Market Proves Resilient as Investor Confidence Is Tested

Markets entered 2026 with strong momentum and broad optimism, but the first quarter quickly challenged that outlook. A sharp escalation in geopolitical tensions, a surge in energy prices, and a meaningful shift in interest rate expectations combined to test investor confidence. Large U.S. technology stocks, which had led markets higher for much of the past several years, bore the brunt of the adjustment. Yet, despite the headlines and periodic volatility, the broader market has proven more resilient than expected, supported by steady earnings growth and a still-solid economic backdrop.

The Macro Analysis: Earnings Strength and Geopolitical Shocks

Corporate earnings continue to provide a strong foundation for markets. Trailing earnings growth for the S&P 500 is approximately 15%, with expectations for more than 20% growth over the next twelve months. Notably, estimates have continued to move higher despite escalating geopolitical tensions, reflecting underlying economic resilience. This strength is broadening beyond large-cap technology, with solid growth in small caps and improving earnings revisions across cyclical sectors such as capital goods, materials, and consumer-related industries.

The most significant macro development has been the war involving Iran and the resulting disruption of global energy markets. The conflict has severely constrained flows through the Strait of Hormuz, a critical chokepoint through which roughly 20% of the world’s oil and liquefied natural gas typically transit. As shipping activity has slowed and supply chains have been disrupted, energy prices surged, but have recently normalized as hopes of a Middle East détente increase.

The inflationary impact of the war has been felt most acutely outside the U.S., as Europe and much of Asia remain highly dependent on imported energy, leaving them more exposed to supply shocks and price volatility. By contrast, the U.S. continues to benefit from relative energy independence, with domestic production helping buffer the economy from the most severe effects of global disruptions. Despite these pressures, markets have behaved largely in line with historical patterns. Geopolitical shocks tend to create short-term volatility, but rarely alter long-term market direction (see Chart).

AI, Valuation, and Rotation

Artificial intelligence remains the dominant market theme, though leadership is beginning to shift as the cycle evolves. We are still in the early innings, but the scale of investment is already significant. Much of the recent market strength has been driven by heavy spending on infrastructure, including semiconductors, data centers, and power. That has translated into strong performance for hardware-related companies, even as broader technology performance has become more disparate.

At the same time, many software companies have come under pressure. Unlike typical pullbacks driven by near-term concerns, this weakness reflects uncertainty around AI’s long-term impact on business models, competitive positioning, and pricing power, despite continued strong results. Valuations for high-growth software companies are heavily weighted towards projected earnings, with terminal value often representing 60-80% of total value. As AI clouds those assumptions, even modest changes to long-term growth expectations have led to meaningful declines in stock prices.

Capital has rotated accordingly. Investors have shifted away from asset-light sectors toward more capital-intensive companies with hard assets, low obsolescence, also known as “HALO” sectors, including energy, materials, industrials, and utilities, which benefit from tangible cash flows and the physical buildout required to support AI.

Over the longer term, we believe the most compelling opportunities in technology will emerge at the application layer, particularly within software. As we sift through the sector for opportunities, we are focused on high-value, mission-critical software that companies rely on every day to keep their businesses running. These platforms are in a strong position to layer in AI in practical ways that boost productivity, improve decisions, and make these platforms even more essential over time.

Inflation, Commodities, and Underlying Volatility

Commodities have been rising broadly across energy, metals, and agricultural markets, driven by ongoing geopolitical disruptions and supply constraints. Energy, in particular, has added to inflationary pressures and complicated the outlook for monetary policy. This has pushed interest rates higher, with the 10-year Treasury ending near 4.3%. Beneath the surface, market conditions have been far more volatile than index-level performance suggests. More than half of the companies in the Russell 3000 have declined by 20% or more from their recent highs, highlighting the extent of dispersion across sectors and industries (see Table 1). A strong jobs report, combined with a surge in energy prices, has revived the "higher-for-longer" interest-rate narrative, dashing hopes of near-term Fed rate cuts. The Treasury market move has put particular pressure on rate-sensitive assets, including growth stocks, REITs, and long-duration equities.