Investment Overview: 1st Quarter 2026

The economy

The first quarter of 2026 was defined by a tug‑of‑war between underlying economic resilience and increasingly powerful external shocks. Entering the year, both the U.S. and global economies carried forward moderate growth momentum, easing inflation trends, and stable financial conditions. However, escalating geopolitical tensions in the Middle East, renewed trade frictions, and higher energy prices materially altered the backdrop by late February, increasing volatility across markets and clouding the outlook for growth and inflation heading into the remainder of the year.

U.S. GDP growth for the first quarter is tracking near 2% annualized, supported by consumer spending and business investment, partially offset by weaker government activity and softer net exports. Growth momentum softened late in the quarter as higher energy prices and tighter financial conditions weighed on confidence. Inflation continued to ease early in Q1, but rising oil and transportation costs reversed some of that progress. Core inflation remains modestly above the Federal Reserve’s target, while rising inflation expectations — driven by higher energy costs and geopolitical uncertainty — have complicated the outlook for near‑term rate cuts.

Job growth slowed meaningfully, with a net decline in payrolls reported in February and the unemployment rate edging up to 4.4%. That said, layoffs remain contained and jobless claims are still low by historical standards, suggesting employers are cautious rather than distressed.

Consumer confidence weakened as gasoline prices rose and markets became more volatile. Higher mortgage rates further undercut an already fragile housing recovery, keeping home sales subdued and reinforcing the broader cooling trend in housing‑related inflation.

U.S. manufacturing re‑entered expansion territory in Q1, with the ISM Manufacturing PMI holding above 52 in both January and February — the first sustained expansion in over a year. However, the Prices Paid Index surged to levels not seen since 2022, driven by higher steel, aluminum, and energy costs tied to tariffs and conflict‑related supply disruptions.

U.S. trade policy remained unsettled. Following the expiration of emergency tariffs in February, a new 10% global surcharge was enacted, with existing steel, aluminum, and auto tariffs remaining in place. The average U.S. tariff rate remains near decade highs, raising costs for manufacturers and consumers alike and contributing to persistent goods inflation.

Global growth remained steady over the quarter, but projections were revised downward. Prior to the commencement of the war in Iran, the IMF was projecting 3.3% global GDP growth in 2026, supported by AI‑related investment and easier financial conditions. However, growth forecasts for Europe and Asia were revised lower during the quarter due to their heavy reliance on imported energy and exposure to Middle East supply disruptions. Global GDP growth is likely to be revised downward relative to pre-war forecasts if current conditions persist into Q2, with recessionary risks expanding sharply in a prolonged or escalating scenario. While global inflation had been easing entering 2026, the quarter ended with renewed pressure. Oil price spikes of 30%–50% and higher shipping and insurance costs raised stagflation risks, particularly for Europe and emerging Asia.

The first quarter of 2026 reinforced a familiar theme: the global economy remains fundamentally resilient, but increasingly vulnerable to policy and geopolitical shocks. While growth has not stalled and labor markets remain intact, higher energy costs, tariff uncertainty, and elevated inflation expectations complicate the path forward. As we enter Q2, markets are likely to remain sensitive to geopolitical developments and policy signals, with diversification and risk management playing a critical role in portfolio construction.

Fixed income

Fixed income markets posted slight losses as bond yields rose modestly in the first quarter. Interest rates rose dramatically in March, overtaking declining February rates. Rising interest rates reflected the inflationary shock of higher oil prices, a worsening federal fiscal situation, and diminished expectations for a Federal Funds Rate decrease. Credit spreads widened from historically tight January levels on increasing rate volatility. Corporate default rates increased slightly on high-yield debt but remain well contained. Despite the March selloff, the Bloomberg U.S. Aggregate Index finished the quarter down just 0.05% while posting a respectable 4.35% return over the last 12 months. 

The 10‑year Treasury yield finished the quarter at 4.32%, modestly higher than end-of-year levels, but up substantially from the 3.94% print at the end of February. The yield curve flattened over the quarter with short- to intermediate-term bonds (2-5 years) moving up sharply on diminished expectations of near-term rate cuts.

The Federal Reserve cut its Fed Funds target rate on two separate occasions during the fourth quarter of 2025, following a 25-basis-point September rate cut. At the end of 2025, markets were essentially pricing in two additional rate cuts in 2026. 

The Fed held its target rate steady at its March 18 meeting and described inflation as “somewhat elevated” while explicitly citing uncertain economic implications from developments in the Middle East. The Fed Funds Target Rate range currently stands at 3.50%–3.75%.

As we progress into the second quarter, market expectations have turned decidedly hawkish. Interest rate futures markets currently imply a high probability that the Fed Funds Rate remains in the 3.50%–3.75% range through year‑end 2026. While the Fed’s stated position remains at one rate cut in 2026, Fed Chair Powell noted that “there was meaningful movement toward fewer cuts [by committee members]” at its most recent meeting.

Treasury yields of selected maturities for recent time periods are displayed below (data from Bloomberg).

Total return numbers for various fixed income indices over the past quarter and 12 months are below (data from Bloomberg).

Equities

Stock markets began 2026 with a modestly positive start before taking a step back once the war in Iran began at the end of February. The market effects of the Middle East conflict to date have included higher oil prices, higher interest rates, and elevated geopolitical uncertainty. Most major market averages retreated in March, pushing the S&P 500 to a decline of over 4% for the first three months of the year, its worst quarter since 2022.

Overall, the first quarter of 2026 saw mostly lower returns, with value stocks outperforming growth stocks for the second consecutive quarter. International equities continued to outperform the S&P 500, although they finished the quarter slightly negative following the onset of hostilities in the Middle East. Looking back further, nearly all major market indices have posted very strong 12-month returns, as shown in the table below.

Diversification outside U.S. large-cap indices has benefited investors recently. Small- and mid-cap indices have equaled or bettered the return of the S&P 500 over the past 12 months, and international stocks have also generally outperformed over recent periods. These areas of the market appear to have benefitted from less demanding valuations and less concentration from a handful of mega-cap companies.

Earnings growth has remained strong, as any adverse effects of higher energy prices have not yet filtered into corporate earnings reports. In fact, companies appear poised to deliver a sixth straight quarter of double-digit earnings growth when first quarter results are reported. However, in many cases valuations have compressed from elevated levels, leading to negative returns for the quarter among the S&P 500, Dow Jones Industrial Average, and the Nasdaq Composite.

Concerns of an expensive market persist. The S&P 500 now trades around 20 times its expected earnings over the next 12 months, above its average multiple. While this is lower than readings of the recent past, the expected earnings growth is still in the double-digit range, a level that may be difficult to achieve given growing uncertainties in the world.

Returns from this point will likely be decided by companies’ ability to continue to meet elevated expectations. The ability of corporate America to manage through the uncertainties of the past several years has been remarkable, but a prolonged period of higher energy prices can lead to higher inflation and a greater chance of an economic slowdown. If these conditions were to materialize, earnings growth could slow significantly and would likely pressure stock returns. Given the potential for quickly changing narratives, the prospects for volatility and the need for diversification seems prudent.

Below is a table displaying various equity index returns for the past quarter (data from Bloomberg).

Sector returns

First quarter sector returns were highly variable and diverged from recent trends. Somewhat surprisingly, more than half of the market’s sectors were higher for the period. However, most of the positively performing sectors this quarter carried relatively light market weights in the index and were not enough to push the broad S&P 500 higher. The technology sector, which comprises nearly one-third of the index, had one of its worst periods in some time and played a large part in dragging down the overall index.

The energy sector was by far the best performing sector for the quarter, as the price of crude oil spiked following the onset of the war in Iran, and sent shares of companies in the oil and gas industry higher. Energy stocks had lagged the market over most of the past three years, but conflicts in South America and the Middle East flipped the script and sent the sector to its best quarter in four years.

Other positive areas of the market for the quarter were also beneficiaries of recent geopolitical conflicts. For example, fertilizer companies within the materials sector and defense companies within the industrials sector caught a bid. Furthermore, safe haven areas in the utilities and consumer staples sectors also performed relatively well.

Conversely, many of the large growth companies retreated, as a general “risk-off” sentiment to the market emerged. Prior period leaders including the technology, communication services, and consumer discretionary sectors, which house the “Magnificent Seven” stocks, all fell nearly 10% during the quarter. Companies in the financials sector dropped the most for the quarter, as the rate backdrop coupled with fears of a potential consumer slowdown pressured shares.

As we move further into 2026, many investors maintain hopes of broader stock market participation. While first quarter results did show some signs of broadening participation, concerns about lofty valuations and geopolitical uncertainties remain. A diversified portfolio with growth as well as more defensive exposure is likely to remain prudent against a backdrop of heightened and persistent uncertainty.

The following table details S&P 500 sector total returns for the quarter (data from Bloomberg).