After a strong finish to 2025, investors entered the new year with optimism around economic growth, moderating inflation, and the potential for lower interest rates. Market leadership broadened beyond technology stocks, with a continued rotation into sectors more closely tied to the overall economy. Concerns around spending on artificial intelligence and the timing of its potential payoff remained, prompting investors to continue to diversify away from megacap technology stocks. Notably, small-cap, international and emerging market equities were solid outperformers during the quarter.
The backdrop shifted meaningfully in March following the outbreak of the war in Iran. The conflict quickly became the dominant driver of both equity and fixed income markets, introducing a new layer of uncertainty. Oil prices surged, inflation expectations moved higher, and questions emerged over the potential impact on global economic growth. As a result, volatility picked up, with markets reacting sharply to geopolitical headlines.
The S&P 500 ended the quarter with a total return of -4.3%. For much of the first two months, pullbacks were relatively contained, with investors stepping in to buy dips – a strategy that has been rewarded over the past several years. However, sentiment shifted as the conflict in Iran escalated, and markets trended lower into quarter-end. Even so, the overall reaction was more benign than might typically be expected for such a significant geopolitical event. Within sectors, Energy was the clear standout, benefiting from higher oil prices, while more defensive areas such as Utilities outperformed as investors sought safety amid uncertainty.
Fixed income markets faced a similar push and pull. Earlier in the quarter, expectations for moderating inflation and eventual rate cuts put downward pressure on bond yields. That trend reversed quickly as the Iran conflict drove oil prices higher and reignited inflation concerns. Still, the Bloomberg U.S. Aggregate Bond Index finished the quarter virtually unchanged. For the Federal Reserve, the war presents another challenge to navigate as it aims to achieve its goal of bringing inflation down to its 2% target. At the start of the year, expectations were around one or two rate cuts in 2026, supported by signs of easing inflation and a gradually softening labor market. The rise in energy prices and renewed inflation concerns have made that path less certain. The timing and extent of future rate adjustments will likely depend on how the geopolitical situation evolves and whether inflation pressures prove temporary or more persistent.
Importantly, investors have already begun to look beyond the near-term uncertainty. By mid-April, the S&P 500 had fully recovered its first-quarter losses. Similar to last year’s trade tensions, market movements have been driven largely by headlines – this time on ceasefire discussions and ongoing negotiations to end the war. Also similar is the speed at which confidence has returned to the market, underscoring how quickly investor sentiment can shift in this type of environment.
Looking ahead, the trajectory of the conflict in Iran will remain a key focus. Attention will also center on its potential impact on inflation and whether the Federal Reserve can look through the recent increase in the price of oil and proceed with rate cuts later this year, especially with a new Fed Chair expected in May. Beyond geopolitics, questions around the pace and sustainability of AI-related investment—and its potential disruption across industries—will continue to be closely watched. Encouragingly, the fundamental backdrop remains supportive, with steady economic growth and solid corporate earnings expected in 2026. While uncertainty is likely to persist, the first quarter reinforced an important principle: maintaining a disciplined, long-term approach remains the most effective way to navigate periods like this, even as headlines continue to drive short-term movements.