Q1 2026: Quarterly Market Report

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4 days ago
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Loadstone Group's Q1 2026 quarterly market review

The first quarter of 2026 was shaped by a convergence of pressures that had been building beneath the surface of what appeared to be a resilient market. Scrutiny of AI-related capital expenditure intensified as investors questioned whether returns would justify the spending. Then the conflict in the Middle East

arrived, sending energy prices sharply higher and shifting market focus from growth to inflation. Rate cut expectations were pushed back significantly, bringing value back to the dollar, and assets that had led the rally through 2025 came under pressure.

The quarter's returns reflected a clear shift in market leadership. Commodities surged 24.4% as energy prices rose sharply following the closure of the Strait of Hormuz. Equity market performance diverged significantly, with small cap and value stocks posting modest gains while growth fell 8.4%, extending a rotation away from the concentrated mega-cap positions that had dominated recent years. Trades that had performed well through 2025, including gold and emerging market equities, came under pressure as the dollar strengthened. Fixed income markets sold off broadly as inflation expectations moved higher and rate cut hopes were pushed back.

Equities

The US was the weakest major market of the quarter, though the headline decline of 4.3% requires context. The S&P 500 had been trading in a narrowing range on declining volume since the end of October, with the Nasdaq having peaked on October 30. The Dow Jones and Russell 2000 held up relatively well into late January and early February before broader selling pressure spread.

When the conflict began on February 28, the initial market reaction was notably measured, with the S&P posting green sessions on both February 27 and March 2. The more significant selling began on March 3, reinforcing that this was a market already in the process of reassessing rather than one reacting to a single external shock. From peak to trough the S&P declined 9.79%, modest in the context of the 20% drawdown seen in early 2025. Retail investors turned net sellers of single stocks for the first time since 2023 through this period, with weekly equity purchases falling approximately 30% through March, as capital rotated toward cash and dollar denominated instruments.

Technology bore the brunt of the quarter's losses. Beyond the broader market pressures, software names faced a more specific challenge as investors began to price in the risk that AI is not merely competing with established software businesses but displacing core functionality that many had been delivering as a paid service. Energy was the clear sector winner as oil prices surged.

UK and European markets had not undergone the same period of consolidation and entered the quarter with more momentum still intact. When sentiment shifted they had further to fall. The FTSE All-Share, supported by its commodity tilt and a weaker sterling, delivered positive returns of 2.4%. The MSCI Europe ex-UK fell 2.3% as rising gas prices raised concerns about the growth outlook. Japan was the standout performer globally, with the TOPIX Index gaining 3.6%, supported by yen weakness and the perception that the ruling LDP's election victory in February would bring additional growth-boosting stimulus.

Fixed Income

Fixed income had finally regained its relevance as an income generating asset coming into 2026, with rate cuts already underway and further easing widely expected through the year. The energy shock changed that quickly. As inflation expectations moved higher, rate cut hopes reversed, and bond markets sold off broadly. The 10-year Treasury yield rose from 4.19% to 4.34% over the quarter, though US bonds were relatively insulated given America's position as a net energy exporter. The picture was considerably more difficult elsewhere.

UK gilts were the worst performing sovereign market, falling 2.0%. The UK's relatively high dependence on natural gas left it particularly exposed to the energy shock, and the Bank of England struck a decisively hawkish tone at its March meeting, strongly implying a bias toward rate increases. Even the committee's most dovish member signalled that hikes could not be ruled out.

Japan fell 1.6% as investors anticipated looser fiscal policy following the LDP election victory, pushing longer dated yields higher. In credit markets, spreads widened across both investment grade and high yield, with European high yield the weakest performer at -1.7%, reflecting both the energy shock's greater impact on the continent and a broad retreat from risk assets through the quarter.

Currencies and Gold

The dollar strengthened broadly through the quarter, gaining against most major currencies as three forces converged. Geopolitical conflict outside the US drove capital toward the dollar's unparalleled liquidity and reserve currency status. America's position as a net energy exporter gave it relative economic resilience that energy importing regions could not match, widening the growth differential at precisely the moment it mattered most. And as rate cut expectations were pushed back significantly, the interest rate differential moved further in the dollar's favour, attracting yield seeking capital from lower rate environments. Sterling held relatively well given the circumstances, though the path to year end looks less straightforward than it appeared in December.

Gold peaked at approximately $5,600 per ounce on January 29 before falling nearly 27% to its low on March 23. Priced in dollars and offering no yield, it is acutely sensitive to dollar strength and rising rate expectations, and the quarter delivered both simultaneously. Central bank liquidations added further selling pressure, with some reserve managers raising cash to cushion the economic impact of the energy shock. The longer term case for gold as a hedge against sustained inflation and geopolitical uncertainty remains credible, but the quarter served as a reminder that it is an asset requiring patience rather than one that provides consistent near term protection.

What changed since the year-end outlook

The broad institutional consensus at year-end was constructive on equities, bonds, and sterling. That framework remains, but has become less uniform. Some houses have trimmed their targets, others have held firm.

The range of outcomes has widened. Institutions have not turned decisively bearish, but the confidence with which the positive case was held three months ago has softened at the margin.

Developing Themes

These are some of the developing themes we are watching beyond the immediate market picture.

Energy transition and nuclear. Big technology companies are increasingly committing to nuclear energy through long-term power purchase agreements, driven directly by the electricity demands of AI data centres. This is drawing sustained capital toward grid upgrades, energy infrastructure, and the industrial businesses building the physical backbone of AI adoption.

Defence and European rearmament. NATO members agreed at the June 2025 summit to target defence spending of 5% of GDP by 2035, driven by sustained pressure to contribute more to collective security. The conflict in Iran has since reinforced that urgency, with European nations increasingly recognising the need to build independent defence capability. The spending is committed and funded, and the investment case for defence contractors and infrastructure businesses is supported by a multi-year demand cycle that is only beginning to work through earnings.

Vietnam. FTSE Russell confirmed this week the reclassification of Vietnam from frontier to secondary emerging market status, effective September 21, 2026. Significant passive capital inflows are anticipated as index trackers adjust their allocations. Vietnam has also emerged as a structural beneficiary of the shift in global manufacturing away from China, surpassing its neighbour as the leading supplier of certain electronics to the US market for the first time last year. Two distinct tailwinds arriving simultaneously, though it is worth noting that Vietnam's role in global supply chains continues to attract scrutiny given the degree to which Chinese components flow through the country.

Broadening market participation. The rotation away from mega-cap concentration that accelerated through Q1 continues to present opportunities in equal-weight indices, mid-caps, and value oriented names. Small cap returned 1.5% and value 1.3% in a quarter where growth fell 8.4%. If earnings breadth improves through 2026, this trend has further to run.

Conclusion

On April 8, a Pakistan-brokered ceasefire triggered one of the strongest single-day rallies in over a year, with the S&P 500 gaining 2.5% and oil falling sharply on news of a temporary reopening of the Strait of Hormuz. The index has since extended its recovery to seven consecutive positive sessions and the technical picture has improved. The ceasefire is two weeks in duration rather than a resolution, however, and buying volume has not yet demonstrated the conviction that would confirm a durable low. Q1 earnings, expected to show approximately 13% growth, will be the first real test of whether corporate profits are holding up against higher energy costs and softening consumer confidence. As markets move deeper into the second quarter, volumes historically thin and institutional participation eases, a combination that can amplify moves in either direction. The investment case remains intact, but this is a market that continues to reward patience and considered positioning over the reach for return.

If you would like to discuss how the current environment applies to your individual situation, please get in touch.