INTRODUCTION
The first quarter of 2026 began on constructive footing, with broad equity participation and improving market breadth. That tone gave way in February and March as two forces reshaped the environment: a reassessment of artificial intelligence's impact on software business models, and the escalation of U.S.-Israeli military action against Iran. The subsequent Strait of Hormuz closure sent oil prices sharply higher, introducing a stagflationary dimension that complicated the Federal Reserve's policy path. The S&P 500 finished the quarter down 4.3%, though broader measures held up materially better; the equal-weighted S&P 500 and Russell 2000 each gained approximately 1%, reflecting a rotation away from concentrated large-cap technology positions.
Figure 1 — Q1 2026 Asset Class Performance. Geographic and capitalization diversification produced materially different outcomes than the headline S&P 500 return.
MACRO ENVIRONMENT
U.S. GDP growth slowed to 0.7% annualized in Q4 2025, with forecasters projecting a Q1 2026 recovery toward 2.6% on fiscal tailwinds and continued consumer spending. The Federal Reserve held the federal funds rate at 3.75% at both its January and March meetings. PCE inflation ran at 2.8% and core CPI at 2.4%, both above the Fed's 2% target. The labor market softened; January payrolls came in at 126,000 and February produced a net loss of 92,000 jobs against consensus expectations for a gain, with unemployment holding at 4.3% to 4.4%.
The geopolitical shock arrived on February 28, when U.S. and Israeli airstrikes on Iran triggered retaliatory action and the effective closure of the Strait of Hormuz, a corridor carrying 20% to 30% of global crude flows. Oil prices surged from $57.50 at year-open to over $104 per barrel by late March, adding simultaneous inflationary pressure and a meaningful growth headwind. The Fed acknowledged competing policy signals at the March press conference; fewer rate cuts are now priced for 2026 than at year-start.
ASSET CLASS REVIEW
Domestic Equities
The S&P 500 fell 4.3% and the Nasdaq 100 declined 5.8%, with losses concentrated in large-cap technology and growth names. Sector leadership shifted sharply: energy, utilities, and consumer staples outperformed, while information technology, communication services, and consumer discretionary lagged. The AI disruption narrative placed structural pressure on the software-as-a-service model; software stocks declined approximately 23% through late February, with several large SaaS names falling 30% to 60% from all-time highs. Despite multiple compression, fundamentals held; the S&P 500 net profit margin reached a record 13.2%, revenue grew 8.2% year-over-year, and full-year 2026 earnings growth is projected at 17.4%.
International Equities
Japan's TOPIX gained 3.6%, the top-performing major market, supported by yen weakness, LDP re-election fiscal stimulus expectations, and a Bank of Japan more concerned about upside inflation than downside growth. The MSCI Europe ex-UK fell 2.3% as elevated energy costs raised growth concerns; the UK's FTSE All-Share gained 2.4% on its commodity weighting and weaker sterling. Emerging markets were stable at -0.1%, with commodity-exporting economies offsetting dollar-strength headwinds. International equity valuations relative to the U.S. remain at historically wide discounts.
Fixed Income
U.S. Treasuries were flat for the quarter, serving as an effective safe haven during March's volatility. UK Gilts fell 2.0%, JGBs declined 1.6%, and EM debt fell 1.1% on dollar strength and risk aversion. Credit spreads widened across categories: global investment-grade bonds returned -1.3%, U.S. high yield fell 0.5%, and European high yield declined 1.7%. Spreads had entered the year at historically tight levels; the Q1 widening reflects that dynamic reasserting itself. All-in yields on investment-grade intermediate-duration bonds remain attractive relative to the prior decade.
Figure 6 — Fixed Income Returns, Q1 2026. U.S. Treasuries provided safe-haven protection while credit spreads widened across investment-grade and high-yield categories.
Alternatives
Gold extended its multi-year advance above $4,000 per ounce, gaining approximately 67% over the prior twelve months on central bank accumulation, geopolitical uncertainty, and U.S. fiscal concerns. Commodity-related strategies and energy infrastructure appreciated sharply on the oil surge. Private credit maintained sound fundamentals, with floating-rate structures benefiting from the higher-rate environment. Macro and commodity-oriented hedge fund strategies delivered uncorrelated returns during March's cross-asset volatility.