Navigating the Storm – Resilience in the Face of Geopolitical and Technological Disruption

The first quarter of 2026 tested investor discipline in ways that few had anticipated at the year's outset. What began as a continuation of the constructive environment established in 2025 evolved into a quarter defined by two powerful and unexpected forces: the outbreak of military conflict with Iran and the accelerating debate over what artificial intelligence will ultimately mean for the technology sector. Despite these headwinds, markets demonstrated a remarkable degree of underlying resilience, and investors who remained focused on fundamentals rather than headlines found real opportunities within the volatility.

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The broad-based Standard & Poor's 500 Index (S&P 500) posted a total return of approximately -4.3% for the quarter — its weakest three-month performance since 2022. Yet beneath that headline number, the story was more nuanced. The average stock within the index actually outperformed the cap-weighted result by nearly 5%, as market leadership broadened meaningfully away from the mega-cap technology names that had dominated the prior two years. Small-cap stocks, as measured by the Russell 2000, eked out a modest gain of approximately +0.9% for the period, and value stocks outpaced growth in each of the three months. This rotation reflects the kind of environment in which careful individual stock selection can add meaningful value, a principle that is consistent with our core competency.

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Amid the turbulence, we remained disciplined — trimming positions that had reached full valuation and selectively adding to names we believe were unfairly caught in the crossfire of macro-driven selling. Our focus, as always, remained on companies with durable free cash flow, strong balance sheets, and clear earnings visibility.

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Energy, Geopolitics, and the Rate Cut That Wasn't

The defining macro event of the quarter arrived in late February with the onset of U.S.-Israeli military operations against Iran. The financial market consequences were swift and significant. Iran's disruption of oil flows through the Strait of Hormuz — a critical chokepoint for global energy supply — triggered the largest quarterly surge in oil prices in decades. U.S. crude futures rose approximately 77% over the quarter, ending March above $100 per barrel for the first time since 2022. Gasoline prices followed, with the national average climbing to $4.02 per gallon by quarter-end.

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The energy shock had a cascading effect on the Federal Reserve's policy thinking. Coming into 2026, investors had broadly expected one to two rate cuts over the course of the year, a reasonable expectation given the inflation progress made throughout 2025. Those expectations were dramatically repriced as oil-driven inflation re-entered the picture. By March 31st, futures markets were pricing in zero rate cuts for all of 2026 — a remarkable pivot from expectations just 90 days earlier. Bond yields rose in response, creating an additional valuation headwind for equity markets broadly, and particularly for rate-sensitive sectors.

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This dynamic reinforced a lesson we have observed many times: monetary policy expectations can shift quickly, and portfolios built on the assumption of a specific rate path are inherently fragile. Our emphasis on companies that generate substantial free cash flow and carry manageable debt levels is designed to navigate these kinds of shifts without requiring a precise macro forecast.

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The AI Question: Creative Destruction Comes to Technology

The second major force shaping the quarter was the evolution of investor thinking around artificial intelligence — specifically, the growing recognition that AI's disruptive potential extends not only to legacy industries, but to many of the high-multiple software and technology companies that had been its greatest beneficiaries. If AI tools can meaningfully reduce the cost of building and deploying software, automating workflows that once required expensive enterprise subscriptions, then the long-term revenue models of many established software businesses, especially Software as a Service (SaaS), come into question. We are monitoring this situation very closely.

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This thesis weighed heavily on the sector. Prominent software names declined anywhere from 10% to 60% or more from their prior highs. Even companies more directly tied to AI infrastructure were not immune, posting meaningful declines as investors recalibrated expectations around the pace and sustainability of capital spending plans that had approached $700 billion annually. The technology sector moved from trading at a premium to being somewhat undervalued relative to our internal assessments of intrinsic worth.

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We believe the market's reaction to this theme has, in several cases, been excessive. There is no denying that the AI buildout is real, the productivity gains are real, and the hyperscalers' capital expenditure plans for 2026 are, if anything, larger than previously expected. The question of who ultimately captures the economic value created by AI is a legitimate one — but it will be answered over years and decades, not in a single quarter. We have used this dislocation as an opportunity to selectively add exposure to companies where we believe valuations have overshot to the downside, maintaining ample exposure to the “pipes and plumbing” of the infrastructure buildout, as well as software names poised to benefit from the AI theme.

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Sector Performance – Where the Action Was and Wasn't

Energy was the quarter's decisive winner, with the sector rising approximately 34% to 38% depending on the index measured — its strongest quarterly performance in four years. Major integrated oil companies surged, and energy-related names across the materials and industrials sectors benefited as well. Defense companies, fertilizer producers, and other businesses with direct or indirect exposure to geopolitical disruption also outperformed. Utilities and consumer staples, traditional safe havens, held their ground reasonably well as investors sought defensive positioning.

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On the losing side, the damage was concentrated precisely in the areas where the twin forces of AI disruption and rising rates hit hardest. Technology was the largest drag on the index at the individual stock level, with the sector's biggest names accounting for a disproportionate share of the S&P 500's decline given their outsized index weights. Communication services fell sharply due to concerns about advertising spending and AI competition. Financial services suffered as rising rates pressured net interest margin outlooks and concerns around consumer spending resurfaced. Consumer discretionary was also a notable underperformer, reflecting the direct burden that higher gasoline prices place on household budgets.

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Current Conditions and the Setup for the Balance of 2026

As we move into the second quarter, the fundamental picture for U.S. equities is more constructive than the first quarter's performance might imply. Corporate earnings have, somewhat surprisingly, proven resilient — consensus earnings estimates for 2026 have been revised modestly higher since the conflict began, reflecting a baseline expectation that geopolitical tensions will find some path toward resolution. The S&P 500 now trades at approximately 19 times forward earnings, a meaningful de-rating from the 23-plus multiple of late 2025, and growth stocks specifically are trading at discounts to fair value not seen since the 2022 bear market trough.

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Presently, there is no shortage of risks the equity market must deal with. In addition to a prolonged disruption to the Strait of Hormuz, and the AI and Software valuation reset, stress in private credit has been a “top of mind” concern for many investors. Private credit defaults hit a record 9.2% in 2025, and in early 2026 major firms specializing in this asset class faced rising redemption pressures and scrutiny over liquidity. Private credit grew from roughly $1 trillion to more than $2 trillion in assets over the past several years, and a significant stress event in that space could ripple into public equity markets through forced asset sales, widening credit spreads, and a general repricing of risk.

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The path higher requires a few things to fall into place. A de-escalation in the Iran conflict — or at minimum a reduction in the energy supply disruption — would relieve inflation pressure and restore the Federal Reserve's flexibility to resume gradual rate cuts. A successful first-quarter earnings season, which just started in mid-April, could rebuild confidence in the fundamental underpinning of the market. And continued evidence of AI monetization — of the capital being spent translating into real productivity and revenue gains — would help reestablish a constructive narrative for the technology sector.

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We believe the market's broadening is a healthy development. Three consecutive years of returns dominated by a narrow group of mega-cap technology stocks created concentration risk that was always likely to revert to the mean at some point. The emergence of value stocks and small caps as competitive return sources in early 2026 is the kind of rotation that historically signals the continuation of a bull market rather than its end. It is also the kind of environment that rewards the disciplined, fundamental approach we have practiced for many years.

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Our portfolio construction for the balance of the year will continue to emphasize quality — companies with pricing power, strong balance sheets, and the ability to generate free cash flow across a variety of economic environments. We see selective opportunities in technology names that have been indiscriminately sold, in energy infrastructure, in defense, and in financial services companies with the balance sheet strength to navigate a period of elevated interest rate uncertainty. We will, as always, remain patient and opportunistic, guided by valuation discipline.

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We look forward to communicating our thoughts to you in our next quarterly correspondence. As always, we appreciate your trust.

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For questions, please contact:

Marshall Kaplan, mkaplan@ingalls.net 212-269-0264

Rochelle Wagenheim, rwagenheim@ingalls.net 212-269-0265

Michael Nelson, mnelson@ingalls.net 212-269-9785

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