April 24, 2026
Executive Summary:
After a strong 2025, stocks finished the first quarter lower as the conflict with Iran and the effective closure of the Strait of Hormuz triggered an 84% spike in oil prices and a sharp risk‑off move. In this environment, the S&P 500 declined 4.2% for the quarter, while the equal-weighted S&P 500 and the Russell 2000 small-cap indexes still managed modest gains of 0.9% and 0.6%, respectively. International stocks continued to outperform, with the MSCI EAFE Index up 1.2% and the MSCI Emerging Markets Index up 3.8%, helped by more attractive valuations and tailwinds from rising commodity prices.On April 7, 2026, President Trump announced a two‑week ceasefire with Iran that included plans to reopen the Strait of Hormuz. Stocks surged on the news, and the S&P 500 went on to hit a new all‑time high six days later as investors rushed to buy the dip.
Even before the war with Iran and the ensuing oil shock, we were concerned that U.S. growth was narrow and fragile: more than 100% of net job creation over the past year came from the non‑cyclical health care sector, and the economic expansion rested on three unsustainable pillars—near‑record peacetime budget deficits, an AI capex boom, and consumption increasingly driven by the wealthiest 10% who benefit most from the AI boom and Fed‑inflated asset bubbles. In the first quarter, there were mounting signs that the AI capex cycle is becoming harder to sustain, and we are concerned that persistently higher oil prices could be the catalyst that bursts the AI bubble and pushes the credit‑sensitive, cyclical parts of the economy into contraction.
We continue to believe the U.S. equity market offers poor long-term risk-reward: the S&P 500 is extremely expensive, dangerously concentrated in a handful of mega-cap tech names, and consensus earnings expectations remain overly optimistic given an energy shock, high rates, and a slowing labor market. Additionally, the latest surge to all-time highs has been narrow, AI-obsessed, and driven more by narrative and positioning than by fundamentals. In our view, the S&P 500 is being driven by an AI‑fueled bubble and has become increasingly detached from macro fundamentals. We continue to see oil prices — not the S&P 500 — as the more honest macro signal, and they remain pinned near their recent highs.
We remain underweight equities given their poor long-term risk-reward and the rally’s narrow, AI-driven breadth. Instead, we favor assets that have historically done well in modest-growth, rising-inflation environments — international and emerging-market stocks, value equities, hard assets such as gold and commodities, and short-duration fixed income. We remain focused on risk management and pruning weak positions to better preserve capital if the current energy shock ultimately tips the economy toward recession. We plan to maintain a highly diversified and balanced asset allocation until economic uncertainty diminishes and equities present a more favorable risk-reward opportunity.
First Quarter 2026 Market Review:
After a strong 2025, stocks finished the first quarter lower as the conflict with Iran and the effective closure of the Strait of Hormuz triggered an 84% spike in oil prices and a sharp risk‑off move. In this environment, the SP 500 declined 4.2% for the quarter, while the equal-weighted SP 500 and the Russell 2000 small-cap indexes still managed modest gains of 0.9% and 0.6%, respectively. International stocks continued to outperform, with the MSCI EAFE Index up 1.2% and the MSCI Emerging Markets Index up 3.8%, helped by more attractive valuations and tailwinds from rising commodity prices.
The market’s breadth improved early in the quarter as investors rotated out of many high‑growth technology names and into value and small‑cap stocks. The SP 500 technology sector fell 7.8% in Q1 amid growing questions about whether leading AI companies can earn attractive returns on the massive capital spending plans now underway. At the same time, the software sector dropped sharply—down 24.3%—as investors increasingly viewed AI as a direct threat to traditional software‑as‑a‑service business models.
Energy stocks were the only major sector to generate positive returns in March, supported by the historic spike in oil prices and heightened geopolitical risk. Outside of energy, all ten remaining large-cap sectors finished the month lower, including both cyclical areas such as Industrials, Materials, and Consumer Discretionary, and traditional defensives like Health Care and Staples, underscoring just how broad the March sell‑off became.
The spike in oil prices, driven by the war with Iran and the closure of the Strait of Hormuz, pushed interest rates modestly higher over the quarter. The U.S. 2‑year Treasury yield rose 0.33% to 3.81%, while the 10‑year yield increased 0.15% to 4.32%, flattening the yield curve to 0.51%—slightly below its 50‑year median of 0.80% and signaling tighter financial conditions.
Before the conflict, markets were pricing in roughly two Fed rate cuts in 2026. As the oil shock lifted inflation expectations, the Fed shifted to a clear “wait‑and‑see” stance, and the market now indicates that short‑term rates are likely to remain near current levels through year‑end unless the data deteriorate meaningfully.
Despite the war in Iran and a broadly risk‑off backdrop, gold—the classic safe‑haven and “risk‑off” asset—fell sharply in March as higher real interest rates, a stronger dollar, and profit‑taking after a powerful rally more than offset safe‑haven demand
The U.S. economy continued to show resilience, growing at roughly a 2% pace even as the unemployment rate held near a historically low 4.3% for March. Inflation, however, moved the wrong way: headline inflation jumped to about 3.3% in March, while core inflation remained stuck around 2.6%. Core inflation has now run above the Fed’s 2% target for an unacceptable five years.
On April 7, 2026, President Trump announced a two‑week ceasefire with Iran that included plans to reopen the Strait of Hormuz. Stocks surged on the news, and the SP 500 went on to hit a new all‑time high six days later as investors rushed to buy the dip. Over the thirteen trading days since the announcement, the SP 500 and Nasdaq 100 rallied 8.4% and 17.1%, respectively, while WTI crude fell only 4.7% to around $94 -- hardly a signal that the underlying energy shock has been fully resolved.
Nearly three weeks into the ceasefire, the Strait remains effectively closed and negotiations are stalled, yet markets are trading as if the war is largely behind us and the resilient U.S. economy will easily absorb the spike in energy and commodity prices. In our view, this “epic” rally has far more to do with systematic and quantitative trading strategies that buy on price and volatility signals—regardless of fundamentals—combined with FOMO (fear of missing out) than with any genuine improvement in the macro backdrop.
Despite the SP 500 sitting at a record high, oil prices remain nearly 60% above their pre‑war level, and the oil futures curve estimates that oil will be priced at $77.5 in December, about 30% higher than before the war, leaving the global economy in the midst of an energy shock.
While the equity market seems to be pricing in an oil spike with little lasting impact on growth, we view the oil market as a more reliable gauge of both progress with Iran and the underlying fundamentals. If crude prices stay elevated through year‑end, as the futures curve currently implies, we believe the economy and the stock market will be vulnerable. Historically, oil shocks of this magnitude have often preceded recessions, as persistently higher energy costs eventually squeeze consumers, compress corporate margins, and tighten financial conditions.
Although the SP 500 is at an all‑time high, oil prices remain significantly above their pre‑war levels, signaling that the underlying energy shock has not been resolved. Even after the ceasefire, both the spot price of oil and December futures are trading near their wartime highs, suggesting that oil markets still expect tight supply and elevated geopolitical risk. In our view, the oil market is a more reliable gauge of progress with Iran—and of the eventual economic impact—than the SP 500.
In summary:
- Stocks remain priced for perfection at a time when underlying risks have clearly increased. Valuations sit near record highs, ebullient analysts expect roughly 17–18% earnings growth in 2026, and consensus assumes the AI capex boom will simply power through any macro headwinds. We believe that optimism is even more misplaced today than it was before the energy shock. The AI bubble continues to mask a weak, overleveraged economy, and we have now layered a major energy shock on top of those existing vulnerabilities.
- In our view, if AI capital spending slows and/or a prolonged energy shock hurts consumption and keeps interest rates higher for longer, both the economy and the stock market face substantial downside risk from current levels.
Economic Outlook
As value investors, our asset allocation is driven by long-term valuation measures and the risk-reward opportunities present in the market. Moreover, we analyze leading economic and market indicators to determine the likely paths of economic growth and inflation. This enables us to strategically position our portfolio to perform well in all economic environments.
Before the war with Iran and the ensuing oil shock, we were concerned that U.S. growth rested on three unsustainable pillars: near-record peacetime deficits (5.3% of GDP), AI capital spending driving about a one‑third of economic growth, and consumption concentrated among the wealthiest 10% who benefit from the AI boom and the Fed-inflated asset bubbles.
At the same time, inflation has been above the Fed’s 2% target for five years, eroding purchasing power and leaving many Americans feeling like they are in a recession despite positive economic growth. Now we have layered a major energy shock and problems in the private credit market on top of those existing vulnerabilities. In our view, if AI capital spending slows and/or a prolonged energy shock eventually hurts consumption, the economy could be vulnerable to a recession, since oil spikes of this magnitude have typically preceded economic downturns.
The first unsustainable driver of economic growth is the near‑record peacetime budget deficit. In 2025, government revenues grew a solid 11.4% while spending rose only 4.6%—a favorable mix helped by higher tariff collections and a reduction in federal headcount—yet the deficit still sits at a dangerously high 1.7 trillion dollars, or 5.3% of GDP. The core problem is spending, not revenue: receipts are about 18.8% of GDP, slightly above the 55‑year average of 17.9%, while outlays are roughly 24.2% of GDP—more than 2 percentage points (about 690 billion dollars) above their historical norm of 22%. Most striking, government spending remains near recession‑type levels despite a historically low 4.3% unemployment rate; if an energy shock or AI‑driven disruption weakens the labor market, the deficit could quickly blow out to truly epic levels.
Through Q4 2025, government revenue growth (11.4%) outpaced spending growth (4.6%), aided by tariff revenue and a reduced Federal workforce. Yet the deficit remains unsustainably large at $1.7 trillion (5.3% of GDP). The problem is spending, not revenue: government receipts at 18.8% of GDP sit above the 55-year average of 17.9%, while spending is 24.2% of GDP—2.2 percentage points above historical norms, or $690 billion annually. Importantly, this recessionary level of spending persists even though the unemployment rate is only 4.3%.
Source: FRED
The second unsustainable growth driver is the AI investment boom. Even though AI stocks surged after President Trump announced the ceasefire, there are growing signs that the boom may be deflating. The Financial Times reports that roughly one-third to nearly half of planned AI data centers are now at risk of delay or cancellation as developers face shortages of critical electrical equipment, limited grid capacity, and mounting local opposition over power use, noise, and land use.
Investors are also increasingly worried about the basic economics of AI. Many AI companies are burning substantial amounts of cash because they are effectively “giving away” compute—pricing services well below their true cost—which makes it very difficult to identify real, unsubsidized demand for AI and to forecast sustainable unit economics. AI usage today is, in large part, a subsidized experiment rather than a proven, profitable business model.
At the same time, the four public hyperscalers (Amazon, Alphabet/Google, Meta, and Oracle) have guided to roughly 550 billion dollars of combined AI‑related capital spending in 2026—an unprecedented figure. Investors are increasingly asking whether these firms—and the large private players like OpenAI and Anthropic—can earn acceptable returns on that investment, and how much of today’s AI ecosystem is actually profitable once subsidies, underpriced tokens, and promotional usage caps are stripped away.
Finally, private credit has become a major source of funding for AI companies and their capital‑intensive data center build‑out. BIS and industry estimates suggest private credit now has more than 200 billion dollars in outstanding loans to AI-related companies, with that figure projected to rise to 300–600 billion dollars by 2030. Recently, however, the private credit sector has run into trouble: defaults are rising, several funds have faced redemption pressure or imposed withdrawal limits, and investors are questioning dubious valuation marks and loan quality.
Given that the AI build‑out will likely require well over 3 trillion dollars in additional capital over the coming years, stress in private credit—via higher defaults and investor redemptions—will push up the cost of capital for AI companies and increase the risk of slower capex growth, more project delays, or outright cancellations. If financial conditions tighten and data center growth slows, the AI stock bubble—and the growth it has been propping up—will be at risk.
The AI boom has also powered a massive stock market rally over the past three years, creating a “wealth effect” that represents our third unsustainable growth driver. AI mania—amplified by the Fed’s extremely loose post‑pandemic financial conditions—has pushed both stocks and home prices to record highs. Because the top 10% of households own roughly 85–90% of publicly traded equities and a disproportionate share of housing, they feel wealthier as asset values increase and they spend more.
Today, nearly half of all U.S. consumer spending comes from the top 10% of earners, a sharp increase from prior decades and a sign that growth is unusually dependent on the behavior of a relatively small, affluent group. In our view, the Fed’s profligate post‑pandemic policies have fueled asset bubbles in both financial markets and housing; when those bubbles inevitably deflate, the households that have been driving this “wealth effect” will reduce spending, leaving an already uneven economy even more vulnerable.
While the S&P 500 reached an all-time high this week, the University of Michigan Consumer Sentiment Index collapsed to a record low of 49.8 in April — the weakest reading since the survey's inception in 1978. This striking divergence perfectly illustrates our longstanding view: years of wasteful post-COVID government spending and the Fed's reckless monetary policy inflated asset bubbles and drove inflation higher, making most Americans feel as if we were in a recession.
Wall Street versus Main Street: While the S&P 500 reached a record high this week, the University of Michigan Consumer Sentiment Index hit an all-time low, illustrating our view that the Fed’s policies that created asset bubbles and inflation have hurt most Americans.
The war with Iran and the closure of the Strait of Hormuz triggered a classic oil shock. Roughly 20% of the world’s oil consumption moves through this narrow chokepoint, and nearly three weeks after the ceasefire, the Strait remains closed, and oil prices are still about 60% above their pre‑war level. While ebullient equity investors pushed the S&P 500 to a record high after the ceasefire, believing the war was over and the resilient economy would absorb the energy shock, we are concerned that higher oil prices can act as a catalyst for major economic problems. In fact, 8 of the past 14 oil shocks (oil jumps by 50% year over year) led to a recession, and every U.S. recession since 1970 has been preceded by a material rise in oil prices.
In our view, the economy has too much debt and too little underlying growth to comfortably absorb a sustained oil shock. Over the past year, overall payrolls have been essentially flat—up just 0.16%—and from March 2025 to March 2026, health care and social assistance alone generated roughly 680,000 new jobs, more than the entire net gain in U.S. employment, while the rest of the economy, in aggregate, lost jobs. The credit‑sensitive, cyclical parts of the economy have shown little growth, and we are concerned that this oil shock could be the catalyst that tips them into a downturn.
In 8 of the 14 historical episodes where oil prices spiked more than 50% year‑over‑year, a U.S. recession followed within the next two years -- a pattern that underscores how dangerous today’s oil shock could be for the economy.
Source: FRED/Yahoo Finance, and recession dates from NBER
Employment growth has slowed to 0.16% over the past year, significantly below its 65-year average growth rate of 1.67%. Over the past year, health care and social assistance created roughly 680,000 jobs—more than the entire net gain in U.S. employment—while the rest of the economy, in aggregate, shed jobs.
Source: FRED
In summary,
- Even before the war with Iran and the ensuing oil shock, we were concerned that U.S. growth was narrow and fragile: more than 100% of net job creation over the past year came from the non‑cyclical health care sector, and the economic expansion rested on three unsustainable pillars—near‑record peacetime budget deficits, an AI capex boom, and consumption increasingly driven by the wealthiest 10% who benefit most from the AI boom and Fed‑inflated asset bubbles.
- In the first quarter, there were mounting signs that the AI capex cycle is becoming harder to sustain, and we are concerned that persistently higher oil prices could be the catalyst that bursts the AI bubble and pushes the credit‑sensitive, cyclical parts of the economy into contraction.
Stock Market Outlook:
The stock market, in our view, still offers a poor long‑term risk‑reward. The S&P 500 is extremely overvalued, with elevated concentration risk, as 10 mega-cap technology stocks account for 38.6% of the index's market value. While stocks are priced for perfection, Wall Street’s EPS growth estimate of 18.6% in 2026 and 16.1% next year looks wildly optimistic, especially given the energy shock, higher interest rates, and anemic labor market growth.
The S&P 500’s surge to new highs after President Trump’s ceasefire announcement has been driven largely by a narrow group of AI‑linked names, and in our view, the combination of aggressive earnings assumptions, concentrated leadership, and AI‑driven narrative chasing has all the hallmarks of late‑cycle speculative behavior rather than a healthy, durable bull market.
Finally, the S&P 500 has reached a new record high as investors believe the war is effectively over and that elevated oil prices will not seriously damage the economy. We see it differently. In our view, the index is being driven by an AI-driven bubble that has become increasingly detached from underlying macro fundamentals. We continue to believe the oil and bond markets offer a cleaner read on the true economic backdrop — and both crude prices and bond yields remain meaningfully above their February lows. History also offers a cautionary rhyme: during the 1973 oil embargo, stocks fell sharply after the embargo ended, as the economy rolled over into recession.
The S&P 500’s April surge looks narrow and speculative rather than healthy and durable. The index rallied 9.3% in April to a new all‑time high, but the largest 15 technology names alone contributed roughly 7 percentage points of that gain—about three‑quarters of the move—which underscores how dependent the rally has become on a very small group of AI stocks. Tech was also the only sector to set a new high alongside the index, while key cyclical areas like financials remain stuck below their 200‑day moving averages, a troubling signal given that a healthy financial sector is usually critical for sustainable economic growth.
Source:Stockmarketcharts.com
Market breadth during this three-week rally has been weak, which is a significant negative. Only about 53% of S&P 500 stocks are trading above their 50‑day moving average, and just 57% are above their 200‑day, even as the S&P 500 sits at a record high. Under the surface, leadership is even narrower: roughly 4% of NYSE stocks are making new highs today, compared with about 15% at the S&P 500’s January peak and 23% at the December 2024 high—another sign that this advance is being driven by a relatively small group of names rather than broad, healthy participation.
Source:Stockmarketcharts.com
Also, meme stock mania returned during the market's three-week rally. Allbirds, the defunct shoe company, rebranded itself as “NewBird AI” and announced a pivot into AI compute infrastructure—despite having no operating history in that business—and the stock promptly exploded, rising about 1,000%.
Source:Stockmarketcharts.com
Avis Budget Group, the rental car company, is another example of the mania and speculative excess in the three-week rally. A highly leveraged car rental company with a tough, cyclical business suddenly morphed into a meme stock, and its shares spiked about 900% in a matter of weeks due to a short squeeze and retail FOMO, rather than any meaningful change in fundamentals.
Source:Stockmarketcharts.com
These kinds of moves are classic late‑cycle tells. When a defunct sneaker brand can rename itself an “AI company” and a heavily indebted car rental company can rocket 600–700% on a short squeeze, only to crash more than 70% in days, it suggests prices are being driven by narratives and positioning, not by fundamentals or durable value creation. In our view, BIRD and CAR are not isolated events; they are symptomatic of an environment in which speculative froth has reached levels historically associated with market peaks rather than the early stages of a new, healthy bull market. The subsequent 70%+ collapses from the peak were just as swift, underscoring how much of the move was pure positioning and narrative, not durable value creation—exactly the kind of late‑cycle behavior that tends to accompany market tops.
The 1973 Arab oil embargo — a sudden cutoff of oil exports to the U.S. and its allies — caused prices to quadruple virtually overnight, triggering severe fuel shortages across the country. The shock sent stocks into a deep bear market, with U.S. equities losing roughly half their value between early 1973 and late 1974 — and notably, the worst of the decline came after the embargo formally ended in March 1974. The economy fared no better, sliding into a stagflationary recession from late 1973 to early 1975, defined by weak growth, surging inflation, and rising unemployment. Today, while much of the market's attention remains fixed on the S&P 500 and AI stocks, we believe oil prices remain the more telling fundamental signal — just as they were in 1974.
Sources: S&P 500 daily closes via Yahoo Finance (^GSPC). Oil prices: Saudi Arabian Light posted price perFederal Reserve History — Oil Shock of 1973-74OPEC archives.
Two robust long-term valuation models—Market Value to GDP and Shiller’s CAPE—indicate that the S&P 500 is projected to deliver annual returns between -3.4% and 1.4% over the next decade. Given that 10-year Treasury Inflation-Protected Securities (TIPS) currently yield a real return of 1.94%, equities are substantially overvalued and present an unattractive risk premium.
Market Value to GDP – "Still, it is probably the best single measure of where valuations stand at any given moment." –Warren Buffett, December 10, 2001. Based on market value relative to GDP, stocks are more than 100% above their historical average and more expensive than they were during the 2000 technology bubble. Over the next ten years, the model forecasts an annual return of -3.4% for the S&P 500.
Source: Longtermtrends.com, Allocate Smartly
Shiller's CAPE (a valuation measure that smooths out cyclical earnings fluctuations) indicates that stocks are more than 90% above their long-term average, and the 10-year expected return is about 1.4% per annum. Since the 10-year Treasury Inflation-Protected Securities (TIPS) yield a real return of 1.92%, the S&P 500 offers an inadequate risk premium.
Source: Longtermtrends.com, Allocate Smartly
In summary:
- We continue to believe the U.S. equity market offers poor long-term risk-reward. The S&P 500 is extremely expensive and dangerously concentrated, with roughly 10 mega‑cap technology stocks accounting for close to 40% of the index. Additionally, Wall Street continues to forecast highly optimistic earnings growth despite an economy navigating an energy shock, elevated interest rates, and a labor market losing momentum.
- Just as troubling, the latest surge to all‑time highs has been narrow, AI‑obsessed, and increasingly detached from underlying fundamentals. Weak breadth, heavily concentrated leadership, and meme‑stock eruptions in names like Allbirds and Avis tell us that this market is being driven more by narrative and positioning than by improving fundamentals. Finally, while much of the market's attention remains fixed on the S&P 500 and AI stocks, we believe oil prices remain the more telling fundamental signal — just as they were in 1974.
Portfolio Review:
The benchmark for our model portfolio is the Traditional Blend — 60% equity and 40% bonds. Our goal is to outperform the benchmark with less risk. To outperform, our investment portfolio is diversified and economically balanced. We eliminate laggards and tilt the portfolio toward our location in the business cycle. Finally, to manage risk, we volatility-weight our positions and set a volatility target equal to our benchmark's historic risk level. When volatility increases, our asset allocation dynamically reduces our equity risk exposure.
As value investors, our asset allocation is driven by long-term valuation measures and the risk-reward opportunities present in the market. Moreover, we analyze the leading economic and market-based indicators to determine the probable path of the rate of change for economic growth and inflation. This enables us to strategically position our portfolio to perform well in all economic environments.
The material in this newsletter is for educational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy, or investment product.
Before the war, our portfolio delivered strong risk-adjusted returns because we were underweight the expensive AI-related technology stocks and were diversified and balanced with international equities, emerging markets, and gold. Additionally, we invested in short-term government notes, which have less inflation risk than longer-term bonds. In March, the war began, and most asset classes, except oil and energy stocks, performed poorly.
We were disappointed with our March results; the portfolio carried more volatility and risk than we are comfortable with, driven primarily by gold. After an exceptional run — gold was up roughly 60% in 2025 and another 20% in January and February — its volatility spiked as prices surged, and then the onset of war turned that elevated volatility into an 11.4% drawdown in March. Historically, gold has been a reliable safe‑haven in periods of crisis, but this time its prior strength set the stage for aggressive profit‑taking once the conflict began.
Our mistake was not reducing the position when volatility exploded in January. Our framework is built around risk allocation, not dollar allocation, which means we reduce position size as volatility rises. In gold, we let our historical expectations — “gold usually does well in geopolitical shocks” — override our discipline. Rather than trying to anticipate how gold would behave this time, we should have simply followed our process and reduced the position.
In January, gold rallied 13%, and its implied volatility spiked to 50%, more than 5 standard deviations above its long-term average. This was a clear signal to reduce our gold position.
Source:Stockmarketcharts.com
We believe we are in a very high-risk environment and that the risk-reward in equities is poor. Stocks are effectively priced for perfection, with investors crowding into AI‑related names while largely ignoring the potential damage an oil shock can inflict on an already fragile economy. No one knows how long the Strait of Hormuz will be disrupted or whether the current energy shock will tip the world into recession. Rather than trying to predict the outcome, we are sticking to our value‑driven investment framework.
Today, we are underweight equities because their long‑term risk‑reward is unattractive, and the recent rally’s narrow breadth reinforces our caution. In a regime of modest growth and rising inflation, we prefer assets that have historically done well in similar environments: international and emerging‑market equities that benefit from dollar weakness, value stocks that tend to outperform when inflation is higher, hard assets such as gold and commodities that act as direct inflation and weak‑dollar hedges, and short‑duration fixed income to help mitigate inflation and interest‑rate risk. If the energy shock evolves into a full‑blown crisis and the economy slides toward recession, our focus on managing portfolio volatility and pruning weak positions will help us preserve capital through what could be a very challenging period.
We plan to maintain a highly diversified and balanced asset allocation until economic uncertainty diminishes and equities present a more favorable risk-reward opportunity.
