Economic and Market Update

Latest Developments and Economics

A couple months ago this letter mentioned the unpredictability present in the recent environment. The war against Iran that began at the end of February fits that description. The energy shock is the single subject dominating the news flow. The administration came out and said that this war would last only a few weeks. Here at the end of March it continues with no de-escalation in sight. The U.S/Israeli initial goal was to eliminate the Iranians ability to develop a nuclear weapon and to threaten their neighbors. Along the way there was also mention for regime change, a much more ambitious endeavor. As for the Iranian government, their goal is to survive – which they can do by waiting this out. They have been successful in cutting off a major chokepoint in the Strait of Hormuz, a channel where 20% of the world’s daily oil flows. Yemen’s Houthi rebels are now starting to threaten another oil chokepoint in the Red Sea. The impact on oil prices is global as Saudi Arabia, UAE, Qatar and Iraq flow through Hormuz and many have had to shut production.

The strait closure has a greater impact abroad as the U.S. is more energy independent than in the past and certainly more than Europe, Asia and Africa. The beneficiary of this conflict so far is Russia. Not only has the U.S. taken their eye off Ukraine but, Russia is selling more unsanctioned oil at inflated prices. The rise in oil prices has been quick and steep. Brent is showing more price sensitivity than U.S.-based WTI. The release of 400 million barrels globally from the strategic oil reserve replaces about 20 days of lost production. Should this continue, oil prices could rise further and some countries around the world could experience physical shortages of the commodity.

The longer the conflict continues unresolved the greater the impact on oil prices. There are two takeaways from the adjacent chart. First, oil prices increase as this goes through spring unresolved with Brent price potentially reaching $150/bbl if it goes through mid-June. Second, oil prices are expected to take time to normalize as production and supply chains come back online. Projections are that oil will not approach pre-conflict prices until end of the year and may not get back to $60 soon.

One last item is that strait closure affects more than just oil. It also affects derivative products of oil as well as natural gas and fertilizer. About 20% of global natural gas, from Qatar, flows through the strait with no replacement possible as liquified natural gas must travel via sea, unlike oil which can travel across land pipelines. The strait also carries about 33% of global fertilizer trade through nitrate and phosphorus-based products. The timing of spring planting season in some parts of the world could have significant impact on crop yields and food supplies.

All of this is having an impact on near-term inflation. The energy shock will cascade through products that require transportation and put upward pricing pressure on those products (i.e.: food). In addition, the tariffs are still having a general impact as well. Despite this shock in the near term, intermediate term inflation expectations still reflect moderation towards the Fed’s 2% target.

This puts the Federal Reserve in a tough spot. They are dealing with an increase of inflation through the energy prices and a slowing labor market. New job creation has slowed markedly and has held up only with significant support from health care sector hiring.

Federal Reserve participants now see potential risks to both inflation and full employment in the short term. This means that further interest rate cuts look likely to be pushed off until the conflict settles. Some forecasts have incorporated a potential rate increase due to inflation, however there is a very high bar before a rate hike is part of Federal Reserve conversations. In a recent speech at Harvard Chairman Powell felt rates were “in a good place” and that rate hikes in the face of supply shocks have little effect. Usually, the shock is passed by the time rate changes would have an impact. While initially a source of inflation, if the shock were to go on longer, then the possibility of an economic slowdown increases.

At this point the conflict can either move towards resolution or escalation. President Trump continues to talk about negotiations while also threatening escalation with targets of power, water and infrastructure if the waterway isn’t opened by April 6. Moreover, recent polls by Pew research show that 61% disapprove while 37% approve of the administration’s handling of the war. In addition to popular feelings, political pressure in the form of upcoming mid-term elections may also have an impact on reaching a settlement to this conflict sooner rather than later.

Even with this uncertainty the jobs market remains stable, the consumer remains resilient and there has been no negative impact on earnings expectations of U.S. companies, so the economy is holding up well in the face of many headwinds.

Financial Markets

This was not a good quarter for many asset classes. Global stocks, bonds, private assets and even gold all had their troubles during the first quarter. Entering 2026 the markets had quite a bit to digest – high stock valuation, concerns about AI in terms of both capital expenditures and replacement of certain industries, and some trouble spots in private credit all were present before the conflict with Iran at the end of February. That became THE issue during the month of March, and financial markets responded sharply.

At the index level the S&P 500 looked rather calm entering March, however turbulence lay below the surface. The ensuing conflict had a more significant impact on the entire market this month. The S&P 500 lost 4.33% for the quarter with all of it coming in March. This represented the worst quarterly performance since the third quarter of 2022. The index was down as much as 7% during the month but a relief rally on the last day of March softened the blow. All sectors, except energy, were down during the month of March. The decline left the S&P 500 below its 200-day moving average.

Growth stocks led the way down in the quarter with that factor down over 8%. It was Financials, Consumer Discretionary and Information Technology that ended the month almost in correction territory with all three sectors down over 9% for the quarter. There was a rotation out of technology into the more value-orientated and defensive parts of the index. As a result, Communication and Health Care joined the previously mentioned sectors with a loss during the quarter. The rotation kept Real Estate, Industrials Staples, Utilities and Materials positive for the quarter but, none came close to energy. The Energy sector recorded a quarterly return of over 38% for Q1 of 2026 (and not all of it was in March). The Mag 7, which has led the market the last few years, could be renamed the ‘’Drag 7’ so far in 2026 as they collectively entered correction territory (down more than 10% from highs). This drawdown was led by Microsoft and Meta (Facebook) both down over 30%.

Quarterly Returns - Equity Indices

Quarterly Returns - U.S. Fixed Income

The rotation out of technology also extended down market capitalization and, even with a rough March, both S&P MidCap 400 and S&P SmallCap 600 ended the quarter in positive territory. Given the energy vulnerability relative to the U.S., the conflict was especially hard on Developed and Emerging International stocks by erasing their 2026 gains. The S&P Developed Ex-U.S. is now flat for 2026 and the S&P Emerging is down 2.57%.

Fixed Income did not really provide much cover either during the quarter. Most sectors that were not cash were either flat or slightly down. The realization that interest rate cuts may not be forthcoming due to the inflationary effects of the conflict on energy prices sent bond prices down. As Powell referenced in his recent speech, the Fed is a position to wait and see what happens on the geopolitical and resulting economic front to make any moves. The market is now pricing in only one cut later this year. Credit spreads also were negatively affected due to this policy change as well as energy prices and the uncertainty of geopolitics.

The higher for longer interest rates, plus a flight to quality, have temporarily strengthened the dollar. This also had the impact of sending gold down. Staying on commodities, oil took up the precious metals slack with Brent oil futures rising a historic 55% for the month. Once the conflict is resolved the direction of the dollar will be something to watch – does it resume the recent decline, or does it retain the strength it found during the conflict?

Another sign of anxious financial markets is the level of volatility index (VIX). The implied volatility rises in times of stress in the markets. The markets so-called fear gage’ has risen to 30 indicating heightened volatility. The market VIX was only this high twice in the last 5 years – the day tariffs were announced last April and the Japanese carry unwind in August of 2024.

Finally, private markets have been getting attention due to defaults. While there have been some high-profile events regarding the asset class these seem to be limited to very specific, more aggressive parts of that market. While there have been corrections and some normal liquidity gating, there are no signs of a widespread issues. Even Chairman Powell commented that "We're looking for connections to the banking system, and things that might, you know, result in contagion. We don't see those right now." So, while some investors are experiencing undesirable results that are a normal part of financial market investing, there are no signs of systemic threats to financial markets according to Powell.