Quarterly Investment Research Note – April 10th, 2026

1^st Quarter 2026 Market Recap Summary

• The S&P 500 returned -4.33% in the first quarter of 2026, weighed down by a number of headwinds. Large-cap technology stocks came under pressure as investors questioned both the pace of AI spending and its potential to disrupt existing business models. Concerns around credit rattled Financials. In March, escalating conflict in the Middle East, combined with an oil spike and rising interest rates, pushed equities to their quarterly lows.¹

• Within Large-caps, Value stocks outperformed Growth stocks by nearly 12%, led by the Energy sector due to soaring commodity prices.  The price of Brent Crude oil surged to its highest levels since 2008 at the apex of the conflict.  The Russell 1000 Value index returned +2.10% for the quarter while the Russell 1000 Growth index was down -9.54%.²

• The market saw significant divergence and broadening out from the concentrated Mega-cap Technology trade that has dominated the market narrative.  The average S&P 500 stock was flat for the quarter, while the market-cap weighted index fell.  Mid and Small-cap stocks were areas of strength for portfolios in the quarter, with the S&P MidCap 400 and S&P SmallCap 600 Indices returned +2.50% and +3.51% respectively for the quarter.³

• Earnings optimism remains the key fundamental underpinning for the constructive outlook on equities.  In the US, S&P 500 earnings are expected to grow to $323 (19% year-over-year growth) and $377 (17% year-over-year growth).  Due to this earnings outlook, the S&P 500 forward P/E multiple has contracted in the 1^st quarter and sits at 19.8x currently, down from 22.3x to start the year.^4,5

• The bond market was volatile in the 1^st quarter, the Bloomberg U.S. Aggregate Bond Index finished -0.05% in total return for the quarter. The benchmark 10-year U.S. Treasury yield hit a low of 3.97% in February prior to the Middle East conflict yields rose precipitously along with higher energy prices, elevated inflation expectations and uncertainty added to the Federal Reserve’s policy rate path.  The 10-year yield ended the quarter at 4.30%.^6,7

• The Federal Reserve held rates steady in January and March after, cutting its target rate by a total of 1%: a 0.50% cut in September, followed by 0.25% cuts in November and December to end 2025.   The Fed is taking a cautious approach to further rate cuts and acknowledged the uncertainty in its forecasts.

• The U.S. economy remains a mixed bag but is generally still expanding.  Real GDP slowed to just 0.5% in the 4th quarter of 2025, and while economic growth is expected in 2026, job growth has moderated over the past year (although the latest report surprised to the upside, with the economy adding 178,000 jobs and the unemployment rate edging down to 4.3%).  The impact of the recent oil shock on consumers is only beginning to emerge and will be an important factor to watch as we move through 2026.⁸

• Inflation’s progress toward the Fed’s 2% target has shown signs of stalling, with Core PCE at 3.1% as of January 2026. Rising energy costs are likely to flow through into the data in the months ahead, adding another layer of uncertainty to the Fed’s policy outlook.⁹ 

1^st Quarter 2026 Market Recap

The 1^st Quarter of 2026 reflected a diverging and broadening of market leadership, with valuations resetting in mega-cap growth, resilience in earnings, and macro uncertainty, particularly geopolitics and inflation, driving volatility across both equities and bonds.

The S&P 500 returned -4.33% during the quarter, although the average stock in the index was roughly flat. From January 28th through March 30th, the index declined -8.9%, reflecting a broad repricing of risk as rising interest rates, higher energy prices, and escalating geopolitical tensions weighed on investor sentiment. Within the tech-heavy NASDAQ Composite, the index fell -6.96% for the quarter, but the average constituent experienced a maximum drawdown of approximately -33% from its year-to-date high, highlighting some of the depth and persistence of weakness within the Growth cohort.¹⁰

Small-cap stocks, represented by the Russell 2000, ended the quarter up modestly +0.89%.  Outside of the US, International stocks had a strong start to the quarter but were upended by the geopolitical distress and subsequent energy price shock.  The MSCI EAFE and MSCI Emerging Markets were down moderately but in the midst of drawdowns that reached -10.76% and -13.51% respectively from their year-to-date peaks.  Japan equities were modestly positive, with the MSCI Japan IMI index gaining +1.81%, supported by Yen weakness and policy continuity.¹¹   

Value stocks outperformed Growth by a wide margin, as each of the “Magnificent 7” declined during the quarter, with average returns down -12.1%.  In contrast, Value benefited from the continued strength of the “HALO” trade: “Hard Assets, Low Obsolescence”.  Traditional Value sectors such as Energy, Utilities, Materials, Industrials, and Consumer Staples were supported by their exposure to tangible assets, strong cash flows and business models less susceptible to AI-driven disruption.  Energy stocks were further aided by rising oil and natural gas prices amid escalating Middle East tensions.  Financial stocks were the worst performing sector as credit concerns weighed on banks and asset managers.¹²

The re-pricing of Technology stocks this quarter was largely centered on the evolution of the AI trade. Investor focus shifted from early-cycle enthusiasm, driven by productivity gains and seemingly parabolic earnings potential, toward a more grounded assessment of capital efficiency, return on investment, and the durability of underlying business models.

As the cycle matures, two key questions have emerged and remain largely unanswered:

1) What level of return will ultimately be generated from the unprecedented capital investment across hyperscalers, data centers, and AI infrastructure? 

Spending has accelerated at a historic pace, but the timeline and magnitude of monetization remain uncertain. Markets are beginning to differentiate between companies that are enabling the buildout versus those that must justify the spend through incremental revenue and margins.

2) Will the proliferation of AI lead to commoditization across the ecosystem eroding durable competitive advantages?

As capabilities become more widespread, the risk is that differentiation narrows and excess capacity weighs on profitability of incumbents, in other words, will AI ultimately “eat itself”?  This concern was highlighted during the quarter in a viral commentary piece projecting a scenario in which rapid advances in AI could displace large portions of knowledge-based labor.  While AI has the potential to drive significant productivity gains, it also raises the possibility that value accrues unevenly, with margin pressure emerging across parts of the ecosystem as both labor and certain AI-driven services become increasingly commoditized.

Taken together, this shift marks a transition from a narrative-driven phase of the AI cycle to a more fundamental, cash flow–oriented phase.  While the long-term opportunity remains significant, markets are beginning to demand evidence of sustainable economics, not just potential.  This has led to increased dispersion within Technology and reinforces the importance of selectivity going forward.

The other main pivot point of the quarter that remains as an overhang is the ongoing Middle East conflict and the subsequent impact of constrained global energy supply in the region.  Disruption to key transit routes or production hubs has the potential to push oil and natural gas prices higher, feeding through to inflation and complicating the path forward for central banks.  Beyond the direct impact on energy markets, the uncertainty has weighed on risk sentiment and increased volatility across asset classes.  While markets have thus far absorbed these developments relatively well, this remains a fluid situation and a key risk to monitor as it could have meaningful implications for both global growth and inflation in the quarters ahead.

For equity portfolios, the first quarter underscored the value of diversification: exposure to the Energy sector and other Value-oriented sectors helped mitigate drawdowns in Growth-heavy allocations.  Investors navigated multiple headwinds during the quarter, with focus centered on two key elements: (1) the evolution of the AI trade, particularly around capital efficiency, return on investment, and the durability of business models, and (2) the ongoing Middle East conflict and its impact on global energy markets, inflation expectations, and overall risk sentiment.

The volatility experienced during the quarter falls within the normal range of outcomes for equity investors and reinforces the importance of maintaining a patient, long-term perspective to benefit from the compounding growth of markets over time.  With a potentially strong earnings season on the horizon, a renewed focus on the underlying fundamental backdrop, which remains generally constructive, would be a welcome development for investors.

In Fixed Income markets, volatility was also present due to fluctuating interest rates, credit spreads and exchange rates but high-quality bonds still provided a measure of stability as stocks wobbled.  The Bloomberg US Aggregate Bond Index finished barely lower, down -0.05%.  Credit markets were mixed, with investment-grade corporates, as measured by the Markit iBoxx Liquid Investment Grade Index, down -0.56%, and high yield, represented by the Bloomberg US High Yield Corporate Bond Index, falling -0.50%.  Municipals also posted slight losses, with the Bloomberg Municipal Bond Index down -0.18%.¹³

More rate-sensitive and spread-oriented sectors underperformed, including emerging market debt (Bloomberg Emerging Markets USD Aggregate Index -1.35%) and floating-rate loans (S&P UBS Leveraged Loan Index -1.87%). Overall, the quarter highlighted the ongoing impact of elevated rates and macro uncertainty, with limited diversification benefit from bonds despite improved starting yields.¹⁴

Interest rate volatility was introduced via rising inflation expectations after the Middle East conflict which caused further uncertainty in the outlook for the Federal Reserve.  The yield curve modestly flattened during the first quarter of 2026, driven by a rise in short-term yields relative to the long end.  While yields increased across much of the curve, the move was led by the front end, reflecting a recalibration of expectations around the timing and pace of Federal Reserve rate cuts. The 2-year Treasury yield rose to 3.79% from 3.47% at year-end, while the 10-year increased more modestly to 4.30% from 4.18%.¹⁵

The Economy, Inflation, and the Fed

The US economy entered 2026 in a balanced and resilient position, continuing to defy expectations that higher interest rates would weaken growth, buoyed by strong consumer spending and capital investment.  While economic momentum has moderated, the expansion remains intact.  The labor market has cooled from the tight conditions of 2021-2023, but it continues to show underlying strength, with unemployment at 4.3% and job creation still positive, albeit at a slower pace.¹⁶

Consumer activity remains the primary driver of economic growth, supported by robust household balance sheets. Household net worth remains near all-time highs, and while excess savings have declined from pandemic-era peaks, debt service ratios remain manageable by historical standards.  This has allowed consumption to remain resilient, even as borrowing costs have increased.

However, there are emerging signs of moderation.  Real GDP growth slowed to 0.5% in the fourth quarter of 2025, reflecting a deceleration from earlier in the cycle.¹⁷  While the economy is expected to grow modestly in 2026, the trajectory is less certain, particularly as higher energy prices begin to weigh on consumers and business activity.

Inflation’s progress toward the Federal Reserve’s 2% target has shown signs of stalling.  Core PCE remains elevated at 3.1% as of January, and rising energy costs are likely to filter through into broader inflation measures in the coming months. This dynamic has introduced additional uncertainty into the outlook and complicates the Fed’s policy path.¹⁸

The Federal Reserve finds itself navigating a delicate balance between supporting growth and ensuring inflation continues to move lower.  After implementing rate cuts in late 2025, policymakers have adopted a more cautious stance, emphasizing data dependency and acknowledging the potential for inflation to remain persistent.  At the latest FOMC meeting in March, Fed officials projected just one rate during 2026.  Fed Funds futures markets are pricing in a steady Fed Funds Rate in 2026 with the next policy action not happening until September 2027. ^19,20

Overall, the economy continues to transition from a period of above-trend growth to a more normalized environment, as it absorbs the impact of tighter financial conditions alongside evolving trade policy and geopolitical disruptions. Growth remains positive but more measured, with pockets of resilience offset by areas of emerging softness.  At the same time, uncertainty around global supply chains, energy markets, and policy direction has increased, contributing to greater volatility in both economic data and markets.  While the expansion remains intact, the path forward is likely to be less linear, with outcomes increasingly influenced by external factors rather than purely domestic fundamentals.

As always, we remain focused on navigating these environments with a disciplined, long-term approach.  We will continue to follow up with timely communication as markets evolve throughout the year.  Please reach out at any time with questions or to discuss your portfolio. 

Footnotes:

1. Morningstar Direct Data
2. Morningstar Direct Data
3. Morningstar Direct Data
4. Yardeni Research
5. JPMorgan Guide to the Markets
6. Morningstar Direct Data
7. US Treasury
8. St. Louis Fed FRED Database
9. St. Louis Fed FRED Database
10. Morningstar Direct Data
11. Morningstar Direct Data
12. Morningstar Direct Data
13. Morningstar Direct Data
14. Morningstar Direct Data
15. US Treasury
16. St. Louis Fed FRED Database
17. St. Louis Fed FRED Database
18. St. Louis Fed FRED Database
19. Federal Reserve
20. CME Group FedWatch

The views expressed herein are those of John Nagle on April 10^th, 2026 and are subject to change at any time based on market or other conditions, as are statements of financial market trends, which are based on current market conditions. This market commentary is a publication of Kavar Capital Partners (KCP) and is provided as a service to clients and friends of KCP solely for their own use and information. The information provided is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal or tax advice. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s investment portfolio. All investment strategies have the potential for profit or loss and past performance does not ensure future results. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. The charts and graphs presented do not represent the performance of KCP or any of its advisory clients. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results.  There can be no assurances that a client’s portfolio will match or outperform any particular benchmark. KCP makes no warranties with regard to the information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, the information. The information is subject to change and, although based on information that KCP considers reliable, it is not guaranteed as to accuracy or completeness. This information may become outdated and KCP is not obligated to update any information or opinions contained herein. Articles herein may not necessarily reflect the investment position or the strategies of KCP. KCP is registered as an investment adviser and only transacts business in states where it is properly registered or is excluded or exempted from registration requirements. Registration as an investment adviser does not constitute an endorsement of the firm by securities regulators nor does it indicate that the adviser has attained a particular level of skill or ability.