Q2 2026 Market Commentary

2nd Qtr 2026 SCM Market Commentary.pdf

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As we entered into the new year, we believed that 2026 would be a more difficult year in the financial markets, and so far, it has been. As of April 10th, William O’Neil + Company is reporting that S&P 500 (SPY), Dow Jones Industrials (DIA), and AGG Intermediate Bond Index (AGG) are all down for the year. Currently, the biggest headwind in the financial markets is the war in Iran. In this commentary we will give a recap of the first quarter of 2026 and then talk about the repercussions of the Iran conflict in the financial markets.

The S&P 500 (the 500 largest companies in America) headed into the new year at expensive valuations after three good consecutive years. Historically, the S&P 500 trades between 13.8 and 20.5 times earnings going back 30 years according to J.P. Morgan Research. On January 1, 2026, the S&P 500 was trading at 22 times earnings, which was almost 10% above the upper end of the historical trading range, and only happens 16% of the time.

The 61 day sell-off in the markets from January 28th to March 30th is the longest sell-off in the markets since 2022 and has created -10% market declines in all of the major stock index including the Dow Jones, S&P 500, and NASDAQ. Although the length of the decline is the longest in four years, the depth of the market decline is actually normal with the financial markets routinely having at least one -10% draw down in any given year. Indeed, during the last 10 years, 7 of those years have had at least one -10% decline. Going back to 1950, the markets have historically had an intra year declines of -13.7%. (S&P 500, McGraw Hill). So, the first quarter sell-off in terms of percentage decline is not unusual.

The war has also caused a spike of uncertainty. Wall Street uses the Chicago Board of Exchange to track option price movements to track expected short-term (30 day) volatility. This measure is known as the Vix Index, or Fear Index. The idea on the Vix is that traders will buy options (which give traders the right, but not the obligation) to buy or sell stocks in the future at preset prices. So, it allows traders or investors to buy insurance on investments. Long term investors can use the prices that traders are willing to pay for options in the future as a mathematical estimation of how much fear is in the market. Typically, the Vix Index trades between 15-20, but on March 8th the Vix Index traded at 52.11, a very high number, which has only happened 70 times during the last twenty years. In each of the last 70 occasions that the Vix Index traded above 52, the S&P 500 was higher on a 1, 2 and 3yr basis after the occurrence. This does not mean that the market is going to go up tomorrow, but it does mean that short-term investors became very negative and sold stock and purchased a lot of portfolio protection, which in turn pushed stock prices to low levels, which creates opportunity for longer term investors.

While the Vix index looks at sentiment, the fundamental good news is that earnings of companies in the S&P 500 grew +12.8% last quarter of 2025, and marked the sixth straight double digit earnings growth quarter for America’s top 500 companies according to FactSet Research. For the first quarter of 2026, FactSet, which combines all of Wall Street’s earnings estimates into one report, expects earnings growth of the companies in the S&P 500 to be +13.2%. Moreover, profit margins, aided by the adoption of new AI (artificial intelligence) is at an all-time high, which should help stocks move higher once the uncertainty drops.

This combination of falling stock prices and rising earnings has created a situation where stocks are no longer expensive based on a Price/Earnings ratio, and are back in line with historical valuations. (Please see chart below).

What happens next depends upon how long the Strait of Hormuz remains closed. The Strait of Hormuz is one of the most important strategic waterways in the world. The International Energy Agency estimates roughly 20% of the world’s total crude oil consumption and approximately 7.3 billion barrels of oil or 25% global seaborne oil trade passes through it annually. Moreover, it’s not just crude oil, it’s a list of vital commodities used in a wide range of products from fertilizers to chip making. (Please see chart below).

With the Strait closed, oil prices have spiked from $61 per barrel in January to as high as $115 per barrel in early April. To keep a lid on prices, the United States authorized a release of 172 million barrels of oil from the countries’ SPR (Strategic Petroleum Reserve) as part of a 400million-barrel global oil release in conjunction with other nations. These releases are designed to hit the market over the next couple of months to offset the closure of the Strait of Hormuz. Goldman Sachs estimates the 172 million barrels from the U.S. SPR will be exhausted or fully committed by mid-summer of 2026, at which point the oil market will lose its primary safety net.

This is what has the financial markets concerned, if the Strait of Hormuz is not opened by mid-summer, we will see an oil shortage and prices will spike further causing a series of negative consequences. The U.S. would be more insulated than either Europe or Asia because the EIA (U.S. Energy Information Administration) estimates only 2% of U.S. petroleum consumption comes through the Strait of Hormuz. Furthermore, the United States has become much more energy efficient, with energy accounting for only 3.4% of the average family’s budget in January 2026, vs 8.1% of the average family budget at its peak in 1980 (see chart below).

Despite the improved energy efficiency, the U.S. would still be heavily financially affected. European and Asian economies would slow down, which would then reduce our exports to those regions, and a spike in oil would in turn lead to higher inflation because oil and its by-products are used in so many applications, the cost of those products would increase. To control the cost increases, the Federal Reserve would then not only not cut interest rates this year, they may have to actually raise interest rates to control inflation. The Federal Reserve has estimated that $10 increase in the price of oil per barrel leads to a 0.2-0.4% increase in annual inflation. This would create other pressures as well. The depth and severity of these problems would depend upon the length of time and number of vital commodities withheld from the global economy due to a prolonged shutdown of the Strait of Hormuz.

Debt servicing due to higher interest rates would be another primarily economic pain point. The Congressional Budget Office estimates $9-$10 trillion of Treasury debt will need to be refinanced this year, including a Pentagon request for $200 billion to fight the Iran war. Most of this debt was issued during the pandemic-era at historically low interest rates and now must be rolled over at much higher yields. Most likely the new yields will be in the 3.5%-4.5% (but potentially higher if oil spikes above $150 per barrel) range which will significantly increase borrowing cost and increase the budget deficit. This in turn crowds out discretionary spending which limits how policy makers can spend money. Higher or even elevated for longer interest rates will also lead to further cracks in the private credit markets. The private credit sector has been growing for years and is now estimated to be a $3 trillion industry, according to Morgan Stanley. Typically, private credit are loans by private equity firms and Business Development Companies (BDC) that are not banks, who often make loans at higher interest rates to companies that banks have passed on. But private credit’s mounting problems are also becoming increasingly visible, especially after two companies backed by private credit companies, auto-industry firm Tricolor and First Brands declared bankruptcy last September. Jamie Dimon, CEO of JP Morgan, warned after the pair went bankrupt that problems in credit are rarely isolated. This has led to investors trying to pull their money out of private credit funds and the underlying funds unable to meet redemption request. Higher interest rates will put more stress on these loans, and these firms are having a hard time meeting withdrawal requests.

While the financial markets will face headwinds related to the Iran war, in the long run, some market strategists see a silver lining. Steve Eisman (former managing director at Neuberger Berman, and known for his “Big Short” trade) argues that replacing the Iranian regime that has been a thorn in America’s side for almost 50 years is not a bad thing. Moreover, the way in which the U.S. has militarily quickly defeated both Venezuela and Iran sends a clear message of American hard power to U.S. rivals, mainly China. Both Venezuela and Iran used Chinese air defense systems, primarily for long-range surveillance and radar coverage. Under the “Oil-for Weapons deal,” Iran especially relied on China’s most advanced air defense and surface to air missile systems (HQ-9B), and positioned these systems around their high value targets. Before the war, the Chinese advertised their air defense system to be better than the Russian systems and as good as or even better than the American Patriot air defense system, widely considered to be the best in the world. During early fighting in Iran, the US-Israeli strikes were able to defeat the Chinese air defense systems without taking any losses. This has big geo-political ramifications because China’s President Xi has stated he wants the Chinese military to be ready to take Taiwan, by force, if necessary, by 2027. The Chinese commanders now know that their air defense systems, in their current configurations, cannot stop American stealth fighters (F-35, F22) or American stealth bombers (B-2) and this alone could push back or even prevent a war between the U.S. and China from breaking out.

These market strategists also argue the quick U.S. military victories (achieving a peace deal is another matter) has cemented the U.S. as the world’s foremost military power as well as the world’s largest economy. The U.S. has been able to fight half way around the world against Iran, a country twice as big as Ukraine, with a far larger economy and military, and greatly degrade that country’s military in very short period of time while only losing 13 service members. In comparison, Russia which was still considered the third strongest military behind the U.S. and China, is still trying to take over Ukraine, a country on its doorstep with a much smaller economy, military, and population than Iran. After four years of fighting, the Russians still do not have air or naval superiority over Ukraine and the UK ministry of Defense in February of 2026 estimated that the Russians have lost 1.2 to 1.25 million soldiers killed, missing or wounded in fighting since 2022.

In conclusion, the Iran war has dropped the financial markets back into historical valuation ranges. Fortunately, American companies have entered this crisis from a strong earnings and profitability profile. If the war is ended or the Strait of Hormuz reopened with vital commodities once again being delivered to the global economy before the global safety nets of energy reserves run out, estimated to be around mid-summer, we believe the economy and financial markets will rebound. However, if the conflict drags on without the Strait of Hormuz being reopened, we believe we will see a string of negative consequences leading to higher inflation, higher interest rates, and falling profit margins. As of April 12th, the United States has decided to escalate the war in the hopes of ending the conflict by imposing a blockade on ships that trade with Iran, since this is what Iran has been doing to its neighbors. Iran does have large reserves of grain, but imports almost all of its produce, vegetables and proteins, and relies on oil exports (which were not restricted during the war) to pay its’ vast patronage system which keeps the regime in power. If the escalation works, and there is a peace deal, the financial markets should stabilize and then move higher. If it fails, we will most likely see the markets move lower and may need to get more defensive in portfolios. In the meantime, we continue to like companies who provide goods and services that consumers need to use on a daily basis, regardless of economic conditions and who are returning cash back to investors from either dividends or share buy backs as the best avenue for positive risk adjusted returns.

Thank you for your continued support.

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