The opening months of 2026 proved an unsettling ride for investors. Markets had only just recovered from the shock of Donald Trump’s verbal sallies on Greenland – and more hands-on intervention within Venezuela – when US and Israeli forces launched an attack on Iran.
The attacks threatened to be the US president’s most impactful geopolitical intervention to date, with energy markets thrown into turmoil. By the end of the quarter, the prospect of a resolution certainly seemed remote – and yet global equity markets largely appeared to have accepted a new ‘normal’.
Bond markets, however, were not so nonchalant. Yields spiked out – particularly for those countries seen as most vulnerable to higher energy prices – and the market fragility even produced a new acronym. A decade and a half ago the ‘PIGS’ of Portugal, Italy, Greece and Spain were shunned; now investors worry about the ‘BIF’ trio of Britain, Italy and France.
While stockmarkets seemed happy enough to go along with the president Trump’s assurances over peace talks then, bond investors were less inclined to take any solace from the latest Truth Social post – and yields remained stubbornly high by the end of the quarter.
In this hectic period, other factors that at any other time might have proved disruptive for markets went largely unnoticed. “Megacap tech companies came under increased scrutiny during fourth-quarter earnings season,” points out Zara Nokes, global market analyst at JP Morgan Asset Management.
“Meanwhile, attention turned to tariffs once again after the US Supreme Court ruled against the use of the International Economic Emergency Powers Act to justify the ‘reciprocal’ tariffs announced in 2025, with the US administration implementing a flat 10% tariff on all imports in response.”
And all this played out against a backdrop of AI disruption. Investors were increasingly seeking to assess the disruptive potential of artificial intelligence technology, while also fretting about its creators’ enormous levels of spending. For now, the ultimate impact of AI remains unclear and investors are still in the process of assessing its long-term impact on individual businesses and sectors.
“For years, the only reason to sell the US has been price but now, as well as high valuations, there is inflation, an unpredictable government and a weaker dollar.
Unsuspected frAIlty
Hitherto unsuspected fragility emerged in the previously dominant AI trade over the first quarter of 2026. Investors fretted about the level of spending from the AI companies themselves – already around $680bn (£502bn) for 2026 and counting – but also about the companies that may be disrupted by it.
The ‘AI losers’ trade saw a significant sell-off in the software segment – for example, the S&P Software & Services Select Industry index dropped 23% from the start of January to late February. UK data groups such as Relx and LSEG – until recently seen as ‘AI winners’ – were caught up on the weakness.
“While technology stocks posted strong fourth-quarter earnings, investors increasingly began to scrutinise the ability of the hyperscalers to deliver returns against the ever-increasing levels of AI-related capex being announced,” says Nokes at JP Morgan Asset Management.
“In the first few weeks of the Middle East conflict, the tech sector proved to be relatively more resilient than the broader US market as investors looked to higher-quality companies at a time of elevated economic uncertainty. Nonetheless, even the tech sector was down 3.8% in March – versus a drop of 5.0% for the wider US market.”
HALO effect?
Against the backdrop of AI disruption, investors turned to companies they viewed as having more resilience – and another acronym emerged. This was the ‘HALO’ trade of ‘Heavy Assets Low Obsolesce’ businesses with tangible assets, predictable cashflows and little apparent vulnerability to disruption from AI. They included insurance, energy infrastructure and commodities groups.
The pivot to these areas served investors well when the US and Israel attacked Iran in February. At that point, the only areas that defied the general gloom were the energy companies – the MSCI World Energy index is up 37% for the year to date. This in turn helped support commodity-heavy markets and Latin American indices have enjoyed a good run, with the MSCI Brazil index up 19.1% over the year to date.
It was a tougher picture for other emerging markets, however – and particularly the Asian economies, which are more dependent on imported fossil fuels. India, in particular, saw its stockmarket sell off, as investors worried about the economic hit from higher energy costs. Overall, the war put a dent in the otherwise strong recent performance from the world’s emerging economies.
Elsewhere in the world BP and Shell helped support the FTSE 100, which proved more resilient than many other global markets during the crisis. The index ended the quarter up 3.4%, although it was another difficult period for the UK’s small and midcap companies.
Europe was also hard-hit – especially energy-heavy economies such as Germany. There, the Dax index was down 7.5% over the quarter, with many industrial companies particularly weak. Software giant SAP was another leading European stock to find itself caught up in that ‘AI losers’ trade.
Following the ever-more erratic daily newsflow could have disastrous consequences for portfolios.”
As Nokes points out, overall, Japanese stockmarkets were the place to be over the quarter. New prime minister Sanae Takaichi was elected with a decisive mandate for economic reform, sending stockmarkets soaring.
And, while investors might reasonably expect some volatility from equity markets, bond markets are usually a more sober affair. Not this quarter. The war in Iran triggered a bond market wobble, particularly evident in countries with high debt, energy vulnerability – or both, such as the UK. Government bond markets were volatile throughout the quarter, with short-dated bonds hit particularly hard. Markets shifted abruptly from pricing rate cuts to rate hikes.
Pressing question
Markets have grown very used to turmoil under the current administration in the US. Just as they become comfortable with the last bit of policymaking, another disruptive policy is announced. This makes any kind of prediction even more fraught than usual – and you can double that with the crisis in Iran. For investors, the difference between a war that is over within months and one that endures beyond that is significant.
The most pressing question is whether markets are currently being too optimistic. The S&P 500, for example, is back up to the level it was at the start of the year and there appears little acknowledgement of the pain that might lie ahead for the global economy.
The International Monetary Fund has already revised its economic forecasts lower, with the UK seeing the large downgrade to growth. Even then, the organisation makes it clear that, should the war persist, these forecasts may have to be revised lower still – and goes on to warn that, should oil prices average above $110 per barrel next year, a global recession would be a ‘close call’.
To date, the first-quarter earnings season has been supportive – with companies reporting minimal impact from the Iran crisis – and this has helped maintain stockmarket confidence. Such confidence remains at odds with sentiment in commodities markets and in bond markets, however, and reality check is still a possibility.
“Short-term trading of this market is not easy,” says Fabiana Fedeli, CIO equities, multi asset and sustainability at M&G. “Following the ever-more erratic daily newsflow could have disastrous consequences for portfolios. And, in a market where the direction of macroeconomic conditions is difficult to predict, it is next to impossible to take broad directional trades based on macro considerations.”
A focus on fundamentals
In the end, investors can only base their decisions on the information available to them. “Our starting point is to focus on what is being discounted in markets and ask whether valuations look sensible relative to current facts, historical context and plausible medium-term outcomes,” says Fedeli.
The upside with such a level-headed approach is that market volatility does throw up opportunities. Fund managers are looking at where they are exposed – companies that may see a hit from tariff disruption, say, or are vulnerable to high energy prices – and also where the market may have mispriced the risks. Ranmore Global Equity fund manager Sean Peche holds Easyjet, for example, arguing the market has over-estimated the group’s vulnerability to fuel price hikes as around 80% of its fuel costs are hedged.
The sell-off in the software sector has also provided interesting opportunities. “We have rotated holdings in technology as we believe some companies caught in the so-called ‘SaaSpocalypse’ are unlikely to be displaced by AI but rather will be enhanced by it,” says Fedeli. “We have financed some of these positions by trimming our investments in memory names across the US and Asia.”
There is growing interest too in some of the left-behind areas of quality, with managers such as Ben Peters on the Evenlode Global Equity fund revisiting consumer staples. The sector would be a natural choice in a recessionary environment and, after a period of weak performance, looks cheap relative to historic norms.
For her part, Fedeli believes that, among the consumer staples stocks caught up in the recent sell-off, there may well be the winners of tomorrow. “Spending is steadily rotating away from goods towards experiences, benefiting companies exposed to leisure and travel,” she explains.
“Consumers are also increasingly focused on value and convenience, while health and wellness considerations continue to influence purchasing decisions.” Nevertheless, some worries remain over the ability of consumer staples companies to maintain pricing power.
US weighting game
Perhaps the biggest decision now facing investors is on the relative weight of the US. The country’s stockmarkets have had a difficult start to the year relative to their global peers, yet remain a huge part of global indices. “For years, the only reason to sell the US has been price but now, as well as high valuations, there is inflation, an unpredictable government and a weaker dollar,” says Ranmore’s Peche.
He points out that trillions in US debt need to be refinanced this year and will do so at much higher rates. In the near term, there is also the potential impact of the SpaceX floatation. While a prospectus has not yet emerged, if it comes to market in June or July, it could have a disruptive effect on US indices. “Passive funds will be selling something else to accommodate it,” Peche adds.
All of which begs the question, where could investors turn if they trim back on US allocations? Ben Durrant, manager on the emerging market equities team at Baillie Gifford, makes a strong case for the asset class, arguing emerging markets are embedded in the two key structural forces of the age – the energy transition and AI. Data-centres are stuffed full of Asian-made technology, he elaborates, while the energy transition requires commodities that are mostly located in emerging markets.
So all-encompassing just a few months ago, investor concerns around ‘US exceptionalism’ and the impact of AI have not gone away and are likely to remain dominant themes as the year progresses – always presuming the fog of the Iran war clears. Investors are slowing adjusting – both to a new geopolitical order and the changes wrought by AI. The transition is likely to prove rocky for markets over the months ahead.
