The first weeks of 2026 offered a deceptively calm start for investors. Equity markets rose on strong Q4 2025 earnings, enthusiasm for AI-driven productivity, and expectations of at least one Federal Reserve rate cut. Value stocks outperformed growth early, while emerging markets, especially Taiwan and South Korea, benefited from AI-related semiconductor demand. Japan’s TOPIX led major markets, up 3.6%, supported by yen weakness and the ruling Liberal Democratic Party’s February election win, seen as pro-stimulus. The FTSE All-Share gained 2.4%, aided by commodity exposure and a softer sterling. However, cracks emerged in mega-cap tech as investors questioned whether hyperscalers could justify surging AI capital spending and deliver returns to shareholders a concern that would intensify throughout the quarter.

Precious metals started 2026 on strong footing, with gold at high levels and silver rising, supported by inflation-hedging demand and industrial use linked to the energy transition. Yet the quarter brought unexpected volatility rather than a steady climb, as both metals saw sharp swings that surprised many systematic and momentum-driven funds. Gold was initially a widely favoured trade, paired with emerging market equities as a hedge against a weaker dollar and geopolitical risk. But when the Middle East conflict broke out and the US dollar surged, these crowded positions unwound quickly, driving simultaneous declines in gold and EM equities. Silver’s higher beta magnified the swings. Despite this, the Bloomberg Commodity Index led the quarter, up 24.4%, driven mainly by energy, while precious metals’ volatility remained a standout story.

The defining macro event of Q1 2026 was the escalation of conflict in the Middle East, which quickly reshaped the investment landscape. The conflict severely damaged regional energy infrastructure and effectively closed the Strait of Hormuz, a critical route for over 80% of Asia-bound global oil and gas. The impact on energy markets was immediate and dramatic: Brent crude surged 63% in March alone, marking the largest monthly increase in 40 years. Grain and other agricultural commodities also jumped, as the Strait is vital for food shipments. The supply shock posed a major challenge for central banks. The Fed, ECB, and Bank of England faced rising inflation while weighing growth support, with the BoE keeping rates steady in March amid unprecedented uncertainty.

The geopolitical shock turned an already uncertain equity market into a highly volatile one. The S&P 500 fell 4.3% for the quarter, but this headline masked extreme internal divergence. BlackRock reported that 74% of its constituents moved more than 5% in either direction, with dispersion reaching the 98th percentile, levels last seen during the Global Financial Crisis. The sell-off was global. The MSCI World dropped 3.5%, while European equities (MSCI Europe ex-UK) fell 2.3%, pressured by soaring gas prices and growth concerns. Emerging markets were broadly flat (-0.1%), though Asia’s oil exposure weighed on some markets, while Taiwan and Korea benefited earlier from AI. In the US, value stocks (+1.3%) outperformed growth (-8.4%), and technology, the most crowded sector early in the year, fell 3.8% in March. Higher-quality tech names held up better, as investors favoured cash flow visibility amid heightened uncertainty.

Government bond markets saw some of the quarter’s most dramatic repricing. At the start of Q1, most major central banks were expected to cut rates multiple times in 2026. By March, markets had sharply reversed, pricing in potential rate hikes, triggering notable losses across sovereign bonds. UK Gilts fell 2.0%, the worst-performing major market, while European bonds declined 0.6% as the ECB hinted at a possible hiking bias. Japanese Government Bonds dropped 1.6%, with long-dated issues selling off ahead of the February snap election amid expectations of looser fiscal policy. ECB projections suggested headline inflation could reach 3.1% year-on-year in Q2, before the March oil peak. US Treasuries stood out, ending the quarter flat. As a net energy exporter, the US was less affected by oil, and a cooling labour market non-farm payrolls fell 92,000 in February helped moderate domestic inflation. The Fed kept rates unchanged in March, maintaining a dovish outlook for one cut in 2026, in contrast to the more hawkish BoE and ECB.

The geopolitical shock was the sharp rise of the US dollar. As tensions escalated and global risk appetite weakened, investors moved into dollar-denominated assets, unwinding positions that had been built on expectations of a weaker dollar. This reversal hit gold and emerging market equities especially hard, as both were widely held as hedges against dollar weakness. When the dollar surged, these crowded trades declined quickly, highlighting how fast sentiment shifts can force investors to exit. Dollar strength also created headwinds for emerging market debt, which fell 1.1% during the quarter, as borrowing costs increased and import pressures intensified. In contrast, a weaker sterling supported UK equities with international exposure, helping the FTSE All-Share post a positive return.

One of the most structurally important stories of Q1 2026 unfolded quietly within corporate financials: artificial intelligence shifted from an investment idea to an operational reality. Microsoft reported that AI now writes 35% of its code, Meta cut 21,000 jobs while boosting productivity, and Intuit, ServiceNow, and Salesforce each saw efficiency gains of 15–30%. The move to agentic compute AI systems managing other AI systems accelerated in late 2025 and continued through Q1 2026, pushing enterprise adoption from augmentation to automation.

BlackRock noted that coding questions on Stack Overflow, once over 300,000 per month in 2020, are now near zero, highlighting deep labour and cost implications. Hyperscaler capex is projected to reach more than $600bn in 2026, up from $360bn in 2025, while global AI infrastructure spending could exceed $2.2tr by 2028. Companies successfully turning AI into sustainable cost advantages and cash flow resilience are pulling sharply ahead, contributing to record equity market dispersion.

One of the clearest impacts of AI’s rapid progress in Q1 2026 was seen in the software sector. US software stocks dropped 23% from the start of the year to late February, with losses reaching around 30% for the full quarter, bringing valuations back to 2021 levels. This decline reflected a deeper shift, as investors questioned whether the SaaS model can remain viable in a world where AI agents can perform many of the same tasks.

The pressure extended beyond equities. Software-related leveraged loans fell 15-20 points, affecting business development companies and alternative asset managers with heavy exposure. Around 80% of these loans are tied to private equity-backed firms, with over 15% originated during the high-valuation 2020-2021 period. More broadly, traditional market correlations began to break down. While software fell 30%, semiconductors rose 30%, creating a 60-point gap in just a few months. What was once a unified trade fragmented, highlighting the need for investors to focus on company-specific fundamentals rather than broad sector positioning.

Q1 2026 revealed early signs of stress in parts of the private credit market, particularly loans tied to software. Roughly $400bn of software-related loans within the $2.5tr private credit universe came under pressure as public software valuations tumbled. Many deals from 2020-2021, originated at peak SaaS multiples, are still held at valuations that don’t reflect today’s disruption risk. About 30% of these loans mature by 2028, creating refinancing risks amid a tougher operating environment. Funds heavily exposed to 2020-2021 vintages faced material mark-to-market losses, with software-related leveraged loans selling off 15-20 points, even without actual defaults. BlackRock emphasised this is an idiosyncratic, not systemic, stress: even a 25% default with minimal recovery would imply $80bn in losses against $232tr of global private-sector net worth. For exposed investors, however, it’s a stark reminder of the importance of vintage selection and rigorous cash-flow underwriting in private credit.

Cryptocurrencies faced a harsh Q1 2026, with Bitcoin posting its worst opening quarter in eight years. BTC began at $87,500, briefly touched $95,000 in early January, then slid to $60,000 in early February before partially recovering to close near $67,000, down about 25% year-to-date. Ethereum performed worse, falling 35%, and the total crypto market cap dropped roughly $900bn, from $3.4tr to $2.5tr, leaving BTC around 45% below its October 2025 all-time high.

Three main factors drove the decline. First, the Middle East conflict dashed rate-cut hopes as the Fed raised its 2026 inflation forecast, with over 60% probability of unchanged rates through July. Second, Bitcoin ETF outflows amplified selling, with AUM falling 41% to $96bn by mid-February, though net inflows of $18.7bn resumed in March. Third, large holders realised roughly $30.9bn in losses.

The quarter underscored that Bitcoin remains a high-beta risk asset: while gold surged 19% on the same shock, Bitcoin fell 25%, showing a 44-point divergence. Despite this, institutional engagement persisted, order-book liquidity recovered, and BTC dominance stayed above 50%. Bright spots included AI-linked tokens HYPE and TAO rose 39–50%, reflecting AI-driven themes reshaping markets. For mainstream crypto, Q1 2026 was a sobering reminder that macro conditions dominate in the short term.