The first quarter of 2026 was not a great quarter for the markets, but we strive to apply a steady hand and rational tactics as we have done in prior crises.
| Q1 2026 | |
|---|---|
| S&P 500 (Large Cap) – Market Weight | -4.33% |
| S&P 500 (Large Cap) – Equal Weight | +0.62% |
| Russell 2000 (Small Cap) | +0.90% |
Economic Overview
The war with Iran looms large over markets. Within days of the conflict’s beginning, the Strait of Hormuz was effectively closed to most commercial shipping, cutting off roughly 20% of the world’s oil transit. Oil prices surged more than 60% in a matter of weeks. The International Energy Agency has called it the greatest global energy security challenge in history.
While we are not geopolitical experts, we hold to the idea that wars are easy to start but far harder to end. The last quarter century of American history in the Middle East tells us as much. Moreover, it is easier to mine a strait than to un-mine it. At present, headlines alternate between rumors of negotiations and threats of escalation. The only thing that seems certain is that the longer the conflict drags on, the more severe the disruptions to global energy markets will be. Even if an agreement is reached, energy infrastructure has been damaged and may take months or years to repair. Supply disruptions at this scale do not resolve quickly, and many are quick to look to the oil shocks of the 1970s for perspective.
History might rhyme, but it does not repeat itself outright. The U.S. economy is far less exposed to oil than it was the last time the world faced a shock of this magnitude. In the 1970s, energy represented between 9% to 11% of consumer spending. Today that figure is closer to 4%, and the U.S. is now a net energy producer. That said, these disruptions will not be felt evenly around the world. 84% of the oil transported through the Strait of Hormuz flows to China, Japan, India, and other Asian markets.
Even before the oil shock, the outlook on inflation was muddled. Headline CPI came in at 2.4% year-over-year in February. The Fed’s preferred measure, the Personal Consumption Expenditures (PCE) price index, stood at 2.8% in January, still above the 2% target. With the Supreme Court’s ruling against the administration’s “reciprocal tariffs”, inflationary pressure from tariffs might wane, only to be replaced by higher energy prices.
Meanwhile, the labor market struggled to find direction last quarter. The economy added 160,000 jobs in January, shed 133,000 jobs in February, and then added 178,000 jobs in March. Unemployment presently sits at 4.3%. Looking deeper, federal government employment has fallen by 11% since its October 2024 peak, and the effects are starting to show up in the broader numbers. In February, youth unemployment came in at 9.5% and African American at 9.7%; both groups tend to act as forerunners to the overall unemployment rate. Data suggests that upwards of 40% of recent college graduates are under-employed. Pundits are quick to point to AI as a key driver of a weak labor market. While that’s certainly overstated, AI is here to stay and its impact on the labor market will only grow.
Upward trends in inflation and unemployment complicate the Federal Reserve’s path forward. Under normal circumstances, a weakening job market would push the Fed toward cuts. Fed Chair Jerome Powell has acknowledged that, pointing to the uncertainty from the Iran crisis and acknowledging that inflation has not come down enough. The Fed has held its overnight Fed Funds target rate at 3.50% to 3.75% this year, and prior projections for several rate cuts this year have been whittled down to one projected cut at most.
Looking at the economy overall, gross domestic product (GDP) growth has slowed sharply. The fourth quarter of 2025 came in at just a 0.7% pace, a big step down from 4.4% growth in the third quarter. This can be partially attributed to the extended federal government shutdown last autumn. For the full year, growth was 2.2%, down from 2.8% in 2024. The combination of slowing growth and an emerging energy crisis has people reaching for the word “stagflation.” We’re not there, but it remains a risk.
Markets
The S&P 500 total return in the first quarter was -4.33%. The sell-off had two distinct drivers: the oil shock repriced the macro outlook, while growing skepticism around AI’s winners and losers hit the largest tech names hardest. The decline was largely concentrated in the large- and mega-cap tech companies, whose stretched valuations made them the most vulnerable to a repricing. For example, Microsoft was down 23.5%. The equal-weight S&P 500 was roughly flat. Mid-caps and small caps posted small gains. It was the widest divergence between cap-weighted and equal-weight returns in years, and a useful reminder that no one index fully reflects the market.
Needless to say, over the past decade the largest cap stocks were leaders. We were appropriately weighted in them but trimmed that exposure somewhat during the quarter, in part to avoid being overweight in them as their share of the S&P 500 Index declined. The Russell 1000 Growth Index was down 9.8% this past quarter after leading the market for years.
Interestingly, corporate earnings grew over 14% year-over-year last quarter, making the recent decline a case of valuations compressing on sentiment, not on fundamentals. The S&P 500 forward price to earnings ratio (P/E) has fallen to about 21, down from 28 a year ago. That’s still above the 10-year average of roughly 19, but the move is significant. The average forward PE of the Magnificent 7 (Nvidia, Apple, Alphabet, Microsoft, Amazon, Meta, Tesla) is around 28, elevated but well below where they traded at the height of AI enthusiasm. It is reasonable to suggest that PE ratios in this sector should be higher than historical levels because the growth in this space is unprecedented. For example, Nvidia’s earnings nearly doubled in the latest reporting period.
The broader concentration picture is worth understanding. The ten largest stocks now account for roughly 41% of the S&P 500, exceeding the levels of the late 1990s. Information technology alone is 32.3% of the index. That kind of dominance has happened before. Energy commanded nearly 30% of the market in 1980, at the end of the oil boom. Technology reached 35% at the peak of the dotcom bubble. Financials climbed to nearly a quarter of the index by 2006, just before the subprime mortgage crisis. The common thread is not that concentrated markets always crash, but that the sector the market bets heaviest on tends to be the sector most exposed when conditions change.
Not every correction is cause for doomsaying. Volatility in stocks is normal. This quarter’s decline should be placed in context. The S&P 500 has had 56 drawdowns of 10% or worse in the last century. Many of those declines were followed by relatively swift recoveries, while only a handful were part of steeper declines during periods of severe economic turbulence.
The oil shock reshuffled sector leadership almost overnight. Energy surged while consumer discretionary and transportation names fell sharply. Even the usual defensive plays, utilities and consumer staples, didn’t hold up the way investors expected. Outside of energy, there were few places to hide, which is one reason we diversify across sectors rather than trying to predict which ones will lead.
The conventional wisdom still seems to be that the oil price rise is temporary. If these prices persist or advance further, the market may have to adjust from a consensus around a return to 2% inflation to a world closer to 4%. A sustained 50% rise in oil would translate to an increase in the inflation rate of between 1.4% (Goldman Sachs estimate) and 2.0% (Fed estimate). The Fed estimate may incorporate more secondary effects. For instance, a petroleum-induced fertilizer shortage may lead to lower plantings this spring and smaller crop yields later this year.
In fixed income, the forces described above all exacerbated trends we had been writing about in recent quarters. Disappointing inflation news and worsening deficits were already putting upward pressure on intermediate and long-term interest rates. The oil shock adds to inflation, while war related expenditures add to the deficit. For accounts with bonds, we have kept maturities short and credit quality high. One of the most important attributes of a fixed income allocation is its readiness to be redirected into other investments upon opportunity. Liquidity and stability are key. In volatile times, active rebalancing can both augment returns and reduce risk. We do this on a regular basis.
As always, if you or any family members or friends have any questions or would appreciate counsel on any financial matter, we are always available to you and them.