Q1 2026 Market Commentary

Q1 2026 Market Commentary

Serious Risk, Measured Response: Investing Through Geopolitical Uncertainty

Q1 2026 was a reminder that the global economy still runs through a few narrow chokepoints, and the Strait of Hormuz is one of them. Markets absorbed a sharp geopolitical shock, but the reaction was more restrained than the commentary suggested: volatility rose, equities dipped, and energy surged, yet the move remained well short of the April 2025 tariff-driven volatility and drawdown.

What ultimately endures is rarely determined by the headlines. As of this writing, a fragile ceasefire is in place, and conditions in the Strait of Hormuz remain fluid. No one knows how or when this conflict will be resolved or when commerce through it will fully normalize. What markets are signaling, however, is that this shock is unlikely to meaningfully affect inflation, growth, or corporate earnings and therefore does not warrant reactive changes to a long-term investment plan.

Geopolitical Shockwaves and the Primacy of Duration

Early January marked a sharp escalation in U.S. involvement in Venezuela. U.S. strikes culminated in the capture of President Nicolás Maduro, followed by charges including narco-terrorism and cocaine importation conspiracy. U.S. officials also signaled their intent to oversee an interim transition while pursuing claims to roughly $3 billion in sanctioned oil assets and negotiating a U.S.-influenced energy framework.

Late February brought a broader shock as the United States and Israel launched Operation “Epic Fury,” which opened with a “decapitation” strike against Iran’s top leaders and continued with strikes targeting military infrastructure. Iran’s retaliatory strikes across the region increased the risk of a prolonged conflict and disrupted world energy flows. Iran’s strikes against neighboring countries appeared to reinforce coordination and resolve among several U.S. regional partners, while furthering straining relations with NATO allies.

As in prior periods, the critical question for investors was not whether markets would react but whether these events would persist long enough to materially affect inflation, financial conditions, and corporate earnings. Duration, not headlines, remains the determining factor.

In Q1, investors also got a refresher on why the Strait of Hormuz matters: more than 20% of global oil shipments and critical feedstocks for crop fertilizer move through this corridor. Any credible threat to traffic can quickly raise the cost of powering and growing food to feed the world.

There is little doubt that the U.S. has an overwhelming military capability. But geography and the changing complexion of modern warfare mean that even a smaller, weakened adversary can still impose meaningful disruption, especially when a strategic chokepoint is involved. Presently, an uneasy ceasefire is in place, the first round of peace talks failed, and the U.S. has blockaded the strait.  This is not over, and even if it were, there would be a significant lag in ramping up oil and other feedstocks.

How have the markets responded? Compared with the April 2025 tariff shock, the reaction has been muted. Volatility rose, and equities dropped, but nowhere near last year’s move. For now, markets appear to be looking through the headlines and pricing a resolution that avoids a material hit on the economy or corporate earnings.

Figure 1 puts this quarter in context. Volatility and drawdowns increased, but the move remained smaller than in April 2025, consistent with a market pricing a contained macro impact and a credible path to resolution.

Figure 1

Also, like the 2025 tariff policy shock, despite a common media narrative that higher oil prices must be inflationary, there is a credible counterpoint that an energy shock can reduce demand and become disinflationary over time. The tariff episode offers a reminder that fears of runaway inflation were widespread, yet inflation did not rise on the scale many expected. The message from markets, particularly real interest rates, is consistent with prior episodes. While oil prices have surged, expectations for sustained inflation remain contained. What this means for investors is that while the headlines are dramatic, markets are not signaling a lasting economic disruption.

Figure 2: Breakeven inflation curves have often inverted after major shocks and have frequently preceded subsequent disinflation. The curve is a useful real-time indicator of whether markets expect inflation pressures to persist.

Figure 2

Markets & the Economy

Equity Markets: Rotation, not Retreat

U.S. stocks ended the quarter lower overall, but the context behind the decline is what’s most important. The Dow, S&P 500, and NASDAQ declined, while small‑cap stocks (as measured by the Russell 2000) were modestly positive. (1) Sector leadership also rotated: energy, utilities, and consumer staples held up better, while some of the prior leaders, particularly parts of technology and other growth‑oriented segments, lagged. This rotation was driven by investor fatigue over artificial intelligence (AI) return on investment and a sharp rise in energy prices, the latter compounded by geopolitical conflict. Rising energy costs and persistent inflation sparked concerns that the Federal Reserve would abandon planned rate cuts, reducing the appeal of growth stocks and causing investors to reassess what they’re willing to pay. This rotation was further propelled by the “One Big Beautiful Bill Act” (OBBBA), which provided fiscal benefits that favored capital-intensive domestic companies over multinational tech giants. 

Q1 at a Glance (as of March 31, 2026)

Figure 3: We use XLE (State Street Energy Select Sector SPDR) as a practical proxy for oil-sensitive energy prices. The chart shows how the Hormuz-related supply shock lifted energy while broader risk assets reacted, but without the kind of broad, disorderly repricing seen during last year’s tariff scare. Energy’s sharp rise reflects supply disruption, not broad economic overheating.

Figure 3

Inflation and Interest Rates: Sticky Data, a Patient Fed, and a Steepening Curve

The Federal Reserve held the federal funds target range steady at 3.50%–3.75% during the quarter. Even with the policy rate unchanged, the bond market moved as investors weighed a mix of energy-driven inflation concerns, slower-growth signals, and the evolving path of financial conditions. The 10-year Treasury yield rose modestly by quarter-end, while shorter-term yields moved less, contributing to a continued “normalization” (steepening) of the yield curve after a long inversion.

Inflation remained above the Fed’s long‑term target, but the mix mattered: the PCE price index was up 2.8% year over year, and CPI was up 2.4% year over year (12 months ended in February). Energy prices were a key swing factor during the quarter.

Labor Market and the Consumer: Cooling, Not Collapsing

Economic headlines in Q1 often focused on a “weaker” jobs market. The reality was more mixed: employment growth improved in January and then fell in February, while the unemployment rate remained in the mid-4 % range. That pattern is consistent with a labor market that is cooling after a very strong post‑pandemic period, an adjustment that can feel fragile in the data without necessarily signaling a sharp break.

Household spending remains a major driver of the U.S. economy. Several fundamentals have remained healthier than the tone of the news cycle: household leverage has generally declined from pre-2020 levels; wages have risen faster than inflation over the multi-year period since 2020; and broad delinquency rates have remained manageable relative to history. Cash balances remain elevated in aggregate, though not evenly distributed. So, some households feel higher essential costs immediately, while others have more cushion.

The practical implication is that “the consumer” and “the economy” are still not one story, which is why broad diversification and not relying too heavily on a single economic outcome remain important even as leadership shows signs of gradually broadening.

Credit Conditions and “Where Risk Shows Up”

Credit conditions in public markets look contained rather than stressed: spreads have not shown the sustained widening typically associated with recessionary credit events, and the quarter did not see a disorderly repricing in broader risk assets. That said, with policy rates still elevated and growth slowing at the margin, credit remains an important watch point, particularly for more-levered borrowers and less-transparent segments of the lending market.

Stepping back, Q1 reinforced a familiar pattern: markets react to headlines, but longer‑term outcomes are driven by what endures: earnings power, the cost of capital, and the real economy’s ability to adapt.

Looking Ahead to Q2

Portfolio Perspective

In volatile, headline-driven quarters, it can be tempting to focus on what to do next. However, our process begins with your plan because each portfolio is built around your specific goals, time horizons, and cash flow needs. While we make thoughtful, tactical adjustments as conditions evolve, we avoid abrupt, reactionary shifts driven by short-term market movements. Instead, we position portfolios to navigate volatility through diversification, maintain flexibility for near-term needs, and gradually lean into opportunities as they emerge.

During Q1, our portfolio oversight focused on a few practical areas:

• Liquidity and cash needs: making sure near‑term withdrawals, tax payments, and planned spending were funded without forcing long‑term assets to be sold at inopportune times.
• Interest‑rate sensitivity in fixed income: managing bond durations and interest rate exposure to rate changes as the yield curve continued to steepen.
• Equity concentration and leadership risk: how the market’s broadening (or lack of it) affected portfolio diversification, especially after years of narrow leadership.
• Credit conditions: keeping an eye on spreads, defaults, and lending standards for signs that the availability and cost of borrowing were tightening beyond what markets had priced.
• Behavioral discipline: reinforcing the difference between prudent rebalancing and emotional reaction to breaking news.

Looking into Q2 2026, headwinds remain: the war in Iran, a softening labor market, ongoing questions around private credit (which, at this stage, does not appear systemic), recurring shutdown risk, tariffs still in play, and the longer-term overhang of federal deficits and debt sustainability. Offsetting those risks are several constructive fundamentals: resilient corporate earnings, historically strong household and corporate balance sheets, and continued capital investment, particularly in AI and automation, which could drive productivity and, in turn, profit margins over time.

Where do we see opportunities and risks? We start with a strategic allocation and make incremental adjustments as risk/reward shifts. At a high level, we have favored cyclical exposure (including industrials, energy, materials, and financials) while remaining balanced within technology. Overall, our posture remains “stay the course,” with changes made deliberately and not in reaction to daily headlines.

In periods like this, where headlines dominate the narrative, long-term outcomes are not determined by the noise of the moment, but by what ultimately endures and the discipline to stay invested through it.

Firm Update

Our focus remains on continually enhancing the experience we provide to our clients while planning thoughtfully for their long-term success. We’re pleased to share that Seana Rasor has become an equity partner in Waterworth Wealth Advisors, reflecting her continued growth as an advisor and her contributions to the firm. In addition, we have made targeted investments in technology to strengthen our capabilities as the landscape evolves, allowing for more robust analysis and insight. As part of this, we are implementing AI thoughtfully, with clear policies and procedures in place, while maintaining the highest standards for client privacy and the security of sensitive information.

Market volatility will always be a part of our lives. What matters most is how we respond. If recent market swings have made you uneasy or curious about how your plan is positioned, let’s talk. We’re always here to listen, answer questions, and help you move forward with confidence.

Your March portfolio reports have been posted to your eMoney vault, and we will be contacting clients to schedule reviews and check in. If you have something you’d like to discuss, please don’t hesitate to reach out or schedule a meeting at your convenience.

Thank you for your continued trust!

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1. The DOW,  NASDAQ, S&P 500 and Russell 2000 –  are unmanaged groups of securities considered to be representative of the stock market in general