Market Observations
The first quarter proved eventful for financial markets. Equities began the year on solid footing, with the S&P 500 posting a modest gain in January. However, sentiment deteriorated later in the quarter as geopolitical risks intensified. Escalating tensions in the Middle East culminating in the U.S. Iran conflict and the closure of the Strait of Hormuz drove a sharp surge in oil prices and introduced significant volatility across global markets.

By quarter-end, the S&P 500 had declined -4.3%, with most of the weakness occurring in March. Despite this volatility, there were notable areas of resilience. The average S&P 500 stock outperformed the index by nearly 5%, reflecting broader market participation and less concentration in mega-cap leadership. Additionally, manufacturing data showed early signs of stabilization. In this letter, we review key developments from Q1, examine how higher energy prices influenced interest rate expectations, highlight the benefits of diversification, and outline our outlook for Q2.

Equity Market Performance:

Equity markets entered 2026 with strong momentum and broad participation. That trend shifted in late February as the Iran conflict intensified and oil prices accelerated higher. Volatility rose across both equity and fixed income markets, leading to a correction (defined as a decline of more than 10%) in most major equity indices from their January highs.

Performance dispersion widened meaningfully. Large-cap value stocks and small-cap equities proved relatively resilient, capturing less downside than growth-oriented segments. For example:
• Russell 1000 Value Total Return Index: +2.10%
• Russell 2000 Total Return Index: +0.89%
• Russell 1000 Growth Total Return Index: -9.78%

International equities, which also started the year strongly, faced additional headwinds from a strengthening U.S. dollar and higher energy prices. As a result, global ex-U.S. equities declined in March and finished the quarter modestly lower (MSCI ACWI ex-USA Index: -0.71%).

Fixed Income and Credit Markets:

In March, bonds exhibited an unusual positive correlation with equities, declining alongside stocks, though to a lesser extent. Core bonds fell -1.76% during the month, bringing the Bloomberg U.S. Aggregate Bond Index to -0.05% for Q1. This weakness reflected rising inflation expectations tied to higher energy prices and the diminished probability of near-term rate cuts.

Within credit markets, private credit continued to face pressure as investor redemptions increased. After several years of substantial asset growth, investors grew more cautious toward the asset class amid tighter financial conditions and elevated uncertainty.

(MSR) Mortgage Servicing Rights Insights

Mortgage Servicing Rights (MSR) demonstrated robust fair values and high trade activity throughout Q1 2026, though performance was marked by extreme volatility in the final month of the quarter.
• High Liquidity: Bulk MSR trade activities remained robust and active during the start of the year.
• Major Transactions: A significant deal occurred in early 2026 when PennyMac Financial Services Inc. acquired $740 billion in mortgage subservicing rights from Cenlar Capital Corporation, making PennyMac the second-largest mortgage servicer in the U.S..
• Trade Multiples: Bulk portfolios generally traded at servicing fee multiples between 5.00x and 5.50x.
o Government MSRs: Traded at approximately 4.00x.
o Newer Conventional (2024-2025): Traded between 4.00x and 4.50x.

• Early Stability: In January, MSR fair values remained resilient against minor mortgage rate and float income volatility.
• Quarter-End Decline: By late Q1 (February 28 marks), fair values experienced slight declines due to weaker mortgage rates and lower float income rates.
• Rate Volatility: After a decline to 6.008% in late February 30-year fixed mortgage rates reversed course, rising over 30 basis points to 6.34% by late March due to global political and economic turmoil.
• Float Income: Escrow float income values, the second largest contributor to overall MSR value, declined in late Q1 following a 14.6 basis point drop in the float income rate.
• Prepayments: Prepayment speeds showed a slight increase in February, particularly for 2023–2025 vintages, before higher rates in March began dragging refinance volume downward again.

Outlook for Q2

Looking ahead, developments in the Middle East remain the most critical factor shaping the near-term outlook. The Strait of Hormuz remained closed at quarter-end, with negotiations ongoing. Any progress toward reopening the passage would likely ease energy prices, reduce inflation pressures, and give the Federal Reserve greater flexibility on interest rate policy. Conversely, a prolonged disruption would allow elevated oil prices to more fully filter through the broader economy, potentially weighing on consumer spending and business investment while keeping inflation stubbornly high.

Investors will continue to closely monitor the risk of a sustained oil supply shock, as prolonged disruptions could push energy prices even higher. Elevated energy costs have already driven short-term inflation expectations higher and are likely to keep the Federal Reserve on hold, limiting the prospect of interest rate cuts in the second quarter and beyond. Adding to near-term uncertainty, U.S. midterm elections are approaching a period that has historically been associated with increased short-term equity market volatility.

Beyond geopolitics, investors are also watching relative weakness in Technology and AI-related stocks. Expected AI-related capital expenditures for 2026 climbed to an estimated $700 billion but may now be showing signs of peaking. Related pressures are evident in the private credit market, which has expanded rapidly over the past five years and is now facing greater scrutiny amid tighter financial conditions.

Despite these headwinds, corporate earnings expectations remain resilient. Consensus forecasts currently call for nearly 13% earnings growth in Q1 2026, with results to be reported during the second quarter. To date, earnings expectations have largely withstood the energy shock, likely reflecting market assumptions that supply disruptions will be resolved in a timely manner.

The statements expressed herein are as of the date published, are subject to change at any time based on market or other conditions and are based on information from sources believed to be reliable. This publication is intended merely to highlight issues and is not intended to be comprehensive or to provide advice. Permission is given for personal use only. Any reproduction, modification, distribution, transmission or republication of the content, is prohibited.