Are We Still in the Same World?
In the story of Rip Van Winkle, a man falls asleep in the Catskill Mountains one afternoon and wakes up twenty years later with a long white beard and an old dog who no longer recognized him. He wanders back into his village to find that everything has changed: his wife is gone, his friends are dead or moved on, and the country he had lived in no longer exists. He had gone to sleep a subject of the British crown and woken up a citizen of a new nation. And yet, for a time, he kept talking about King George as though the crown still ruled and kept expecting the world to operate by the old familiar rules – not out of stubbornness, but simply because nothing inside him had registered that the ground had shifted beneath his feet while he slept.
The question we have been sitting with this quarter is whether investors risk something similar. After five weeks of war in the Middle East, oil prices that have nearly doubled, and a Federal Reserve that went from discussing rate cuts to discussing rate hikes, are we still investing in the same world we were on February 27th? Or did something fundamental change, and are we, like Rip, in danger of operating by rules that no longer apply?
The World Looks Different Than It Did in January
In the final days of February, the market environment most investors had been navigating simply stopped. The backdrop of gradual disinflation, a softening labor market, a patient Fed, and a broadening stock market rally gave way to something no year-end prediction captured: a direct U.S.-Israeli military campaign against Iran, a closed Strait of Hormuz, and five weeks of sustained fighting across the Middle East. The opening salvo on February 28 took out Supreme Leader Khamenei and triggered a wave of retaliatory missiles and drones across the region, sending crude oil from roughly $70 a barrel to over $120 in a matter of weeks. It is worth sitting with that for a moment before reaching for interpretation.
As of this writing, there is meaningful reason for cautious optimism. The U.S. and Iran have agreed to a two-week ceasefire, with talks beginning in Islamabad mediated by Pakistan, and Iran has agreed to allow ships to pass through the Strait of Hormuz during that period. Markets responded quickly: on April 8, the Dow gained more than 1,325 points, the S&P 500 climbed 2.5%, and oil prices dropped more than 16%, their largest single-day decline since the early days of COVID. The ceasefire is fragile, the situation remains fluid, and two weeks is not a resolution. But direction matters enormously in how markets think about risk, and the direction has shifted.
What History Actually Says
Shortly after the conflict began, we sent clients a note drawing on the historical record of how markets have responded to major geopolitical shocks. The core takeaway bears repeating: while these events reliably produce sharp short-term volatility, they have rarely caused lasting damage to markets. The Korean War, the Cuban Missile Crisis, the Gulf War, the Iraq invasion, Brexit, and even COVID were all followed by strong returns over the following year as uncertainty faded and the business environment stabilized. Russia’s invasion of Ukraine coincided with a bear market in 2022, but that bear market was driven overwhelmingly by inflation and aggressive Fed rate hikes, not the invasion itself. The true historical exception was September 11th, which combined a domestic attack, a market shutdown, and a genuine short-term paralysis of parts of the U.S. economy.
The key distinction is between bad world news and events that genuinely damage corporate earnings over time, because earnings are what drive markets over any meaningful period. For a geopolitical shock to cause sustained market declines, it generally has to be prolonged and economically disruptive at a scale that alters the profit outlook for businesses across the broad economy. The most direct way this conflict could do that is through energy prices feeding into inflation, which is exactly what we saw play out, and what made the Fed’s position so uncomfortable heading into the ceasefire.
The Quarter Underneath the Headlines
Stepping back from the geopolitical noise, the Q1 numbers tell a story worth understanding. The S&P 500 fell 4.3% for the quarter, but that headline number is misleading. The decline was concentrated in the largest technology companies, while the average stock in the S&P 500 and smaller company indexes each gained nearly 1%, outperforming the headline index by roughly 5%. The most technology-heavy index, the Nasdaq 100, fared worst, falling 5.8%, as the handful of mega-cap names that had driven most of the market’s gains in recent years continued to lose ground.
Among sectors, energy stood alone. The energy sector surged nearly 38% as oil prices climbed sharply on supply concerns and the outbreak of the conflict. Nearly every other sector finished the quarter in negative territory, with technology, consumer discretionary, and financials each falling more than 7%. Our energy overweight, which we identified as our highest-conviction sector position in our year-end outlook, was the most meaningful bright spot in our portfolios during the quarter, helping to offset weakness elsewhere. As the ceasefire took hold and oil prices fell sharply on April 8, energy stocks gave back some of those gains, which is exactly how a hedge is supposed to work. The position did its job, and we continue to hold it as a buffer in case tensions flare again before a permanent deal is reached.
The most important number in the quarter, though, is not any of those. It is earnings. S&P 500 companies are expected to report for Q1 2026 profit growth of 13.2% compared to a year ago, which would mark the sixth consecutive quarter of double-digit growth. Analysts are projecting similarly strong growth of 19%, 21%, and 19% for each of the next three quarters. Corporate profits are the primary engine of long-term stock market returns, and they remain healthy. A market that pulls back on top of strong earnings is a very different situation from one where the pullback reflects a deteriorating business environment. We are in the former.
The Fed’s Uncomfortable Position, and Our Contrarian View
The Iran conflict put the Federal Reserve in a difficult spot, and understanding why matters in terms of how we are thinking about bonds.
When oil prices nearly doubled in six weeks, near-term inflation expectations jumped sharply, and the Fed’s March meeting notes revealed a central bank that was beginning to discuss whether rate hikes, rather than cuts, might be necessary. At the peak of the conflict, the market was pricing a greater than 50% chance that the Fed would raise rates before year-end, the first time that figure had crossed that threshold. That is a striking reversal from the start of the year, when the expectation was for multiple rate cuts.
We think the market has this wrong, and that the Fed will be back to cutting rates before the year is out. Even if oil prices stay elevated for a few more months as global supply chains and shipping routes normalize, the Fed does not need inflation to have already come down to start cutting. It needs to believe inflation is on its way down. A credible peace agreement, even an imperfect one, gives the Fed that confidence. History is instructive here: the Fed adjusts policy based on where it expects the economy to be heading, not just where it is today. If the Strait of Hormuz is reliably open and a deal is coming together, the Fed can reasonably look ahead to lower energy prices and refocus on the labor market, which has been softening steadily. That is the sequence we expect to play out, and it is why we think rate-cut expectations can recover meaningfully even before oil prices have fully normalized.
The April 8 ceasefire gave a preview of exactly that. The close to 100% probability of at least one rate cut before year-end fell to 14% in the first six weeks of the war, then jumped back up to 43% in a single day. If the Islamabad talks break down and oil surges again, that repricing reverses quickly. But our base case is that a deal comes together, and that current bond yields are pricing in a rate hike scenario that is unlikely to happen.
This is why we find longer-duration bonds attractive right now. Yields have risen considerably during the conflict, and if the Fed does return to cutting as we expect, that creates a real opportunity for bond investors. Beyond the return potential, bonds continue to play their classic role in a diversified portfolio: if the conflict escalates and stocks sell off, high-quality bonds would likely rally, cushioning the impact. We are positioned with more interest rate sensitivity than most, and we are comfortable with that.
Where We Go From Here
Even after the April 8 surge, the S&P 500 is still roughly 5-6% below where it was before the war began, and oil at roughly $99 remains about 40% above its pre-conflict level. One good day does not undo five weeks of damage, and the ceasefire clock is already ticking. What it does do is change the range of possible outcomes. A lasting agreement that keeps the Strait open and allows oil to settle back toward $75-85 would lift a significant weight from both the stock market and the Fed’s decision-making. Strong corporate earnings, a Fed that can resume cutting, and an energy sector that functions as a hedge (a long-term, structural, or strategic investment designed to minimize risk and protect a portfolio from volatility) rather than a crisis trade (a tactical, often short-term, move designed to capitalize on extreme market disruption) adds up to a reasonably encouraging picture for the second half of the year. The path through the Islamabad negotiations is unpredictable, but both sides have strong reasons to reach a deal.
Our portfolios heading into this period were built for an environment like this one. The energy overweight helped, and our longer-duration bond positioning provided stability. We are keeping both in place. If tensions reignite and oil moves higher again, those positions protect. If a resolution takes hold, the bonds and the quality companies we favor across the rest of the portfolio are well-positioned to benefit.
We think about risk and uncertainty as two different things. Uncertainty is simply not knowing what comes next. Risk is the chance of a bad outcome at a price that does not compensate you for taking it. Markets often treat them as the same thing when conditions are difficult, and the gap between those two concepts is often where the better opportunities are found. A good deal of fear is still priced into markets today, particularly in longer-duration bonds and in the areas we favor relative to the most expensive parts of the technology sector. As that fear fades, we expect the portfolios to reflect it.
So, are we Rip Van Winkle, investing as though it is still February 27th? We don’t think so. The world has changed in ways that matter, and our positioning reflects that. But we also don’t believe the old rules are gone entirely. Corporate earnings are strong, the economy has not broken, and the same long-term forces that drove markets before this conflict began are still intact. The ground shifted. It did not disappear.
Please do not hesitate to reach out with any questions, and I am happy to go deeper on how your specific portfolio is positioned through all of this.
Christian
