ECONOMY
The first quarter of 2026 was defined by a meaningful shift in market narrative, as three major forces came together at once: artificial intelligence disruption, Federal Reserve policy, and geopolitical conflict. What began as a continuation of 2025’s momentum quickly turned into a broad repricing of risk across markets.
Geopolitics played a central role. The escalation of the Iran conflict led to a sharp increase in energy prices, with oil briefly rising toward $115 to $120 per barrel. With approximately 20% of global oil supply moving through the Strait of Hormuz, markets were forced to account for potential supply disruption, reintroducing inflation concerns.
At the same time, expectations for Federal Reserve policy shifted. Markets entered the year anticipating rate cuts, but those expectations were pushed further out as inflation remained persistent, partly due to rising energy costs. The 10-year Treasury yield moved to around 4.4%, reinforcing a higher-for-longer rate environment and creating pressure across both equities and fixed income.
The market also began to reassess the artificial intelligence investment cycle. While the long-term opportunity remains significant, it has become clear that building AI infrastructure requires substantial capital. Investments in semiconductors, data centers, and energy have shifted the narrative away from near-term profitability and toward longer-term spending.
Despite the volatility, several underlying fundamentals remain intact. Earnings growth expectations, particularly in AI-related sectors, continue to exceed the broader market, and the U.S. economy has shown resilience. However, investors are now operating within an environment of persistent inflation risks, higher interest rates, and geopolitical uncertainty.
DOMESTIC EQUITY
After leading markets higher in 2025, the S&P 500 experienced a pullback (-4.5%) in Q1 as valuations adjusted to higher interest rates and shifting AI expectations. Much of the weakness was concentrated in the Technology sector (-7.8%), particularly in software and AI-focused companies, as increased investment raised questions around margin sustainability and timing of returns. Investors also began differentiating between companies benefiting from AI and those potentially facing disruption.
Leadership shifted toward more defensive and inflation-sensitive sectors. Energy was the clear standout (+35.0%), supported by higher oil prices and strong free cash flow generation. Consumer staples (+6.1%) held up well as investors leaned into businesses with stable demand and pricing power. Materials (+8.8%) and utilities (+7.0%) also posted strong returns, highlighting the importance of diversification within equity portfolios.
Small-cap U.S. equities finished the quarter roughly flat, masking notable volatility. The asset class was up nearly 10% earlier in the quarter before reversing those gains. This move was largely tied to shifting interest rate expectations, as rising yields and delayed Fed cuts pressured companies more sensitive to financing costs.
INTERNATIONAL EQUITY
The Iran conflict had a more pronounced impact on developed and emerging market equities than on the U.S., due to greater sensitivity to energy prices and global trade. European and Asian economies, which rely more heavily on imported energy, faced increased pressure as oil prices rose above $100 per barrel, raising input costs and weighing on growth. Strong early-quarter performance helped developed markets finish slightly positive (+0.2%), while emerging markets edged lower (-1.6%). A stronger U.S. dollar and tighter global financial conditions also acted as a headwind, particularly for emerging markets.
FIXED INCOME
In fixed income, the Bloomberg U.S. Aggregate Bond Index was flat (+0.1%) from a total return perspective, though prices declined as yields moved higher. The rise in the 10-year Treasury yield toward the mid-4% range weighed on longer-duration securities. Credit spreads remained relatively stable, indicating the move was driven more by interest rate repricing than credit deterioration. Higher yields have improved the forward-looking return profile, particularly for income-focused investors, and now offer more compelling income opportunities than earlier in the year.
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