After three consecutive years of double-digit gains, U.S. equity markets stumbled in the first quarter of 2026, pressured by escalating geopolitical tensions in the Middle East, a sharp rise in energy prices, a reassessment of mega-cap technology valuations, and fading confidence in near-term Federal Reserve easing. The S&P 500 Index1 declined 4.6% during the quarter, as the outbreak of the U.S.-Israeli war against Iran in late February and the effective closure of the Strait of Hormuz upended the constructive outlook that had prevailed entering the year. The Nasdaq Composite Index2 fared worse, falling 7.1%, as the mega-cap AI trade that had powered markets for two years encountered meaningful headwinds from both rising risk aversion and mounting concerns over the return profile of surging AI capital expenditures. The Dow Jones Industrial Average3 posted a comparatively narrower loss of 3.2%, as its greater exposure to energy and defensive sectors cushioned the blow relative to the growth-heavy Nasdaq.
The S&P 500 Equal Weight Index4 posted a modest gain of 0.2% in the quarter, outperforming the market-cap-weighted S&P 500 Index by 4.8%, signaling improved market breadth and broader participation away from mega-caps. Further evidence of shifting market leadership can be seen in the “Magnificent Seven,”5 which experienced a marked pullback in Q1, delivering an average return of approximately -12.2%. Another notable trend was the sharp divergence between value and growth, one of the most pronounced in recent memory. The Russell 1000 Growth Index6 fell 9.9%, while the Russell 1000 Value Index7 eked out a modest gain of approximately 1.6%, a return differential of 11.5%.
The Russell 2000 Index8 which tracks small-cap stocks, showed notable resilience in Q1 2026, appreciating a modest 0.6%. Small-cap equities benefited from their lower exposure to the multinational revenue streams most vulnerable to geopolitical disruption and rising oil costs. Their relative outperformance versus large-cap growth represented a continuation of the improving market-breadth trend that had emerged in Q4 2025, though this quarter’s catalyst was geopolitical risk rather than rate-cut optimism.
International developed markets outperformed U.S. equities for the quarter, with the MSCI World ex USA Index9 declining 1.5%. However, the quarter was effectively a tale of two halves: the index appreciated 8.8% through 2/25/26, before declining 9.5% over the remainder of the quarter following the Iran war shock. Emerging markets proved slightly more resilient, with the MSCI Emerging Markets Index10 declining 0.5% in Q1 2026, extending 2025’s relative outperformance versus developed markets. The asset class benefited from continued U.S. dollar weakness, robust AI-linked semiconductor demand in Asia, and ongoing corporate governance reforms across the region. Korea and Taiwan were again the primary engines of performance, driven by their outsized exposure to the global AI infrastructure buildout. However, the late-quarter risk-off environment weighed on emerging-market returns as well, particularly among oil-importing economies facing higher input costs. China was a case in point, with the MSCI China Index falling 9.0% in the quarter as it gave back early-quarter gains amid a worsening energy outlook and renewed growth concerns.
On the domestic monetary policy front, the Federal Reserve shifted into a holding pattern, leaving the federal funds rate unchanged at 3.50%-3.75% at both its January and March meetings. The January decision featured two dissents in favor of a rate cut, reflecting lingering concern over a soft labor market. By March, however, the outbreak of the Iran war and the resulting oil-price surge had fundamentally altered the calculus, reinforcing the Fed’s data-dependent stance and reducing confidence in an imminent resumption of rate cuts. Markets broadly interpreted the Fed’s positioning as hawkish relative to the two to three cuts that had been priced in entering the year, and Chair Powell’s emphasis on a “first, do no harm” approach reinforced the view that rate relief is unlikely until the second half of 2026 at the earliest.
In fixed income, rising yields and inflation expectations pressured bond returns across the duration spectrum. The 10-year U.S. Treasury yield ended Q1 2026 at 4.33%, up 17 basis points from 4.16% at year-end 2025, driven by higher near-term inflation expectations stemming from the oil shock. As with equities, the move was not linear: yields traded in a relatively narrow range through mid-February before surging in March alongside crude prices. The iShares Core U.S. Aggregate Bond ETF (AGG)11 was roughly flat for the quarter, with coupon income offsetting price declines. The 2-year U.S. Treasury yield rose more materially, increasing to 3.81% from 3.48% at year-end, as markets recalibrated expectations for Fed easing. Credit spreads widened modestly during the March selloff, with the iShares Broad USD High Yield Corporate Bond ETF (USHY)12 declining 0.4% for the quarter as risk aversion mounted.
Crude oil was the defining commodity story of Q1 2026 and one of the most consequential market developments of the quarter. Brent crude, which had closed 2025 at $60.85 per barrel, traded in a relatively narrow range through late February before the U.S.-Israeli strikes on Iran on February 28th triggered a severe energy supply shock. The effective closure of the Strait of Hormuz, through which approximately 20% of the world’s seaborne oil flows, sent Brent surging more than 60% in March alone, its largest monthly gain on record dating back to 1988. Brent crude prices ended the quarter up 94.5%, as a March release of 400 million barrels from strategic petroleum reserves by IEA nations — the largest emergency release in history — did little to ease concerns over the market’s near-term supply gap.
Precious metals experienced significant volatility in Q1, driven by the interplay of safe-haven demand, rate expectations, and the energy shock. Gold reached a new all-time high above $5,400 per ounce in late January, propelled by central-bank buying, ETF inflows, and intensifying geopolitical uncertainty. However, the metal gave back a significant portion of those gains in March as the hawkish Fed hold, surging real yields, and forced liquidation by leveraged funds weighed on prices. Gold ended the quarter at $4,668 per ounce, up 8% from its year-end 2025 close of approximately $4,325. Silver followed a similar trajectory, rising sharply through January before experiencing one of its sharpest weekly declines in years in early February, as its dual identity as both an industrial metal and a precious metal left it vulnerable to growth concerns and speculative unwinding. Silver ended Q1 near $72.69 per ounce, up 1.0% from its year-end 2025 level.
As we enter Q2 2026, the market narrative has shifted decisively from the monetary-policy-and-AI-driven framework that dominated 2024 and 2025 to one centered on geopolitical risk, energy security, and the specter of a supply-side inflation shock. On one hand, the economy continues to show signs of underlying resilience, and the broadening away from narrow mega-cap leadership may ultimately prove healthy for market structure. On the other hand, energy-driven inflation risk, a more cautious Fed, tighter financial conditions, and unresolved geopolitical tensions have made the path forward less straightforward than it appeared at year-end. In our view, the environment continues to argue for diversification, disciplined risk management, and selectivity across both equity and fixed income allocations.
