies, providing crucial breadth for the market. Most importantly, corporate earnings expectations continue to expand with S&P 500 earnings expected to growth 13.2% in 2026.
Credit fundamentals remain sound. Attractive starting yields have resulted in fixed income returns increasingly driven by income rather than prices appreciation.
This is a moment to stay disciplined. We remain vigilant to the changing geopolitical landscape. We continue to maintain diversified portfolios, balancing risk and opportunities, and positioning to benefit from long-term secular trends while staying alert to evolving macro and policy risks.
We sincerely thank you for your confidence and trust in us. Please do not hesitate to reach out to us if you have any questions or wish to discuss how all this relates to your specific financial situation in more depth.
