Focusing On What You Can Control
The first quarter was a demanding one for investors. The rapid pace of artificial intelligence disruption was dizzying at times, even without the added strain of geopolitical conflict in the Middle East. Together, these forces pushed uncertainty higher and tested investor resolve. Yet when the quarter came to a close, many well‑diversified investors found that disciplined portfolios, free of shiny objects like crypto and private alternatives, proved more durable than the headlines suggested.
The Iran conflict has increased prices, putting pressure on the Fed’s inflation mandate
The Federal Reserve’s rate policy remains front of mind for investors. After four cuts, the target rate is now in the range of 3.50 to 3.75%, and at the March meeting, the Fed projected an additional cut this year and next. But the conflict in the Middle East has created additional challenges.
Rising oil prices are threatening to drag up the cost of goods more broadly. The Organisation for Economic Co-operation and Development (OECD) has increased its forecast for average US inflation in 2026 to 4.2%. That would be materially higher than the recent range of 2.5 to 3.0%, and well above the Fed’s 2% long-term target.
While inflation is facing upward pressure, the picture on employment is slowly deteriorating. The unemployment rate is not particularly high (4.3%) but has been rising, and the growth in payrolls has been steadily declining for four years. These trends could worsen if AI productivity promises are realized.
All of this puts the future path of rates in a state of increased uncertainty.
Chart 1: Inflation concerns resurface as conflict escalates
Source: Crude Oil Brent ICE near term, Bureau of Economic Analysis
Investors are trying to determine the winners and losers as artificial intelligence disrupts markets
While the conflict with Iran is driving day-to-day market sentiment, AI is changing the corporate landscape in ways that will have lasting ramifications for investors. On the one hand, we are seeing a market tailwind driven by the potential for massive productivity gains the likes of which may have never been seen. On the other hand, we are witnessing the headwind of entire market sectors, like Software, facing unprecedented disruption.
Looking at the performance of the S&P 500 in the first quarter, we see that the Software, IT Services, and Professional Services industries all fell 18 to 24%. AI has shown the potential to replicate many products in these industries with breathtaking ease.
If the dot-com boom taught anything, it’s that the ultimate winners and losers in this sprint for AI supremacy will not be known for years. In the short span of a year, we’ve already seen multiple lead changes among the large language model creators. The eventual winner may not even be on the radar yet, and perhaps might be the users of AI, not the creators.
Chart 2: AI has challenged certain market segments
Source: S&P 500 Industry total returns for Q1 2026
The cost of war and heightened inflation pushed Treasuries higher
The falling yields on bonds we saw last year in the wake of rate cuts partially reversed in the first quarter. The uncertain price tag of the conflict in Iran is putting upward pressure on Treasuries, as reduced expectations for rate cuts persist while inflation inches higher.
Rising yields lead to falling bond prices, a dynamic that resulted in muted returns for fixed income in the quarter. Intermediate-term yields (5-10Y) saw some of the greatest increases versus three months ago. On the face of it, there are more attractive yields, but the perceived risk is also higher.
We also noted that the yield spread between credit and Treasuries widened, improving the relative value of corporate bonds. These spreads were coming from very tight levels, and we only see meaningful opportunity in short duration where we opted to trade some Treasuries for corporates in our strategies.
Chart 3: Treasury yields rose as rate cuts slowed
Source: US Treasury Yields, Factset
A well-diversified portfolio pleasantly surprised in a quarter full of scare stories
Between AI and the Iran conflict, investors had every reason to believe that Q1 2026 was going to be a tough one for portfolio returns. Yet there were pockets of strength that helped buoy returns for investors who diversified properly.
While the S&P 500 produced a modestly negative return for the quarter, Gold and Small-Cap US stocks were notably positive. Developed and Emerging International stocks did not repeat their heroics of 2025, but still bested US Large Cap.
As a result, investors with well-diversified portfolios may find that the doom and gloom they are experiencing in the news is not visible in their portfolio. An evidence-based approach to investing will always advocate for diversification, and we are seeing why today. Not only can a well-structured portfolio help to weather the market ups and downs, its smoother returns can reduce the potential for investors to exit the market in fear.
Chart 4: Diversification shone bright amidst dark headlines
* Does not represent any portfolio managed by Strategic
Asset class recap: Diversification offset the decline in US large cap
Taking a step back and looking at asset class performance during the quarter, we find that diversifiers, like Gold and smaller stocks, helped in a well-diversified portfolio as US Large Cap stocks gave back some gains from last year.
Gold still ended the quarter as the best-performing asset class, despite falling as much as 18% from its peak. Those declines came after a two-year 150%+ run in the precious metal. For our strategies that include Gold, we opted to trim our exposure after this epic run.
The weakness in US Large Cap stocks stemmed from a combination of geopolitical uncertainty and artificial intelligence disruption. After years of significant gains, the largest stocks in the index were pricing in perfection, which is a high bar to live up to.
Small stocks provided good diversification benefits. Unlike their larger peers, they began the year with much more attractive valuations, helping to insulate them from some of the headwinds.
Bond performance was fairly neutral in the quarter as income was offset by falling prices. While returns may not have been positive, they still provided capital preservation in an otherwise challenging quarter.
Chart 5: Q1 2026 asset class roundup
Source: Factset
“Happiness and freedom begin with a clear understanding of one principle: Some things are within our control, and some things are not.” — Epictetus
As I look back on the first quarter of 2026, I admit it was an emotionally challenging period for investors. Artificial intelligence provided some of that angst, with headlines swinging between optimism about innovation and concern over disruption. At the same time, financial stresses beneath the surface challenged confidence, particularly in areas where liquidity and transparency were assumptions were tested. Layered on top of that was heightened geopolitical uncertainty, reminding investors that markets do not operate in a vacuum.
And yet… here we are, with the S&P 500 down just 4.3% through the end of the quarter. From the peak (1/27) to the trough (3/30), the index fell just 9.1%. By historical standards, that’s a fairly normal, perhaps even pedestrian drawdown. For context, the 2025 “tariff tantrum” saw stocks fall 18%, only to end the year up 18%. Both 2023 and 2024 had 9-10% drawdowns yet finished the year up over 20%. Treating drawdowns like warnings is a mistake, when history shows they are simply part of the cost of owning risky assets over time.
The takeaway is that these drawdowns, while uncomfortable at times, are predictably unpredictable, and a normal part of a well-functioning market.
As we look toward the rest of the year, there is no reason why it won’t continue to be full of surprises. AI isn’t going anywhere, and we don’t know how the war will progress. In an environment like this, our role is not to predict what comes next, but to help clients focus on decisions that matter regardless of what unfolds. We won’t be scaring you into action with predictions of doom, and we won’t be placating you with rosy predictions about an unknowable future. Instead, we aim to help you shed the burden of worrying about what is out of your control.
Focus on what you can control
Great investors understand the difference between what they can control and what they cannot, and they focus their energy accordingly. Market direction, geopolitical events, and unforeseen shocks (eg. Covid-19) are simply not knowable in advance. In short, the future is uncertain, and pretending otherwise is a distraction.
But that leaves a lot in our control. On the one hand there are the evidence-based actions we take in building and maintaining portfolios. We can:
- Stay invested with a well-diversified asset allocation
- Emphasize factors (eg. Quality, Value, Momentum) that have historically outperformed
- Rebalance opportunistically (systematically sell high and buy low)
On the other hand, there are the actions we can choose not to take. These are the own goals or self-inflicted wounds that trip up many investors. We have the choice to (and do):
- Avoid the temptation to market time in response to fear-laden headlines
- Avoid the lure of illiquid, lightly regulated assets, like private credit and cryptocurrencies
- Understand the risk of holding cash or low-yielding investments in an inflationary environment
These principles have served us well over time, and the first quarter was no exception. They reflect our straightforward, evidence‑based approach to investing, one that emphasizes process and discipline over reaction.
There is a common misconception that successful investing requires predicting or outmaneuvering the market. Many try, and most fall short, not for lack of intelligence, but because the future is inherently unknowable. Rather than rely on forecasts or good fortune, we choose to follow the evidence and remain focused on what is firmly in our control. In doing so, we sleep well knowing our decisions are grounded in discipline, not guesswork.
As we look to the year ahead and beyond, we hope this approach has helped our clients sleep well too. We thank you for putting your trust in us and are honored to have you as part of the Strategic community.
About Strategic
Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on total client assets of over $2.5 billion.
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