The first quarter (Q1) was shaped by two distinct phases. In the opening weeks of the year, global equity markets extended their 2025 gains as strong earnings momentum, broadening global growth and accommodative monetary and fiscal conditions propelled markets to fresh highs. Germany’s Dax, the UK’s FTSE 100, and Japan’s Nikkei 225 all reached record levels in January and February, building on the rotation away from US markets that had characterised 2025. However, the outbreak of war in the Middle East at the end of February, when the US and Israel launched military strikes against Iran, disrupted the Strait of Hormuz, and sparked a surge in oil prices, causing a sharp reversal in risk appetite. The Brent oil price surged from approximately $74 per barrel at the start of the year to around $111 by end-March, an increase of roughly 50%. Markets that had led the rally in the first two months surrendered much of their gains in March, which proved to be the worst month for several major indices since 2022.

Regional equity market performance diverged markedly. The UK’s FTSE 100 led major markets with a gain of 2.0%, its heavy weighting in oil and commodity shares providing a natural hedge against the energy price shock, not unlike its relative resilience during the Ukraine-related energy crisis of 2022. Japan’s Nikkei 225 was also positive with a 1.4% quarterly gain, buoyed by solid corporate earnings, record profit margins and political stability following Prime Minister Takaichi’s emphatic election victory in February. Japan’s currency weakened against the dollar, providing a further tailwind to its export-heavy market. At the other end of the spectrum, US markets bore the brunt of the sell-off. The S&P 500 lost 4.6% while the technology-heavy Nasdaq declined 7.1%, as the Magnificent Seven shares, which had already been underperforming amid increasing scrutiny of AI monetisation timelines, suffered a further decline in the quarter. Germany’s Dax, which had surged to record highs earlier in the year fuelled by fiscal expansion and a rebound in European defence spending, surrendered its gains as Europe’s acute dependence on Middle Eastern energy imports weighed heavily, resulting in a 7.4% loss for the quarter. China’s CSI 300 index lost 3.9%, although losses were tempered by Beijing’s continued support for its technology sector and structural reforms, and by China’s comparatively lower oil dependence, given its rapid expansion of renewable energy capacity and electric vehicle adoption.

The US dollar index benefitted from safe-haven demand during the conflict, gaining 1.7% over the quarter. The dollar’s appreciation weighed on the dollar-based performance of global indices. The MSCI All Country World index (USD based) declined by 3.5% in Q1, reversing its strong gains in the first two months of the year. Despite the late quarter headwinds, the MSCI Emerging Market index (USD based) held up better with a decline of 0.5%, underpinned by the continued outperformance of technology-heavy markets in Taiwan and South Korea, as well as the structural tailwinds that had propelled emerging markets to a 32.9% return in 2025. The resilience of emerging markets, despite a strengthening dollar, reflects the broadening of the global economic expansion. The S&P Global Developed Sovereign Ex-US Bond index, also dollar-based, lost ground in Q1 by 2.9% as rising global bond yields and the appreciating dollar eroded returns. The US 10-year Treasury bond yield, which had eased to 4.16% by end-2025, climbed to 4.31% by end-March as the oil-driven inflation shock forced investors to push back expectations for further Federal Reserve rate cuts.

The surge in oil prices has reintroduced inflation as a key concern for financial markets. Prior to the conflict, inflation had been on a steady downtrend in most major economies, providing scope for central banks to continue easing monetary policy. The Federal Reserve had cut its benchmark fed funds rate by a total of seventy-five basis points between September and December 2025, bringing it to 3.75%. However, at its March policy meeting, the Fed held rates steady, signalling that it needed time to assess the inflationary impact of the energy shock. Interest rate futures markets have now pushed back expectations for the next Fed rate cut to 2027. Eurozone inflation jumped to 2.5% in March from 1.9% the month before, complicating the European Central Bank’s easing cycle. The Bank of Japan, which had been gradually normalising monetary policy through modest rate hikes, also adopted a wait-and-see approach. Only the People’s Bank of China, facing deflationary rather than inflationary pressures, maintained its easing bias.

Despite the geopolitical turbulence, the underlying global economic expansion remained intact entering the quarter. In the US, GDP growth in Q4 2025 moderated to 1.4% quarter-on-quarter annualised due to the prolonged government shutdown, but the underlying economy remained healthy, supported by monetary and fiscal stimulus and continued AI-related investment. S&P 500 earnings for Q4 2025 grew an estimated 14% year-on-year on revenue growth of 9%, the strongest top-line expansion since Q3 2022, keeping profit margins at record levels. Earnings growth was broad-based, with 10 of 11 sectors posting positive gains, led by technology, industrials and communication services. The One Big Beautiful Bill Act, which combines tax cuts and fiscal stimulus, is expected to support US growth over the balance of 2026, with the Fed’s GDP forecast of 2.4% for 2026 appearing achievable provided the conflict does not persist. The US economy’s reduced dependence on imported energy, thanks to the shale revolution, provides a buffer that was notably absent during previous oil crises. Corporate earnings remain healthy, with S&P 500 companies expected to deliver 12-13% earnings growth in Q1, for the sixth consecutive quarter of double-digit growth.

In Europe, the economic recovery was gaining traction before the conflict intervened. Eurozone GDP grew 0.3% quarter-on-quarter in Q4 2025, or 1.5% year-on-year, with Germany’s historic dismantling of its “debt brake” continuing to support the fiscal outlook. However, Europe’s heavy reliance on imported energy, particularly from the Middle East, leaves the region vulnerable to a prolonged disruption. Independent research firm, Capital Economics’ baseline scenario forecasts eurozone GDP growth of just 0.7% for 2026, down from a pre-war forecast of 1.1%, although this assumes the conflict de-escalates by end-April and the Strait of Hormuz gradually reopens. The UK faces similar headwinds from rising energy costs and is forecast to achieve only 0.5% GDP growth in 2026. Despite these challenges, consensus earnings growth forecasts remain in double digits across most European markets, reflecting the positive momentum that preceded the conflict and the lagged benefits of ECB rate cuts.

In Asia, Japan’s economy benefitted from rising household disposable income, fresh fiscal support under the Takaichi government and the Bank of Japan’s Tankan survey which showed improved business sentiment in Q1, a reassuring sign that the trade and energy uncertainties had yet to dampen corporate morale. However, Japan’s near-total dependence on imported oil, with virtually all of it coming from the Persian Gulf, leaves it exposed should the Strait remain disrupted for an extended period. China’s economy faces a different set of challenges and opportunities. Beijing is implementing structural reforms aimed at boosting ailing consumer expenditure and the property slump continues but the economy benefits from a burgeoning AI and technology sector. The DeepSeek effect continues to resonate, and China’s diminishing reliance on Middle Eastern energy, aided by its massive investment in renewables and electric vehicles, provides relative insulation from the oil shock. Emerging market economies more broadly are expected to achieve around 3.2% growth in 2026, with consensus earnings forecasts of over 20%, the highest among global regions.

Looking ahead, the trajectory of markets hinges principally on the outcome of the Iran conflict and its impact on energy supplies and inflation. Both the US and Israeli administrations have signalled a desire for a swift resolution, with President Trump indicating that hostilities could wind down within two to three weeks. A ceasefire and reopening of the Strait of Hormuz would likely trigger a sharp decline in oil prices and a powerful rebound in equity markets, particularly in energy-dependent regions such as Europe and Asia that have been most penalised. Encouragingly, the underlying economic fundamentals remain solid, with global purchasing managers’ indices still in expansionary territory, corporate earnings growing at a healthy clip, and consensus forecasts pointing to 15% global earnings growth in 2026.

The current sell-off has compressed forward price-to-earnings multiples, with the S&P 500 forward PE declining to approximately nineteen times, below its five-year average, restoring value to markets that were previously priced for perfection. In balanced portfolios, the rise in bond yields has made government bonds more attractive, providing improved diversification against equity risk. In the near term, volatility will persist until the energy supply situation is resolved, but the episode is more likely to prove a temporary disruption to what remains a durable global economic expansion, underpinned by strong earnings, accommodative policy settings and structural investment in artificial intelligence and infrastructure. As was the case in Q1 last year, when tariff fears caused a near-identical 4.6% decline in the S&P 500 only for the index to rally over 20% in the subsequent nine months, history suggests that pullbacks rooted in geopolitical shocks, rather than fundamental deterioration, tend to be buying opportunities.