Lemming definition: A lemming is a small rodent, usually found in or near the Arctic in tundra biomes.
What does it mean to call someone a lemming?
"Lemming" slang is a derogatory term for a person who mindlessly follows the crowd, trends, or a leader, often to their own detriment, lacking individual thought or judgment.
Just as our furry friends, the lemmings, have a reputation of running to and fro searching for food and new habitat, the first quarter of 2026 saw volatility surge as investors reacted aggressively to every economic and geopolitical news report as well as to Presidential social media commentary. Stocks were pressured as military conflicts (and the associated ramifications to the economy by virtue of much higher oil prices) combined with more traditional market concerns of overvalued assets (in private credit) and potentially negative impacts of AI on labor markets’ stability. Fortunately, still-stable economic growth and corporate earnings helped to support markets throughout the quarter.
CBOE Volatility Index
The quarter began with growing hopes that leadership would broaden beyond the mega-cap technology complex and into other areas of the market. In January, investors added investment dollars to international, industrial, energy, small cap, and more defensive value stocks and pulled funds from “Magnificent 7” names. This reflected a market already primed for rotation rather than stable leadership.
That broadening theme did not produce an orderly handoff. Instead, leadership became unstable and highly tactical. On some days, technology and communication services surged, while on other days investors rushed into defensives or commodity-linked groups depending on the latest reading on rates, inflation, war risk, or growth.
The most frustrating feature of the quarter was how frequently price action appeared to follow the headline of the hour. Markets gyrated between fears of higher oil prices and hopes for a diplomatic de-escalation in the Middle East, a pattern that turned ordinary sessions into significant reversals.
Ultimately, the first quarter of 2026 felt less like classic rotation and more like forced repositioning. Traditional sector rotation usually implies a somewhat coherent migration from one part of the cycle to another, but this quarter looked more like investors repeatedly ripping up one playbook and replacing it with another before the ink dried.
The result was a quarter marked by rampant selling, sudden relief rallies, and repeated headline-driven reversals that made conviction hard to maintain and sector leadership unusually fragile.
So where do we go from here?
In light of the war with Iran, rising fuel prices, and worries about the impact of AI and private credit woes, I’ll discuss our take on the economy and markets for this year in the 2026 Outlook section of this report.
First Quarter Performance Review
Market internals and performance in the first quarter were driven primarily by the Iran war, but also by concerns about private credit and potentially negative impacts from AI. Prior market leaders, the Magnificent 7, sharply underperformed the remaining 493 members of the S&P 500 by 10% in the quarter primarily due to worries around lofty spending on AI and the potential impact on the future profitability of those companies.
- On an index level, the three major large cap stock indices finished the quarter with losses. The Nasdaq was the worst performer among them thanks to weakness in AI-related tech and software stocks. Small caps, however, outperformed large caps as the Russell 2000 finished the first quarter with a small gain, as small-cap stocks are generally viewed as more insulated from the headwinds of the first quarter (i.e., geopolitical tensions, private credit worries, AI concerns).
- Turning to value vs. growth, value massively outperformed growth in the first quarter and managed a modest gain, as value-focused strategies benefited initially from a rotation away from tech and towards sectors less exposed to AI. Value stocks also had the benefit of better dividend yield support. Additionally, late in the quarter, value styles benefited from the surge in the lower-multiple energy and materials sectors, which rallied following the outbreak of the Iran war. Tech-heavy growth strategies finished solidly lower for the quarter.
- On a sector level, performance was mixed as six of the 11 S&P 500 sectors finished the quarter with a positive return.
The best-performing sector in Q1, by a large margin, was energy, which surged more than 30% in the first quarter thanks to rising oil prices. The materials sector, which includes companies with heavy commodity exposure, also was a solid performer on rising natural resource prices following the Iran war. Finally, consumer staples and utilities also finished the first quarter with strong gains, as investors rotated to less volatile, more defensive parts of the market.
Looking at sector laggards, the financial sector was the worst-performing S&P 500 sector in Q1 and suffered solid losses, thanks to private credit concerns. The consumer discretionary sector also posted a moderately negative return on worries that higher oil prices would reduce consumer spending. Finally, the technology sector dropped on weakness in software stocks and AI-linked technology stocks.
- Internationally, foreign markets outperformed the S&P 500 and ended the quarter with only a small decline, despite the surge in geopolitical risks. Emerging markets outperformed both developed markets and the S&P 500 and registered only a fractional loss despite a strong U.S. dollar. Foreign developed markets declined in Q1, but only modestly, and solidly outperformed U.S. markets thanks mostly to the smaller weighting of tech shares in foreign indices.
- Commodities were sharply higher in the first quarter thanks to the surge in the geopolitical risk premium following the outbreak of the Iran war. Oil prices hit the highest levels since 2022 thanks to the Iran war and following Iranian attacks on Gulf oil infrastructure, which further reduced global supply. Gold, meanwhile, hit a new all-time high above $5,000/oz. early in the quarter but finished with just a moderate quarterly gain, as the rising dollar pressured gold prices late in Q1.
- Switching to fixed income markets, the leading benchmark for bonds (Bloomberg U.S. Aggregate Bond Index) finished the quarter with a slight loss as bonds were solidly higher mid-quarter but declined in March on rising inflation concerns, as surging oil prices and hotter-than-expected inflation readings reduced expectations for Fed rate cuts. Short-term bills modestly outperformed longer-duration bonds and logged a positive return as they are less sensitive to rising inflation risks compared to longer-duration debt.
- Turning to the corporate bond market, both high yield and investment grade corporate bonds declined slightly in the first quarter as the Iran war and spiking oil prices raised concerns about an economic slowdown. Reflecting general investor anxiety about economic growth given the war and rising oil prices, both lower yielding but higher quality investment grade corporate bonds and high yield bonds (which have a better yield but also more credit risk) experienced similar small losses for the quarter.
| US Equity Indexes | Q1 Return |
|---|---|
| S&P 500 | -4.33% |
| DJ Industrial Average | -3.19% |
| NASDAQ 100 | -5.82% |
| S&P MidCap 400 | 2.50% |
| Russell 2000 | 0.89% |
Source: YCharts
| International Equity Indexes | Q1 Return |
|---|---|
| MSCI EAFE TR USD (Foreign Developed) | -1.12% |
| MSCI EM TR USD (Emerging Markets) | -0.10% |
| MSCI ACWI Ex USA TR USD (Foreign Dev & EM) | -0.60% |
Source: YCharts
| Commodity Indexes | Q1 Return |
|---|---|
| S&P GSCI (Broad-Based Commodities) | 40.02% |
| S&P GSCI Crude Oil | 77.70% |
| GLD Gold Price | 8.55% |
Source: YCharts/Koyfin.com
| US Bond Indexes | Q1 Return |
|---|---|
| Bloomberg US Agg Bond | -0.05% |
| Bloomberg US T-Bill 1-3 Mon | 0.88% |
| ICE US T-Bond 7-10 Year | -0.09% |
| Bloomberg US MBS (Mortgage-backed) | 0.40% |
| Bloomberg Municipal | -0.18% |
| Bloomberg US Corporate Invest Grade | -0.54% |
| Bloomberg US Corporate High Yield | -0.50% |
Source: YCharts
What actions did we take in McKinley Carter portfolios last quarter?
- In our fixed income portfolios, we maintained a shorter-than-benchmark duration to lessen long-term interest rate risk and associated volatility. Also, as corporate high yield spreads over U.S. Treasuries remained compressed (expressing optimism on the economy), we maintained our modest high yield and nontraditional bond allocations.
- In our Earnings Focus and Hybrid models, we removed the iShares Russell Top 200 ETF (IWL) and added the Dimensional US Large Cap Value ETF (DFLV) in order to lessen our “Mag 7” stock exposure in favor of more value-oriented stocks that employ a profitability factor.
- In our ActiveTrack models, we lessened our allocation to the iShares Morningstar Growth ETF (ILCG) and added to our iShares S&P 500 Value ETF (IVE) position to increase our value stock allocation.
- We elected to liquidate our tactical positions in the Carlyle Tactical Private Credit Fund (TAKNX) due to broader concerns related to the private credit industry.
- For our Qualified Purchaser clients (at least $5 million in investments, exclusive of primary residence and business property), we made available offerings of stock of private companies such as SpaceX and other pre-IPO companies through the use of Special Purpose Vehicles (SPVs).
2026 Outlook – Mountains to Climb
Stocks begin the second quarter facing three distinct market headwinds:
- Higher oil prices (a result of the Iran war)
- Credit concerns (emanating from private credit funds)
- Worries that AI, while a transformative technology, could have unanticipated negative impacts on important industries like software providers, the legal profession, insurance, and other financial service providers.
Each of these concerns will need to be resolved if the market is going to fully rebound from the Q1 declines, although it’s important to note that economic growth and corporate performance remained solid in Q1 and that is helping to support markets.
Geopolitically, the focus for markets remains on the price of oil. Elevated oil prices pose a risk for the markets and economy in multiple ways including 1) No Fed rate cuts as the Fed worries higher oil prices may spur inflation, 2) Depressed consumer spending as higher gas prices reduce disposable income and 3) Tighter corporate margins given increased transportation and infrastructure costs. Ultimately, that could lead to stagflation in the economy, which would be negative for most assets.
For geopolitical risks to fully recede, we will need to see a credible ceasefire agreement between all parties (the U.S., Israel, and Iran), transit through the Strait of Hormuz return to something close to pre-war levels and a decline in oil prices back towards pre-war levels. Fortunately, on April 7th, a two-week ceasefire was announced and that brings a glimmer of hope regarding the possibility of a wind down of the war.
Private credit, meanwhile, is evoking memories of the financial crisis amongst more tenured investors, fueling fears that the recent influx of investor capital into private credit funds led to poor investing standards and overvaluation. While analogies to the financial crisis are understandable, it’s important to realize the private credit market is much, much smaller than the markets that caused the financial crisis and Fed officials have recently said they see no indication of a systemic problem. While that is reassuring, private credit concerns are still weighing on the financial sector, which is the second-largest sector in the S&P 500 by weight and an important market leader. An easing of private credit concerns and a rebound in the financials is needed to help the market stabilize further in the second quarter.
Finally, turning to AI, opinions on the impact of AI on the economy and markets have shifted from mostly positive to that of increased skepticism, and there are two main concerns associated with AI currently. Both concerns need to be addressed and countered for AI and the tech sector to fully rebound in Q2.
- First, massive spending on AI infrastructure by large tech companies may ultimately have a poor Return on Investment (ROI) and depress future earnings.
- Second, AI advancements may disrupt entire portions of the economy (such as the software sector) and lead to large job losses that hurt overall economic growth.
Inflation, Interest Rates, and Corporate Earnings
When assessing financial markets, we believe that three guiding factors, which we refer to as the “three legs of the investment stool,” are most important to consider – inflation, interest rates, and corporate earnings. These factors are critical to our assessment of how we should allocate our investments. Analyzing these allows us to cut through extraneous “noise” in the economy and to concentrate on what the data tell us about the investment landscape.
Inflation:
The Federal Reserves’ favorite gauge of inflation is the Personal Consumption Expenditures (PCE) Index. While the Fed’s inflation target is 2%, the PCE Index has run above that target level for several years and has recently been moving up not down as tariffs impact goods inflation. The most recent annual Core PCE (excludes food and energy prices) rose 3.0% in February. Despite the Fed’s focus on “Core” data, they will be sensitive to the likely spike in the “Headline” data when March’s numbers are released this month. Additionally, March CPI data will be released prior to the March PCE number, and the headline number will reflect the impact of the higher oil prices experienced last month as a result of the Iran War and the shutdown of the flow of oil through the Strait of Hormuz.
An indication of how quickly energy prices can move based on a revised outlook for the Iran War was seen on April 8 after the announcement of a two-week ceasefire agreement. While the ceasefire was certainly welcome news, a more permanent cessation of hostilities will be needed to further tamp down oil prices and therefore reduce inflation expectations going forward. We believe this is the most likely scenario and anticipate lower oil prices later in the year.
WTI Crude (May′26)
Interest rates:
As growth in employment slowed in the final months of 2025, the Federal Reserve lowered the Fed Funds rate by 0.25% in September, October, and December. With inflation data remaining above the Fed’s target of 2% due to imbedded inflationary concerns exacerbated by the sharp rise in oil prices because of the Iran War, it seems unlikely that the Fed will lower the Funds rate anytime soon. The Fed Fund Futures index is currently forecasting no rate cuts at all over the next twelve months.
At this point, the only realistic chance for the Federal Reserve to lower short term interest rates would be if the economy experienced a material slowing in job growth and a pickup in unemployment claims data. While the new chair of the Fed (Kevin Warsh) is tentatively scheduled to take over for current chair Jerome Powell in May and has expressed a desire to lower rates to stimulate growth, current inflationary forces may make his task difficult. Warsh's main economic argument for lowering rates is that AI will rapidly make the economy more productive, so much so that it can deliver faster growth without generating inflationary pressures. As the Fed chair has but one of twelve votes on the committee, convincing his peers to ignore current inflation data will be a tall order.
As the Iran War and the associated increase in oil prices have led to an increase in near term inflation fears, interest rates have risen in response. With the 2-yr. and 10-yr. Treasury bond yields having moved up, current interest rates are more attractive for bond investors to put money to work than earlier in the year. For fixed income investments, we prefer bonds that are intermediate in length (4-6 yrs.) as they still represent attractive yields with less principal volatility than longer bonds in the event of rising long-term interest rates. For investors looking for short term investments or money market equivalents, Treasury Bill yields exceed most money market funds’ rates and have the benefit of being state tax free.
Earnings:
While first quarter S&P 500 earnings reports have just begun, each quarter of 2026 is projected to grow earnings by double digits over its respective 2025 quarterly report.
Annual earnings growth expectations for large cap, small cap, and international stocks are solidly in double-digits for 2026 and 2027. If the duration of the Iran War is limited to a few more weeks, we will have greater confidence that these projections are sustainable and any discussions regarding a potential recession will dissipate.
Additionally, U.S. companies’ profit margins lead the world despite tariff concerns. We continue to monitor any corporate earnings estimates changes due to revised company guidance and will adjust our outlook if conditions warrant. Profit margins for international companies continue to move upward as well.
The performance of foreign stocks will likely be favorable this year due to better valuations than U.S. markets, good earnings growth, new economic stimulus plans, and a potentially lower U.S. dollar this year after the Iran War has concluded. However, any prolonged hostilities with Iran will be disproportionately negative on European and Asian equities.
Conclusion
The first quarter did contain several negative surprises for investors, and we begin the second quarter with uncertainty over geopolitics, credit, and AI. But there are also positive factors at work that must be considered, including modest long-term inflation forecasts, a still-resilient economy with low unemployment, and strong corporate earnings growth. Those factors supported stocks in the first quarter and despite volatility and elevated uncertainty, the outlook for the economy and markets is not objectively negative. As we saw firsthand in Q1, the geopolitical and corporate landscape can change quickly.
The Three Legs of the Investment Stool
Inflation – while there are short term inflationary pressures related to tariffs and oil prices, longer term inflation indicators are rangebound and are supportive of equities.
Interest rates – the short term pressures on inflation are reflected in rising bond yields, but we believe these to be temporary and are allowing for opportunistic bond buying. Also, the current level of interest rates is not punitive for stock prices and is, worst case, a “neutral” indicator for equities.
Corporate earnings – very supportive of stock prices at current levels as positive revisions and double-digit growth forecasts bolster prospects. Profit margins have, thus far, been unaffected by tariffs.
Markets traditionally “look through” short-term oil spikes and military conflicts and price in what the economic environment will be six months to a year out. We believe this time will be no different and we maintain our positive bias toward stocks and believe any increase in bond yields presents a buying opportunity for bonds with a four- to six-year maturity.