Q1 2026 Market Perspective

As we noted in our previous commentary, the outlook entering 2026 was supported by resilient economic conditions, moderating inflation, and expectations for continued economic growth. While that backdrop remains largely intact, the conflict in Iran has introduced more uncertainty, resulting in market volatility and a divergence across asset classes, sectors, and investor sentiment.

Despite the increased geopolitical instability during the quarter, our outlook remains constructive. Economic growth continues, corporate fundamentals are stable, and the broadening of market participation beyond a narrow group of mega-cap stocks is a healthy development for long-term investors. While periods of volatility can feel unsettling, they remain a normal feature of market cycles—particularly following extended periods of strong returns.

The quarter was defined less by a clear directional move and more by divergence—between sentiment and economic data, across sectors, and within index-level performance. While headline equity indices declined modestly, underlying results were more balanced, with value-oriented, dividend-paying, and smaller-cap equities demonstrating relative resilience. Fixed income also continued to provide stable income, reinforcing its role within diversified portfolios.

In this environment, our investment approach remains consistent. Diversification becomes increasingly important as return drivers broaden and leadership evolves. Periods of dispersion can also create opportunities for disciplined rebalancing—trimming areas of relative strength and adding to those offering improved long-term value. Ongoing tax management remains a key component of this process, particularly when volatility creates opportunities for tax-loss harvesting.

Rather than reacting to short-term market movements or shifts in sentiment, our focus remains on aligning portfolios with your long-term financial plan. This disciplined framework allows us to navigate a more nuanced market backdrop while remaining well positioned to participate in long-term growth.

Source: Q1 2026 Total Return as of 3/31/2026, Bloomberg

• Large-cap U.S. equities declined during the quarter, driven primarily by weakness in mega-cap technology and growth-oriented sectors. In contrast, both mid- and small-cap stocks posted positive returns, highlighting a shift in market leadership away from the narrow concentration that defined much of the prior cycle.

• International markets were more resilient, while emerging market stocks continued to outperform on a trailing twelve-month basis. This relative strength reflects a broader participation across global equities, even as U.S. large-cap indices faced pressure.

• Fixed income experienced some volatility during the quarter—starting the period on strong footing before weakening in March as the Federal Reserve’s narrative shifted. By quarter-end, expectations for interest rate cuts had been largely priced out, a meaningful change from the start of the year when cuts were anticipated by mid-year. Despite this movement, yields continued to provide meaningful income opportunities and reinforce the role of fixed income within diversified portfolios.

MARKET DRIVERS

Soft Data vs. Hard Data

A defining feature of the quarter was the growing disconnect between sentiment and measurable economic activity, which led to investor uncertainty.

Consumer confidence declined approximately 6% from February to March, as concerns around inflation, geopolitical developments, and the broader economic outlook weighed on sentiment. This deterioration has contributed to a more cautious tone among investors and has fueled discussion around downside economic scenarios [2].

In contrast, hard economic data has remained stable. March non-farm payroll growth came in at +178k, far exceeding expectations for +60k, while the unemployment rate dipped slightly to 4.3% [3]. Meanwhile, real-time GDP estimates, such as the Atlanta Fed’s GDPNow model, continue to indicate growth near 2%[4], suggesting the economy remains in expansion rather than contraction.

One way to interpret this gap is through the concept of a “K-shaped” economy. Higher-income consumers and larger businesses remain supported by stronger balance sheets. However, lower- and middle-income households face greater pressure from elevated costs and borrowing rates, while missing out on the equity gains in stocks and real estate. As a result, overall growth can remain firm even as broader sentiment weakens, reflecting a less even distribution of economic strength.

Stagflation Debate

Discussion around stagflation gained traction during the quarter, driven in part by rising energy prices linked to geopolitical tensions.

The Fed’s preferred measure of inflation, Core PCE, currently reflects an annual change of 3.0% (down slightly from the previous reading of 3.1%)[5]. While inflation has declined meaningfully from the post-Covid peaks, progress toward the Fed’s stated 2% target has slowed, suggesting inflation may be stabilizing above target rather than continuing a steady downward trend.

At the same time, economic growth has moderated but remains positive, and labor market conditions continue to show stability. This combination—elevated inflation alongside slowing but positive growth—has led to increased focus on stagflation as a potential scenario. However, current conditions suggest this remains a risk to monitor rather than a base case.

Geopolitical developments add additional uncertainty. Elevated oil prices tied to Middle East tensions have the potential to place upward pressure on input costs, which could feed through to broader inflation while weighing on consumption. Furthermore, the Fed’s job of managing short term interest rates has become more difficult, understanding that pricing pressures are related to temporary exogenous shocks that are more difficult to navigate.

While elements of this scenario are beginning to emerge, a sustained shift in either inflation or growth would likely be required for stagflation to become more fully realized.

Technology Reset, Market Breadth & Shifting Leadership

The first quarter reflected a shift in market leadership.

Large-cap growth indices, heavily concentrated in mega-cap technology and AI-related companies, experienced a pullback as valuations compressed. This adjustment occurred despite relatively stable earnings expectations, suggesting the move was driven more by positioning and sentiment than by a deterioration in fundamentals. Increased scrutiny around the return on AI-related capital expenditures, along with evolving implications for AI software business models, added to the pressure on the sector.

This weakness was not representative of the broader market, as participation expanded across a wider set of stocks during the quarter. This is illustrated by the difference between cap-weighted and equal-weighted indices: while the S&P 500 declined 4.3%, the S&P 500 Equal Weight Index declined by a modest 1.0%, reflecting stronger performance beyond the largest companies. Value-oriented and income-generating segments also performed well, with dividend-paying stocks—represented by the S&P 500 Dividend Aristocrats Index—gaining approximately 1.1%, supported by more attractive valuations and an increased focus on cash flow stability in an uncertain environment [1].

For diversified portfolios, this environment reinforces the importance of maintaining broad exposure across asset classes, sectors, and investment styles. As return drivers become more distributed, our focus remains on optimizing allocations to enhance diversification while reducing both concentration and manager-specific risk.

LOOKING AHEAD

As we move further into 2026, the economic foundation remains supportive of continued expansion. Growth is expected to moderate but stay positive, with GDP projected to trend near 2% over the next several years[4]. Labor market conditions are stable, and while inflation remains above the Federal Reserve’s target, it appears to be leveling off rather than re-accelerating. Together, these factors support a positive outlook for markets, even as expectations continue to evolve.

Recent market behavior reinforces this view, as equity markets have responded favorably in the weeks following quarter-end, retracing the initial reaction to the conflict in Iran. This serves as a reminder of how quickly sentiment can shift, and how markets often begin to reflect improving conditions ahead of clear confirmation in the data.

At the same time, risks remain. The path of inflation, the direction of monetary policy, and ongoing geopolitical developments all have the potential to influence market conditions. In addition, attention will turn to Federal Reserve leadership, as senators are expected to consider President Trump’s nomination of Kevin Warsh as the next Chair of the Federal Reserve. With Jerome Powell’s term set to expire in May, uncertainty surrounding the confirmation process and future policy direction may contribute to near-term market sensitivity. While the fundamental picture remains intact, these factors may continue to drive periods of volatility and changing expectations.

SUMMARY

The first quarter highlights how quickly market volatility can re-emerge as expectations and underlying fundamentals begin to diverge.

While near-term conditions may continue to shift—driven by changes in sentiment, policy expectations, and geopolitical developments—the broader economic foundation remains intact. Growth continues, inflation appears to be stabilizing, and market participation is becoming more balanced across sectors and asset classes.

For long-term investors, this environment reinforces the importance of maintaining a disciplined approach. Diversification remains critical, particularly as market leadership broadens, while attractive yields in fixed income continue to provide income and stability within more balanced portfolios. Periods of volatility can also create opportunities to rebalance portfolios, reinvest cash, and manage distributions in a tax-efficient manner.

As always, our focus remains on aligning portfolios with your long-term financial plan. By maintaining a consistent and process-driven approach, we aim to navigate evolving market conditions while keeping you positioned for long-term success.

APPENDIX

Chart A: 2026 Total Return of Major Asset Class Indexes

Source: Bloomberg; 2026 Total Return, MSCI EAFE, MSCI Emerging market, S&P 500, Barclays Agg & Barclays Muni index; 3/31/2026

1 – Bloomberg: S&P 500 Total Return Index; Emerging Markets Stock Index = MSCI Emerging Markets Net Total Return Index; International Markets Stock Index = MSCI EAFE Total Return Index. Bloomberg Barclays Aggregate Bond Index

2 – https://tradingeconomics.com/united-states/consumer-confidence; https://www.reuters.com/business/us-consumer-sentiment-dives-record-low-april-amid-iran-war-2026-04-10/  

3 – www.bls.gov/news.release

4 – https://www.atlantafed.org/research-and-data/data/gdpnow

5 – https://tradingeconomics.com/united-states/core-pce-price-index-annual-change

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