After three consecutive years of double-digit gains, the first quarter of 2026 demonstrated how quickly market conditions can shift. A single geopolitical event—the escalation of the U.S.-Iran conflict and the closure of the Strait of Hormuz in mid-March—transformed a quiet, rotation-driven quarter into the worst three-month period for the S&P 500 since Q3 2022. However, the underlying story is more complex. Diversification proved effective, defensive sectors performed well, and the long-anticipated rotation from mega-cap growth to value took hold.
The Macro Backdrop
The quarter began with stable markets. The S&P 500 posted modest gains in January, remained flat in February, and market leadership started to expand beyond the Magnificent Seven. Two main themes emerged as March approached.
The first theme was manufacturing recovery. In February, the ISM Manufacturing Index rose above 50 for the first time in nearly a year, indicating expansion, and Industrials reached a new all-time high. The second theme was artificial intelligence disruption. New model launches in January and February prompted a reassessment of whether AI was a productivity tool or an outright replacement for large categories of professional services. Software stocks were most affected by this repricing.
Then came March. The U.S.-Iran conflict escalated sharply, triggering the closure of the Strait of Hormuz—a chokepoint for roughly 20% of global crude flows. Crude oil surged nearly +50% in a single month, finishing Q1 up more than 70% from year-end. The inflation implications were immediate: Core PCE was already running near 3% before the spike, and markets rapidly priced out all expected Fed rate cuts. By quarter-end, a rate hike was being openly discussed.
Major Index Performance
All three major U.S. indices ended the quarter lower, with technology-focused benchmarks experiencing the largest declines. The Nasdaq’s sharper drop reflects its concentration in large-cap technology stocks that led in 2024 and 2025. International equities performed better, with MSCI EAFE down 1.1% and Emerging Markets nearly unchanged at −0.1%.
Source: S&P Dow Jones Indices, Coastal Bridge Advisors, Winthrop Wealth. Total return (USD) as of March 31, 2026.
The Rotation That Finally Showed Up
- The most important development of the quarter was not the headline decline—it was what happened beneath it. For investors with diversified portfolios, Q1 looked very different from the S&P 500’s −4.3% headline.
- Value dramatically outpaced Growth: The Russell 1000 Value gained +2.1% while Russell 1000 Growth fell −9.8%—a spread of nearly 12 percentage points. Value outperformed Growth in every single month of the quarter.
- Small caps showed resilience: The Russell 2000 gained approximately +1.0%, outperforming the large-cap S&P 500 by more than 5 percentage points.
- International equities outperformed U.S. stocks: for a second consecutive quarter, with both developed and emerging markets beating domestic large caps by a meaningful margin.
- Bonds were essentially flat: The Bloomberg U.S. Aggregate Bond Index returned −0.1% as rising yields offset coupon income. High yield held up better, returning approximately +0.1%.
S&P 500 Sector Returns
The sector dispersion in Q1 was extraordinary—nearly 48 percentage points separated the best and worst performers. Six of eleven sectors finished positive, a complete reversal of the market’s recent leadership profile.
Source: S&P Dow Jones Indices / Novel Investor. Total return (USD). Ranked by Q1 2026 performance.
Energy’s +38.3% gain is almost entirely attributable to the oil price shock, but the story in defensive sectors is more instructive. Utilities, Consumer Staples, and Materials all delivered meaningful positive returns in a quarter where the S&P 500 fell more than 4%. These are the sectors that hold up when inflation fears rise and growth expectations fall—exactly the environment Q1 delivered. The underperformers tell the flip side: Financials (−9.4%), Consumer Discretionary (−9.2%), Information Technology (−9.1%), and Communication Services (−6.9%) all reversed sharply after leading the market in 2025.
Magnificent 7: A Difficult Quarter
Market Trends to Watch
For the first time since the AI rally began in early 2023, every member of the Magnificent Seven finished a quarter in negative territory. Combined, the group shed over $2 trillion in market capitalization from their all-time highs.
Source: Market commentary and analyst data as of March 31, 2026. Individual stock returns are approximate.
Microsoft’s −23.5% decline was the steepest, weighed down by questions around the return on its aggressive AI capital expenditure. Tesla (−17.3%) and Meta (−13.3%) also saw significant drawdowns. It is worth noting that Alphabet, despite a −8.1% quarter, remains one of the most attractively valued names in the group at roughly 17x forward earnings. Nvidia, despite its decline, retains 41 of 42 analyst Buy ratings heading into Q2, with the consensus view that AI infrastructure spending remains structurally intact.
Looking Ahead to Q2
Key factors for Q2 include inflation, oil prices, and geopolitical developments. At quarter-end, the Strait of Hormuz remains closed and crude oil is near $100 per barrel. The April and May CPI and PCE data will reflect the full impact of higher energy prices and will significantly influence Federal Reserve policy expectations.
A two-week ceasefire between the U.S. and Iran has triggered a broad relief rally, with oil pulling back below $100 per barrel — but the Strait of Hormuz remains largely blocked, with only a handful of ships transiting versus the normal 135 per day, and 800+ vessels still waiting to clear. The ceasefire is fragile, Israeli strikes on Lebanon are continuing, and Iran has halted oil tanker traffic in response.
The ceasefire provides enough optimism to explain today’s risk-on move, but it doesn’t resolve the supply disruption. Energy and commodity prices are likely to remain on a structurally higher floor regardless of the outcome — governments are already hoarding and restocking in anticipation of renewed conflict, and IATA has noted it could take months for jet fuel supply and pricing to normalize even if the strait fully reopens.
The case for a Fed cut re-emerges on the ceasefire headline, but resurfaces in a more complicated form — oil near $100 keeps inflation pressure alive, limiting the Fed’s flexibility even as growth concerns mount. Value, energy, and defensive positioning should continue to carry a risk premium until the strait is demonstrably clear and shipping resumes at scale. Growth stocks may bounce on the ceasefire relief, but a sustained recovery likely requires both a durable peace agreement and a functioning strait — neither of which is confirmed today.
The underlying earnings picture remains solid—S&P 500 earnings are projected to grow approximately 13% year-over-year in Q1, marking the sixth consecutive quarter of double-digit earnings growth. This was a macro and sentiment-driven correction, not an earnings-driven one. That distinction matters for how you think about the second half of the year.
— John McKay, CFA
This material is provided for informational and educational purposes only and does not constitute investment advice, a recommendation, or an offer or solicitation to buy or sell any security or investment strategy. The views expressed are those of the author as of the date of publication and are subject to change without notice. The author is a financial professional and may hold positions in, or manage client accounts that hold positions in, the securities discussed. Such holdings are subject to change at any time without notice. While the author strives to present information in a fair and balanced manner, no representation is made that this commentary is free from bias, and readers should be aware of potential conflicts of interest. The information presented is derived from publicly available sources believed to be reliable, but accuracy and completeness are not guaranteed. Past performance is not indicative of future results. All investing involves risk, including the possible loss of principal. This commentary does not take into account the investment objectives, financial situation, or particular needs of any specific person. No advisor-client relationship is created by the receipt or review of this material. Readers should consult with a qualified financial, legal, or tax professional before making any financial decisions. Reading this material does not create an advisor-client relationship.
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