Here It Goes Again

Just when you think (think) you’re in control
Just when you think (think) you’ve got a hold
Just when you get on a roll
Here it goes, here it goes, here it goes again

“Here It Goes Again”, OK GO

Never does Yogi Berra’s quip, “It’s tough to make predictions, especially about the future,” feel more relevant than when constructing an economic and market outlook when shrouded in the fog of war.

On Wednesday, we presented our 2Q26 Outlook (you can access the charts here and access the replay of the webinar here) and we greatly appreciated Mr. Berra’s prediction empathy as markets were moving quickly on the back of headlines about a potential ceasefire with the war.

We titled the outlook “Here it Goes Again”, reminding us of those simpler 2000’s times when four bandmates doing a silly dance on treadmills was the most popular video on the Internet, but mostly to communicate the state of being in yet another supply shock, the fourth major supply shock that the global economy has had to withstand in the last six years alone.

It may be tempting to write off these supply shocks as inconsequential to markets. After all, equity market returns have been extraordinary in the past six years (the S&P 500 has delivered 13% annualized returns since the start of 2020, above the index’s long-run rate of return), while today’s S&P 500 is a mere -2.6% down from all-time highs, despite the ongoing and record-setting disruption to global oil markets.

But just as equities have remained resilient in the face of seemingly unprecedented disruptions becoming regular-occurring precedents, we have seen both casualties and champions emerge from these shocks. A casualty has been the end of the 40-year bull market in bonds, while a champion has been the start of a bull market (with to-be-seen duration) in commodities.

So, when we think about the resilience of equities and credit given this backdrop of unprecedented precedents, we much appreciate that this risk-asset durability is partially due to policies that have kept liquidity abundant and idiosyncratic drivers (such as technology/AI) that have allowed for valuations and earnings to defy economic gravity.

Building on the supply shock observations, in our outlook, we introduce a concept that we call “The Revenge of the Real World” and argue that we are in “Episode 3” of this saga. This is a topic we will be writing about in much greater detail in the future, but the quick take is that we are now in the third period in the last 50 years of major market and economic rotations driven by events like supply shocks, fiscal dominance, and the unwind of large concentrations in major equity market indices.

You will hear us talk much more about these bigger tectonic shifts in upcoming work, but for now, we also must spend some time focusing on the tactical drivers that are impacting markets in shorter time horizons. For this analysis, please see the summary below of our key points from the outlook that can accompany the charts or webcast:

War and Its Discontents

• News around the fragile ceasefire in the Iran War continues to drive markets and create daily volatility. We are focused on a small number of factual questions to evaluate the extent of the war’s impact on the macro picture and broader financial markets. Chief among these are 1) whether oil and gas tankers are transiting the Strait of Hormuz; and 2) whether energy infrastructure in the region remains under threat and largely shut down for new production.

• The war’s major economic impact shows up in higher transportation costs, which cause households to spend more on gasoline and businesses to spend more on shipping. The latter will likely show up in higher goods prices, including food.

U.S. Economy

• The U.S. economy was in reasonably good shape prior to the war, with business sentiment showing improvement and orders for new capital goods strengthening. The major exceptions are the U.S. consumer and labor market, where data is mixed to negative.

• Avoiding a worst-case scenario for energy supply helps to avoid a worst-case scenario for global growth, but there will be lingering impacts of the war on inflation and growth.

• Labor Market: We see a “low hire, low fire” employment market remaining, with very few jobs needed to hold the unemployment rate steady due to a shrinking labor force; weak job growth results in further softness in wage growth.

• Inflation: Headline inflation will jump higher on higher energy costs, while core inflation will likely remain high and sticky, despite subdued wage growth.

Policy

• We see the Fed remaining on “hold” with rates in the face of rising headline inflation and core inflation that remains above their 2% target. We see the Fed’s role in a supply shock to be simply “don’t make it worse”, which means the Fed must be careful to keep inflation expectations anchored, as they currently are today. If the Fed cuts rates with the current backdrop, it likely would do little to help the labor market, but it has a greater risk of deanchoring inflation expectations, which could require rate hikes to regain control. Thus, we see the Fed on hold until either inflation crests or the labor market weakens enough to justify them prioritizing full employment over stable prices in their dual mandate.

• Benefits from the OBBB are almost fully offset by higher energy prices.

Fixed Income

• Fixed income markets had a tough Q1, with rates rising sharply in March on fears that higher energy inflation would keep central banks from reducing interest rates. This has created limited opportunities in the riskier parts of the bond market (e.g., corporates) but especially good risk-adjusted returns in the municipal market.

Equities

• In the short term, equity markets face the push-pull between earnings estimates that remain very optimistic for 2026 and 2027, creating a high bar for upside surprises and the potential for volatility, and institutional investor positioning that is now underweight (in the 20th percentile on the Deutsche Bank Consolidated Equity Positioning), which creates the conditions for a “chase” higher in markets if geopolitical news/energy prices remain supportive.

• We remain constructive on equities for long-term investors; however, as we said entering the year, the prevailing environment of an aging bull market and increased volatility warrants a more disciplined investing strategy relative to prior years…playing a more “conservative shot” using our golf analogy from the 2026 Outlook.

• Ultimately, this means capitalizing on the benefits of diversification, prioritizing higher quality, more durable growers within equities and remaining disciplined amid heightened volatility (being opportunistic around pullbacks and looking to rebalance concentrated and extended positions).

• We continue to see supportive trends under the surface, including broadening earnings growth, positive earnings revisions, and healthy earnings momentum, all factors that can support the continuation of the equity bull market. However, we recognize that these trends may begin to waver as the economic and inflationary impacts of geopolitical tensions present a more challenging operating environment. This headwind, combined with lofty expectations, full valuations, and recent above-trend performance, ultimately makes the risk/reward in equities slightly less optimal.

• Overall, we expect positive but more modest returns in equities over the coming quarters, with increased dispersion and performance largely driven by fundamentals and underlying earnings growth. Those companies that can continue to deliver on expectations are likely to be rewarded.

• While we can’t rule out the potential for further multiple compression, the recent rerating, combined with healthy underlying earnings momentum, is providing a more attractive entry point for long-term investors. Historically, buying into periods of geopolitical and policy uncertainty has rewarded investors with returns that skew positive and above average over the subsequent years, considerations that further support our disciplined but opportunistic positioning in equities as we look ahead.

It has certainly been a fascinating start to the year as we continue to experience unprecedented events becoming precedents. We would not be surprised if volatility remains the norm as we move through the second quarter (which should be noted is typically the weakest quarter of mid-term election years, which themselves are the weakest years for equity market returns in the four year election cycle), but will continue to use our tool-kit of disciplined asset-allocation, deep due diligence, and dispassionate analysis to use this volatility as opportunity.

IMPORTANT DISCLOSURES