1st Quarter 2026 Market Commentary

Wars are not good for anyone. There is definitely a human toll, and we should take a moment to think about everyone who has died in the Iran war. This includes US service members as well as innocent civilians in Israel, Iran, Lebanon, and elsewhere.

Wars also have an economic effect and a market effect and since this is a market commentary I must tackle the subject. The question on everyone’s mind is how the war in Iran will affect their wealth, either because of possible job loss, markets going down, price rises, or general economic disruption. I came across this graphic from Clearnomics showing the effects on the market from previous wars:

This does not show a clear negative effect. In 1-, 5-, and 10-year time periods, only 1 out of 6 wars had the S&P500 going down. There was a negative effect in the first year only during the Afghanistan war and Afghanistan was during the dot-com crash. There was a nice recovery after a year. Only the Vietnam war showed an ongoing malaise over the full 10 years.

I know I have had some phone calls from clients who are very concerned, and of course its right to be concerned, but the truth is that the past does not indicate that the Iran war itself will have a lasting negative effect on markets. I think it’s important to understand the state of the economy at the start of the war and the economic effects a longer conflict could have. I will review that in the later section on the economy.

First Quarter Market Results

Let’s discuss what really happened in the first quarter and what has happened in the 13 days since that quarter ended. The S&P 500 dropped 4.33% in the first quarter. The Russell 1000 Growth Index dropped further: 9.78% for the quarter, caused by a combination of war and the perception of AI’s effect on software companies. But not all the stock indices dropped. The Russell 1000 Value Index rose 2.10% and the small-cap focused Russell 2000 index rose 0.89%

International developed markets also performed quite well YTD. The MSCI EAFE index was down 1.24% to March 31, but up 6.09% to April 10.

Bonds were flat this first quarter because longer-term rates rose a bit. The Bloomberg US Intermediate Bond Index rose just 0.11%.

Commodities were excellent in the first quarter, with the Bloomberg commodity index rising 23.3%. The price of oil and gold both helped.

This chart shows the MSCI EAFE index in green, the S&P500 index in blue, the Russell 2000 index in orange, and the Bloomberg Commodity index in grey. The chart is from Kwanti.

The thing is, that March 30 was the low point for the market Year to Date. The S&P 500 dropped 7.05% YTD on that date, but if you look at YTD to Friday April 10th, the S&P 500 is exactly flat for the year. It has made up all that drop in a short time period.

The news headlines are all about war and inflation and would have you believe that the market went down because of that. I say: Don’t be so sure. I believe the stock market was over-extended and this was a needed pullback. War and AI worries were the excuses, but not the actual cause of the pullback. We will never know, but I think it would have dropped in this period anyway.

Economics

Let’s discuss economics. The Trump administration and the war are definitely affecting the US and world economy, especially on the inflation front. The labor market is holding up, albeit at a relatively slow pace. Unemployment went down in the last report from February to 4.4%. This is pretty much full employment, but people still seem unhappy with the labor market. It seems to be a “slow to layoff” and “slow to hire” job market. The number of available jobs is growing very slowly, but at the same time, the workforce has been shrinking because of lower immigration.

US Gross Domestic Product or GDP grew 2.1% in 2025, although it really slowed down in the fourth quarter with a rate of 0.5%. The first quarter of 2026 numbers are not out yet, but estimates from the Atlanta Fed are for growth of 1.3%. 

The real issue is inflation. It was running above the Fed’s 2% target even before the recent spike in oil prices. The most recent US CPI inflation reading for March was 3.3%. The war is likely to raise energy, food, and transportation costs for the year, but housing costs have been decreasing at a slow rate and that is likely to continue. This means overall inflation will be elevated but may peak in the 4-5% range over the summer instead of 7 or 8% that some people fear. Of course, the disruption is not over yet, the world economy will eventually adjust, but it may take time. Still inflation will be running hot and that will keep the Federal Reserve Bank from lowering rates any time too soon. Eventually, it might have to raise rates, but its likely to wait and see first.

Market Outlook

I don’t think there will be a US recession any time soon. The consumer reduced debt levels since the great recession (deleveraging in economic-speak). This means we are not likely to see high foreclosure rates on homes or autos. Higher inflation is likely to cause the consumer to pull back a bit, but not enough for a recession in the near term. I think it’s more likely to be stagflation where the economy muddles along in a subdued way and we have higher inflation. Not the 1970s, but maybe an echo of that. The markets have recently been all about AI and at some point, the air will come out of that a bit. It already has, with the largest AI-linked company stocks, not doing so well in the first quarter. Still, I believe AI will be increasing productivity and the rest of the non-AI part of the stock market has not participated much up till now. So maybe the Mag 7 stocks will do a bit worse, and the rest of the US market will do a bit better.

International markets were badly affected by the war, but I believe they will do better the rest of the year. Japan and Europe definitely still have room to grow, and the valuations are still better than US large cap stocks. 

Bonds may be a problem in 2026. Inflation will cause the yield curve to steepen. It won’t be a complete replay of 2022, when the Bloomberg US Aggregate Bond index dropped 13%, but it may mean not making much money on bonds. It’s a reason to keep your bond duration short, which is a tactical move I have made in portfolios I manage. Shorter-term bonds will be much less sensitive to interest rates.

2026 is probably going to be a good year to have a diversified portfolio. I expect international stocks, Value stocks, and commodities to outperform US Large-cap and especially US Large-cap growth. This may be a year when a diversified portfolio outperforms the S&P500 index which is heavily weighted towards large-cap growth stocks. This is definitely what happened in the first quarter.

I want to leave you with a quilt chart from JP Morgan. This chart shows how different asset classes have performed on a year-to-year basis. It looks so colorful because different asset classes have higher returns in different years. The white blocks marked Asset Alloc. represent a diversified multi-asset portfolio which you can see is always in the middle. Since it’s pretty much impossible to figure out which asset class will outperform in a given year, the diversified portfolio does pretty well most years.

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