Early 2026 reminded investors that markets rarely move in a straight line. Optimism quickly gave way to a quarter shaped by geopolitical shocks, changing views on artificial intelligence and a rotation in market leadership. These forces reshaped sentiment and underscored the value of diversification and discipline.
A promising start, then a sudden shift
Entering the year, markets were supported by solid Q4 earnings, enthusiasm for AI-driven productivity and expectations that the Federal Reserve would begin cutting rates in 2026. Equities extended late-2025 gains.
That calm proved short-lived. In late February, war involving Iran reset the narrative. Oil jumped above $110 per barrel, reviving inflation fears, pushing yields higher, and forcing central banks to rethink the timing and scale of anticipated rate cuts.
Geopolitical risk weighed on equities and widened credit spreads, particularly in lower-quality segments. Even so, the drawdown was contained: The S&P 500 fell 4.3% for the quarter.
Artificial Intelligence: from opportunity to disruption
The AI narrative also evolved. Early in the year, investors focused on whether hyperscale technology firms could earn attractive returns on the massive capital required to build AI infrastructure. As the quarter progressed, the focus broadened.
Markets began to ask which industries could be disrupted by AI adoption. Software was hit hardest, down nearly 30% from the October peak. The sell-off also pressured private credit portfolios with meaningful software exposure.
AI remains a long-term growth driver, but the quarter highlighted that disruption creates both winners and losers — reinforcing the need for selectivity and risk management.
Rotation beneath the surface
Market leadership broadened. Energy led on higher oil prices and renewed risk premiums, while defensive sectors such as utilities and consumer staples gained as investors sought resilience.
Meanwhile, growth-heavy segments that had dominated for years faced headwinds. Rising yields, volatility and geopolitical uncertainty drove a shift toward value, underscoring the importance of diversification across sectors, styles and asset classes.
In fixed income, higher yields and wider spreads pushed the Bloomberg U.S. Aggregate Bond Index modestly negative for the quarter, while higher-quality sectors were relatively resilient.
Assessing the geopolitical backdrop
With the Middle East conflict unresolved and energy prices elevated, investors are assessing whether geopolitics could alter the long-term outlook. Much depends on the conflict’s duration.
So far, markets appear to be pricing a risk premium rather than a lasting loss of supply. After a ceasefire announcement, assets rallied — especially growth — suggesting a durable resolution could support a broader rebound.
History offers perspective: The global economy has shown resilience through major shocks, including Russia’s invasion of Ukraine. Investors who stayed disciplined and invested were rewarded, while moving to the sidelines often carried opportunity costs.
U.S. tailwinds also remain supportive. Pro-business fiscal initiatives, deregulation and continued AI infrastructure spending should contribute to solid earnings growth in 2026 and 2027.
Updating the economic outlook
Forecasting in a geopolitically uncertain environment is difficult, but a baseline outlook is still useful and can be adjusted as conditions evolve.
Earlier assumptions anticipated a brief conflict and a second-quarter normalization of flows through the Strait of Hormuz. Without a lasting resolution, expectations have shifted: oil may average near $100 per barrel in Q2 before easing by year-end.
In this scenario, inflation likely stays closer to 4% in 2026, unemployment drifts higher, and growth softens. Fiscal measures — most notably the “One Big Beautiful Bill” — may boost tax refunds this year and lower tax outlays in 2026, helping consumers absorb higher energy costs.
Expectations for two Fed cuts in 2026 have faded. The first may not arrive until September, and the year could end with only one cut — again depending largely on the conflict’s duration.
Portfolio implications
Broad positioning is largely unchanged. A modest overweight to equities remains supported by earnings expectations and pro-growth fiscal policy. Fixed income remains modestly underweight, with neutral cash.
Within fixed income, one tactical change was made. After spreads widened in March, exposure shifted from short-term bonds to intermediate investment-grade corporates, taking advantage of higher yields where fundamentals remain sound.
Today’s environment calls for balance: manage near-term risks while staying positioned for long-term growth. Diversification, quality, and discipline remain essential in periods of heightened uncertainty.
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