Quarterly Market Review 2026 Q1

The first quarter of 2026 was a tale of two headwinds – first, the shift from excitement about AI to concerns about the potential business disruptions of AI, where stocks tied most closely to AI fell off in January and February.

Then came February 28, when the U.S. and Israel launched strikes on Iran. Stock markets initially absorbed the shock with cautious optimism, expecting a short conflict with limited disruption to energy flows, but that assumption did not hold for long. More than a month later, the Strait of Hormuz — through which roughly 20% of the world's oil and significant volumes of liquefied natural gas pass — remains closed, and the economic ripple effects are widening well beyond what early assessments anticipated.

Economies around the world are now coping with an energy shock that has revived inflation worries, opened the door to interest rate hikes instead of cuts, and raised concerns about slowing economic growth.

The broadest concern now, heading into Q2, is inflation. After several years of fighting to bring inflation under control, markets and policymakers are now confronting the prospect of a renewed inflationary cycle driven not by domestic demand, but by geopolitical disruption to global energy supply. Overall, here are market returns for Q1:

Below are a few data points from Q1:

• The U.S. stock market offered moderate gains in January and February, but dropped abruptly in March, ending Q1 down 3.96%.

• For the second consecutive quarter, U.S. value stocks outperformed U.S. growth stocks.

• In the U.S., small and mid-size company stocks fared better than large cap, which is off to its worst start to the year since 2020.

• International stocks and Emerging Markets were negative in Q1 as well, down 0.94% and 0.17% respectively, but still outperformed the U.S. market.

• The surge in oil prices has analysts lifting inflation forecasts globally, impacting both stock and bond market returns.

• The Federal Reserve held interest rates steady with the federal funds rate remaining at 3.5-3.75%.

Below is a snapshot of key top-line economic indicators:

U.S. Stocks

Despite AI concerns, the U.S. stock market had a mild start to the quarter with modest gains in January and a mild February. With growing fears that AI would disrupt established business models, U.S. software stocks fell 23% from the beginning of the year through February 27. Then, on February 28, the U.S. and Israel launched large-scale airstrikes on Iran. The following weeks saw oil prices surge toward $100 a barrel, global financial markets impacted by the uncertainty caused by the war in Iran, and U.S. stocks tumbling, with the S&P 500 down 4.3% in Q1.

Technology stocks bore the brunt of the March U.S. stock sell-off, while energy was the benefactor (up 38%) due to sharply rising oil prices. Value stocks outperformed growth stocks in each month of the quarter, and smaller companies held up better — the Russell 2000 gained nearly +1% compared to the Nasdaq 100's -5.8% decline. With the Strait of Hormuz still closed at the end of the quarter and the Federal Reserve’s rate cut expectations largely priced out, there is uncertainty heading into Q2.

International Stocks

International equity markets overall managed to hold their ground better than the U.S. in Q1, although performance varied considerably by region. The Iran conflict was a meaningful differentiator: market returns by country generally aligned with each nation's dependence on imported energy. International stocks finished the quarter down nearly 1%, compared to the S&P 500's 4.3% decline — with the outperformance concentrated in January and February before March brought more uniform pressure across global markets.

Japan's export-oriented stock market was the standout among major developed markets, rising 3.6%. European stocks (excluding the U.K.) fell 2.3%, as the sharp rise in gas prices raises concerns about the region's growth outlook.

Emerging markets were roughly flat at -0.17% for the quarter, with relative strength in Latin America tied to rising energy prices. Prior to the start of the Iran war, investors saw potential benefits of AI in emerging markets, particularly for Taiwanese and Korean markets, which together account for 38% of emerging market weightings. However, early gains were lost in March, as more than 80% of the global oil and gas that is transported through the Strait of Hormuz is enroute to Asia, heavily impacting emerging markets returns for the quarter overall.

While no major region was fully insulated from the quarter’s turbulence, international diversification again proved its worth in Q1.

Fixed Income

Before the Iran war began, the Federal Reserve found itself in a complicated position. Inflation remained above its 2% target and the labor market was showing meaningful signs of softening – which would generally lead the Fed to hold interest rates higher for longer to fight inflation, with rate cuts used only if unemployment were to rise significantly. However, facing unusual political pressure from President Trump and an upcoming change of leadership to new Fed chair Kevin Warsh coming in May, the case for rate cuts in 2026 had been building steadily through February.

The war changed that outlook quickly. The surge in oil prices reignited inflation concerns, and by the end of the quarter, expectations for any Fed rate cuts in 2026 had largely evaporated, with bond traders beginning to price in the possibility of a rate hike instead.

That shift impacted the Treasury market, as seen in the graph above. Just before the strikes on Iran, the 10-year Treasury yield — a key benchmark for mortgage rates and broader borrowing costs — had dipped below 4% for the first time since September 2024. By quarter-end, it had climbed back to around 4.4%. Shorter-term yields, which track Fed policy expectations more closely, moved in a similar direction: the 2-year Treasury yield closed Q1 at 3.79%, up from 3.40% before the war began. For bond investors, the result was a quarter defined by rising yields and falling prices — the opposite of what many had expected heading into 2026.

International bond markets faced broadly similar headwinds to the U.S., with the Iran conflict again the decisive turning point. Globally, government bond markets were volatile throughout the quarter, selling off sharply in March as higher energy prices fueled inflation concerns. Shorter-term bonds hit particularly hard as markets shifted abruptly from pricing in potential rate cuts to pricing in possible rate hikes across major central banks.

As of publication, there has already been significant improvement in the expectation for a quicker resolution to the Iran War and markets appear to be looking past the conflict to lower energy prices and lower inflationary pressures once some sort of peace agreement is in place. The market is having an enthusiastic reaction to this potential. Global stock and bond markets are largely positive as of now, despite the weak Q1 environment. Naturally, many unknowns remain, and we will revisit all of this in our next quarterly market review.

As always, please reach out with any questions or if you'd like to find time to meet!

Sincerely,

Your Taurus Capital team