2Q26 equities quarterly outlook

Staying Nimble in 2026: A Disciplined Diversification Approach

May 6, 2026

1Q26 recap

During the three months ended March 31, 2026, the S&P 500^® Index delivered a -4.3% return, with most of the negative performance being generated in March. Generally, value equities outperformed growth equities, and US small-caps outperformed US large-caps. Among the broad indices we track, the best performers were the Russell 2000^® Value Index and Russell 1000^® Value Index, closely followed by the MSCI EAFE Value Index. The worst performers were the Russell 1000^® Growth Index and MSCI EAFE Growth Index.

Figure 1: Total return (%) in US dollars for periods ended March 31, 2026

At the sector level, energy was the leading performer in the S&P 500 Index, delivering a total return of 38.3%. The weakest sectors were consumer discretionary, financials, and technology, each of which lost more than 9%.

Iran’s effective blockade of the Strait of Hormuz during March caused a surge in oil and gas prices globally, with the spot price of Brent Crude rising from US$61 at the end of December 2025 to US$102 at the end of March 2026. Prices of other commodities, including aluminum and fertilizer, for which the Strait of Hormuz is an important channel, increased substantially as well. The US dollar, often seen as a safe currency, rose by 1.7% during the quarter. The US Federal Reserve (Fed) issued a statement in mid-March 2026 indicating that it does not intend to cut interest rates while the economic outlook remains so uncertain. However, the Fed also stated that it would be prepared to adjust its stance based on conditions in the labor market, inflation data, and other developments.

What we are watching

In our 2026 Outlook released in January, we noted that the US economy was generally in good shape, with several fiscal and monetary tailwinds likely to support a broadening of equity leadership. What we didn't anticipate was the US-Israeli war with Iran, the closing of the Strait of Hormuz, and the resulting global inflationary pressures from higher oil prices. We continue to believe that once the fog of war lifts, the US and global economies will likely return to growth, albeit with greater path variability. For investors, selectivity and diversification across market caps, geographies, and styles are likely to remain essential.

Over the past year, the US and global economies have absorbed numerous shocks, including the tariffs imposed in April 2025 and the structural impact of artificial intelligence (AI). These disruptions were cushioned by the One Big Beautiful Bill Act (OBBBA), an AI-driven boom in capital expenditure spending, and a generally expanding global economy. However, the war in Iran and subsequent closure of the Strait of Hormuz have created a global supply shock affecting both energy supply and the broader economy.

The war’s short-term economic impacts will vary across countries and regions, depending on countries’ government policies and whether they are net energy importers or exporters. Many economies in developing countries and in Asia, being net importers of oil coming through the Strait of Hormuz, are likely to experience negative effects. The next most affected region is likely to be Europe, which will have to grapple with its second major energy shock, after the Ukraine-Russia conflict.

Since 1970, many major economies have significantly reduced their oil dependence, with Japan having gone furthest in this direction. Nevertheless, oil still dominates the global energy mix, with roughly 20% of global supply moving through the Strait of Hormuz, primarily destined for Asia. While today's energy markets are more resilient than during the oil crises of the 1970s, the transition to energy diversification will remain a multidecade challenge, and countries around the world may try to accelerate their shift to renewable energy in response to ongoing geopolitical tensions.

Figure 2: Energy market diversification from 1970-2024

Sources: Macrobond, Energy Institute, Nomura Asset Management. Data as of 1970 and 2024 (latest). *Solar/wind includes other renewables.

“
The magnitude and duration of commodity price swings, especially for oil and gas, continue to be the most important variable in determining the future path of the global economy and markets.
”

Linda Bakhshian Chief Investment Officer of Equities

While the US, as a net energy exporter, may be partly insulated from the supply shock, it is not immune to the effects of rising global prices for raw materials that pass through the Strait of Hormuz. The US is already experiencing higher gasoline prices, and we anticipate that inflationary pressures in agricultural products may also rise. Since the 1970s, US oil intensity has declined almost 75%, and oil now represents a small fraction of the operating expenses for most of the S&P 500 Index. However, relative to our outlook from three months ago, when we expected OBBBA benefits to add as much as 0.6% to GDP growth, higher gasoline and food inflation may eliminate more than half of that projected gain.

While the global growth outlook has become more opaque, we remain optimistic that a resolution to the Iranian conflict will emerge soon, allowing conditions to normalize in the second half of 2026. This is our base-case scenario. However, the magnitude and duration of commodity price swings, especially for oil and gas, continue to be the most important variable in determining the future path of the global economy and markets. Extended disruptions to energy flows through the Strait of Hormuz present significant risks, as prolonged closures would likely entrench higher inflation, further eroding real income and consumption while substantially slowing economic growth. This places global central banks in a difficult position as they navigate various growth and inflationary scenarios, while the AI revolution continues to reshape economic fundamentals. The resulting policy responses will be heavily dependent on the persistence of current supply chain disruptions – a swift conflict resolution will be critical to preserving the path to normalized growth.

Diversification and agility remain key to capital preservation and growth

From a fundamental perspective, the events of 1Q26 pressured equity markets in the US and around the world, with the Nasdaq Composite Index now in correction territory and valuations normalizing toward historical averages. However, earnings guidance from listed US issuers has remained fairly resilient, and we will be watching 1Q earnings reporting for management commentary around margin pressures. While we believe AI will remain a focal point for market debate and volatility going forward, we anticipate that the next few quarters will see a fundamental and broadening shift in equity leadership.

Figure 3: Global P/E ratios fell closer to historical norms

Sources: Bloomberg, Macrobond, Nomura Asset Management. Data as of March 31, 2026.

Assuming our base case above, the next phase of US market performance is unlikely to be driven by the narrow concentration in technology stocks that has characterized the past two years. Instead, we expect earnings growth to expand across sectors as companies across industries modernize their supply chains, integrate new technologies, and strengthen competitive positioning. While technology will continue to benefit from these secular trends and the US remains the global center of innovation in many areas, we also believe that the market's search for quality growth will create opportunities in health care, financials, infrastructure, and industrials (defense), especially as valuations have become more compelling relative to history.

Looking further out, we consider that the current disruptions to geopolitical conditions are likely to accelerate a fundamental shift in energy sourcing strategies, with countries prioritizing supply chain diversification to reduce geopolitical risk. In our view, these shifts may create substantial investment opportunities in alternative energy infrastructure, supply route development, and energy security technologies.

AI's transformative impact is creating distinct winners and losers, which will change as the AI ecosystem evolves. Recently, the software sector has faced the greatest disruption, both on private credit and equity markets, as AI platforms shift from consumer applications toward potential enterprise clients. Established software companies that deeply integrate AI into mission-critical systems or serve as distribution partners may benefit, but competitive pressure is intensifying across the broader sector. Given these uncertainties, investors remain understandably cautious as they seek greater insight into whether AI will coexist with or displace existing solutions. Until this fundamental question is resolved, we believe the software sector will likely face continued investor wariness, despite strong earnings from some companies. As we transition from using AI for assistance to relying on autonomous agents powered by AI, we expect that any sector lacking proprietary data to effectively protect from wide dissemination will face potential disruption. In our view, the long-run winners of the AI race will be businesses that mindfully leverage this tool for accelerated growth, rather than dismiss this technology wave.

Figure 4: P/E ratios based on projected earnings for 2026 and 2027

So how should investors diversify? While the near-term dynamics for cyclicals and small-cap companies remain uncertain due to geopolitical tensions, our longer-term outlook for those areas remains generally constructive, supported by several key drivers: domestic manufacturing reshoring, continued deregulation, AI-enhanced productivity gains, and the prospect of moderating interest rates and risk premiums. These factors are likely to favor small- and mid-cap companies, which typically generate more domestically focused revenue streams and currently trade at more attractive valuations.

Regionally, Europe is gradually stabilizing, with financial conditions easing as capital investments by countries such as Germany and France turn positive, though the recent spike in energy prices coupled with limited energy inventories could offset the near-term tailwinds. Japan is benefiting from structural reform, which should continue as the country has largely been sheltered from the current energy shock. China continues to face fundamental and regulatory challenges but seems to be balancing pressures within its economy better. We remain most constructive on emerging markets (EM), recognizing that heightened geopolitical tensions, energy dislocations, and supply chain disruptions will continue to create volatility and dispersion among countries – conditions that favor discerning investment approaches.

Asia stands at the center of the expanding revolution in compute infrastructure, maintaining dominance across the technology supply chain, from advanced semiconductors and memory to packaging, while capturing substantial AI-related capital investment flows. The region's commanding presence – hosting roughly 70% of global chip makers, 90% of AI memory production, and virtually all advanced packaging capabilities – underscores its critical role in digital transformation.

Long-term fundamentals remain attractive for targeted EM economies and corporates, driven by increasing digitalization and rising computing intensity, with companies at the forefront of leading-edge manufacturing particularly able to capitalize on this growth trajectory. More broadly, we identify compelling investment prospects among individual EM companies with the potential to benefit from urbanization, productivity enhancement, and improving living standards. The EM-US valuation gap, based on next 12 months P/E, is currently at a 43% discount, less than one standard deviation away from the historical average of 26%.

From a country perspective, technology leaders in Taiwan and South Korea continue to demonstrate superior earnings visibility while trading at attractive multiples relative to US peers. We maintain an underweight in China due to macro concerns and remain underweight in India given current pricing levels that we consider excessive.

Figure 5: Emerging markets valuations remain at discount to historical average

Conclusion

We believe 2026 is a year to stay nimble, while maintaining discipline focused on medium- to long-term horizons. While geopolitical and economic conditions are likely to shift frequently, creating oscillating headlines, we see substantial scope for patient investors, as structural forces reshape market leadership and broaden equity opportunities beyond current index concentrations.

As the fog of war clears, we believe that energy supply chain disruptions will create compelling rebuild opportunities and accelerating the reconfiguration of global supply chains. This structural shift may open new investment avenues for companies positioned to benefit from this diversification, energy infrastructure development, and the reshoring of critical capabilities.

We believe attractive entry points will present themselves in small- and mid-cap stocks and in EM, where valuations and fundamentals have been improving beneath the surface volatility. Companies capable of translating investment into productivity gains and converting that productivity into sustainable returns represent the potential winners of this next phase.

In our view, long-term investors should prioritize quality factors, cash generation, and pricing power, balanced with positive momentum. In our assessment, actively managed, well-diversified equity portfolios can effectively mitigate the risks associated with overexposure to single market themes or index concentration, while capturing these evolving opportunities.

Staying Nimble in 2026: A Disciplined Diversification Approach

1Q26 recap

Figure 1: Total return (%) in US dollars for periods ended March 31, 2026

What we are watching

Figure 2: Energy market diversification from 1970-2024

Diversification and agility remain key to capital preservation and growth

Figure 3: Global P/E ratios fell closer to historical norms

Figure 4: P/E ratios based on projected earnings for 2026 and 2027

Figure 5: Emerging markets valuations remain at discount to historical average

Conclusion

Disclosures

Policies

What we are watching

Diversification and agility remain key to capital preservation and growth

Figure 3: Global P/E ratios fell closer to historical norms

Figure 4: P/E ratios based on projected earnings for 2026 and 2027

Figure 5: Emerging markets valuations remain at discount to historical average

Conclusion

Disclosures

Policies

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Staying Nimble in 2026: A Disciplined Diversification Approach

1Q26 recap

Figure 1: Total return (%) in US dollars for periods ended March 31, 2026

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What we are watching

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Figure 2: Energy market diversification from 1970-2024

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Diversification and agility remain key to capital preservation and growth

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Figure 3: Global P/E ratios fell closer to historical norms

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Figure 4: P/E ratios based on projected earnings for 2026 and 2027

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Figure 5: Emerging markets valuations remain at discount to historical average

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Conclusion

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What we are watching

Diversification and agility remain key to capital preservation and growth

Figure 3: Global P/E ratios fell closer to historical norms

Figure 4: P/E ratios based on projected earnings for 2026 and 2027

Figure 5: Emerging markets valuations remain at discount to historical average

Conclusion

Disclosures

Policies