Q1 2026 Market Review: Rotation Into Value Continues
Executive Summary
The first quarter of 2026 delivered a continuation of the rotation trade that began in late 2025. Value stocks outperformed growth by 340 basis points, while small caps narrowed the gap with large caps for the third consecutive quarter. International equities led all major asset classes as the dollar weakened and European fiscal policy expanded.
Our model portfolio gained 5.8% in Q1, outperforming the S&P 500 by 160 basis points. The primary drivers were our overweight in international developed markets (+180bps contribution) and commodities (+95bps), partially offset by our underweight in mega-cap growth (-55bps).
Asset Class Performance
The quarter saw a meaningful shift in market leadership. For the first time since 2017, non-US equities outperformed US equities in dollar terms for three consecutive months. This wasn't just a currency effect — local-currency returns in Europe and Japan also led the US.
Q1 2026 Returns by Asset Class
| Asset Class | Q1 Return | YTD | 1Y Return | Signal |
|---|---|---|---|---|
| S&P 500 | +4.2% | +4.2% | +18.4% | Neutral |
| Russell 2000 | +6.8% | +6.8% | +22.1% | Bullish |
| MSCI EAFE | +5.1% | +5.1% | +14.2% | Bullish |
| MSCI EM | +3.9% | +3.9% | +11.8% | Neutral |
| US Agg Bond | -1.2% | -1.2% | +2.1% | Bearish |
| US High Yield | +1.8% | +1.8% | +8.9% | Neutral |
| Gold | +8.4% | +8.4% | +24.6% | Bullish |
| Crude Oil | +3.2% | +3.2% | -2.1% | Neutral |
| Bitcoin | +12.3% | +12.3% | +68.4% | Bullish |
Key Themes
Three structural themes dominated the quarter and will likely persist through the remainder of 2026:
1. The Fed's Deliberate Patience
The Federal Reserve cut rates by 25bps in January, bringing the target range to 4.50-4.75%. But the accompanying statement was notably more hawkish than markets expected, with Chair Powell emphasizing that the pace of future cuts would depend on "continued progress" in inflation data. Markets repriced from four expected cuts to two, driving the 10-year yield from 4.05% to 4.18%.
The labor market remains the Fed's primary concern. Non-farm payrolls averaged 185K per month in Q1, above the ~100K threshold the Fed considers consistent with stable unemployment. Average hourly earnings growth reaccelerated to 4.1% YoY in March, complicating the inflation outlook.
2. European Fiscal Expansion
The most consequential macroeconomic development of the quarter wasn't a data point — it was the EU's landmark fiscal framework reform. The relaxation of the Stability and Growth Pact, combined with Germany's new infrastructure spending program, represents the most significant European fiscal stimulus since the post-COVID recovery fund.
European equities responded immediately. The Euro Stoxx 50 gained 7.2% in Q1, led by financials (+11.4%) and industrials (+9.8%). We believe this is the early stages of a multi-year re-rating as investors recognize that Europe is transitioning from a deflationary, austerity-driven economy to a more balanced growth model.
3. The Hard Asset Bid
Gold, copper, uranium, and agricultural commodities all posted strong gains. This isn't speculative froth — it reflects a structural shift in central bank reserve management (away from US Treasuries, toward gold), a physical supply deficit in industrial metals, and geopolitical risk premia that show no signs of fading.
Copper deserves special attention. The metal broke above $5.00/lb for the first time, driven by a combination of Chinese infrastructure stimulus, EV-related demand growth, and constrained mine supply. We've been bullish since $4.20 and maintain our $6.00 target for year-end.
Sector Analysis
What Worked
- Financials (+8.6%) — Benefiting from steeper yield curves, improving credit quality, and share buyback programs. European banks led, with UniCredit (+14%) and BNP Paribas (+12%) among our top performers.
- Energy (+7.1%) — Despite flat oil prices, the integrated majors traded higher on capital discipline and growing free cash flow yields. Shell's buyback program alone accounted for 2% of its outstanding shares in Q1.
- Materials (+6.4%) — Commodity price tailwinds plus improving Chinese demand. Our overweight in copper miners (Freeport-McMoRan, Teck Resources) added meaningfully to performance.
What Didn't Work
- Technology (+2.1%) — The Magnificent 7 underperformed the equal-weight S&P 500 for the second consecutive quarter. Valuations remain stretched, and the market is questioning the pace of AI monetization relative to capex spending.
- Utilities (-0.8%) — Rate-sensitive sectors suffered as the long end sold off. The 10-year yield moving from 4.05% to 4.18% was enough to push utilities into negative territory.
Model Portfolio Update
Current Allocation
| Asset Class | Weight | Benchmark | Active | Q1 Contribution |
|---|---|---|---|---|
| US Large Cap | 20% | 35% | -15% | +0.84% |
| Int'l Developed | 22% | 12% | +10% | +1.12% |
| Small/Mid Cap | 12% | 5% | +7% | +0.82% |
| EM Equity | 6% | 5% | +1% | +0.23% |
| Core Bonds | 12% | 28% | -16% | -0.14% |
| TIPS | 10% | 5% | +5% | +0.38% |
| Commodities | 12% | 5% | +7% | +0.95% |
| Gold | 6% | 5% | +1% | +0.50% |
Q2 Outlook and Positioning
We enter Q2 with a constructive but selective stance. The macro backdrop supports risk assets — global growth is accelerating, central banks are easing (or pausing at restrictive levels that will eventually normalize), and corporate earnings are growing. But valuations in US large-cap are stretched, and the market is priced for a soft landing with very little margin of error.
Key Changes for Q2
- Adding to Japan: The Bank of Japan's gradual rate normalization, combined with corporate governance reforms, makes Japanese equities one of the most compelling opportunities in global markets. We're increasing our Japan weight from 5% to 8%, funded from US large-cap.
- Reducing high-yield credit: Spreads at 290bps over Treasuries don't compensate for recession risk. We're trimming HY to fund TIPS.
- Maintaining commodity overweight: The structural supply deficit thesis remains intact. No changes.
The regime change from growth-at-any-price to quality-value is not a rotation — it's a reversion to long-term mean. Allocators who built portfolios during the zero-rate era must recalibrate. The next decade will reward diversification, discipline, and a willingness to look beyond US mega-cap.
Disclaimer: This research is provided for informational purposes only and does not constitute investment advice. Past performance is not indicative of future results. See our full disclosure at the bottom of this page.