Alert

The first quarter of 2026 began with genuine momentum and ended in a more uncertain place. A constructive start—solid consumer spending, a cooperative Federal Reserve, and accelerating AI-driven investment—gave way to two developments that introduced meaningful volatility: a market reassessment of how AI will reshape corporate earnings, and the onset of military conflict with Iran.

Most major asset classes finished the quarter modestly lower, with the bulk of the movement concentrated in March. The underlying economic foundation, however, remains more intact than the headlines might suggest.

Key Takeaways on the Economy and Markets

• Stock market. The S&P 500 finished the quarter down approximately 4%, with technology megacaps as the primary drag. Energy stocks rose sharply alongside oil prices, and value, defensive, and dividend-oriented names outperformed. The peak-to-trough drawdown reached roughly 9%—well below the historical intra-year average of 14%.
• Geopolitics. The US-Israeli military campaign against Iran, which began February 28, 2026, was the defining event of the quarter. Iran’s closure of the Strait of Hormuz—through which roughly 20% of global oil and gas flows—pushed WTI crude above $100 a barrel for the first time since 2022.
• Inflation. CPI held near 2.4% through February, then rose to 3.3% in March, driven almost entirely by energy prices. Core inflation remained well-contained at 2.6%, suggesting that, for now, the move is largely temporary rather than a broader price trend.
• GDP and economy. The Atlanta Fed's GDPNow tracker—a real-time estimate, not an official figure—opened the year at 3.1% and moderated to 1.3% for Q1, reflecting softer business investment and trade flows. Full-year growth is still expected near 2.4%, consumer spending grew roughly 5% year over year, and wages rose about 4%.
• Earnings. S&P 500 companies are expected to report Q1 earnings growth of approximately 13.2% year over year—the sixth consecutive quarter of double-digit growth—with full-year 2026 growth projected near 17%.
• Federal Reserve. The Fed's March projections pointed to a median of one rate cut for 2026, with seven of nineteen participants projecting none. The posture remains watchful and patient given ongoing energy-driven uncertainty.
• Valuations. The S&P 500’s forward price-to-earnings ratio declined from roughly 22 times expected earnings at year-end to approximately 20 times expected earnings—just below the five-year average of 19.9 times. The compression was most pronounced in higher-multiple growth names.
• Fixed income. Bonds faced modest pressure as energy-driven inflation pushed yields higher. Municipal bonds held up better given their tax advantages, and investment-grade corporates remain supported by solid fundamentals.

Q1: A Constructive Start, Two Unexpected Tests

The year opened much the way 2025 closed—with broad participation and improving momentum. International equities were outperforming US stocks for the first time in several years, aided by a softer dollar.

The Fed’s easing cycle was intact. Fiscal tailwinds from the budget reconciliation package were flowing through the economy via tax refunds and corporate investment incentives. AI capital spending was accelerating, and the mood among investors was cautiously constructive.

AI Debate

Through January and into February a thoughtful debate emerged around AI—one less about whether it would deliver value and more about how that value would be distributed. Investors began asking whether established software and technology companies would capture AI’s benefits, or whether increasingly capable models might gradually shift the competitive dynamics of industries that depend on per-seat or labor-intensive service models.

These questions extended into areas such as logistics, legal services, financial brokerage, and real estate. It is worth noting that current earnings and economic data show little evidence of these dynamics taking hold. At least so far this has been a recalibration of expectations rather than a reflection of deteriorating fundamentals.

Well-positioned companies with proprietary data, deep customer relationships, and durable competitive advantages appear better placed than the market’s reaction implied, and the picture should become clearer as earnings seasons unfold.

The Iran Conflict

On February 28, 2026, the more immediate driver emerged. The onset of military conflict with Iran and the closure of the Strait of Hormuz, through which roughly 20% of global oil and liquefied natural gas flows, introduced a genuine energy supply disruption.

The International Energy Agency coordinated the release of 400 million barrels from emergency reserves, its largest such action in history.

Consumer prices rose 0.9% in March alone, almost entirely reflecting the energy component. Core prices, which matter most to the longer-run inflation picture, rose a more moderate 0.2% for the month.

The early April ceasefire, while fragile, is an encouraging sign that the disruption may prove temporary.

Regional Impacts

The equity market’s response largely tracked the geography of energy dependence. Economies that rely heavily on imported energy such as Japan, South Korea, Germany, France, and Italy, experienced the most pressure.

The United States and Canada, as significant domestic producers, were more insulated. A strengthening dollar provided an additional cushion for US investors.

Within US markets, energy companies were clear beneficiaries, while technology names faced pressure from both the AI reassessment and modestly rising discount rates.

Importantly, corporate earnings have remained resilient through this period, with Q1 expected to deliver the sixth consecutive quarter of double-digit year-over-year earnings growth.

The Federal Reserve and Interest Rates

The Fed found itself navigating familiar territory: an energy price move driven by a geopolitical event, which is different in nature from demand-driven inflation but produces similar near-term data.

The Fed’s response has been measured, holding rates steady, monitoring the data, and avoiding overreacting to a potentially temporary disruption.

That posture seems appropriate. The Atlanta Fed’s GDP tracker, while softer than it was in January at 1.3%, still reflects a growing economy. Major forecasters expect the full-year outcome to land near 2.4%.

Longer term, we believe productivity gains—running at their strongest sustained pace in decades and increasingly supported by AI adoption — will be a moderating force on inflation over time.

Market Leadership

It is also worth noting that market leadership is beginning to broaden in a healthy way.

The technology megacaps that drove most index returns in recent years are giving way to a wider group of contributors. Earnings growth for the broader market looks particularly compelling in the second half of 2026, and the rotation toward value, dividend-paying, and internationally diversified holdings is consistent with the kind of broad-based expansion that tends to extend market cycles.

Q2 Outlook

The most important variable heading into the second quarter is the duration of the disruption to the Strait of Hormuz.

The early April ceasefire is an encouraging development. If energy supply routes normalize, the March inflation reading is likely to prove temporary, the Fed’s flexibility is restored, and the economy’s underlying momentum can reassert itself.

A more extended period of disruption would require a longer adjustment, particularly for economies more dependent on imported energy than the United States.

Several other factors will shape the year’s second half. The Supreme Court’s decision to revisit certain tariff authorities introduces some fiscal uncertainty that bears monitoring.

A potential change in Federal Reserve leadership adds a degree of policy continuity risk, though transitions of this kind have historically been managed smoothly. November midterm elections will introduce the usual late-year policy discussion.

And earnings season over the coming weeks will provide the most important near-term signal on how corporate America is absorbing the quarter’s crosscurrents. Current guidance suggests the answer is: reasonably well.

Beneath the near-term uncertainty, the foundation is sound.

Consumer spending was growing at 5% entering the quarter. Wages were outpacing inflation. Productivity is at a generational high. Equity valuations have moderated to more reasonable levels. And early diplomatic progress on Iran provides reason for measured optimism.

History offers useful perspective as well: the S&P 500’s average intra-year drawdown since 1980 is 14%, yet the index has delivered positive full-year returns in 34 of those 46 years. The current environment, while uncertain, is well within the range of normal market experience.

Portfolio Context and Positioning

The first quarter served as a useful reminder that periods of volatility are a normal part of investing, and that a well-diversified portfolio is designed precisely for moments like these. As the situation in Iran continues to evolve and the economic picture becomes clearer, we’ll maintain our emphasis on diversification and a balanced mix of growth and income assets across both public and private markets, making opportunistic, data-driven adjustments as conditions warrant. Our focus remains on navigating this period with discipline and perspective, and on positioning portfolios for sustainable, long-term success.

We’re Here to Help

For more information about the economic landscape and what it means for investors, contact your Moss Adams Wealth Advisors firm professional.

Additional Resources

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