1Q26 Letter: “Navigating Through the Storm”
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Economic & Geopolitical Update
Since my last quarterly letter, the global geopolitical and economic outlook has deteriorated considerably. The U.S.-Israeli military strikes on Iran, which began on February 28, have sent oil prices surging above $100 per barrel for the first time since 2022, disrupting roughly 20% of global oil supply flowing through the Strait of Hormuz. The conflict has broadened across the Middle East, with attacks on energy infrastructure in the Gulf states and a near-total halt in tanker traffic through the strait. This has led to a sharp selloff in stocks and other risk assets and meaningfully increased the likelihood of an economic slowdown.
Today’s environment draws inevitable comparisons to the 1970s, when an oil supply shock sent energy prices soaring and the U.S. was faced with higher prices, increasing unemployment, and muted economic activity. This combination of slowing economic growth and higher inflation is known as stagflation – a possibility that is particularly concerning today because the Federal Reserve has limited options to stimulate a weakening economy without further eroding consumers’ purchasing power. Unlike in early 2022, when I last addressed this comparison following Russia’s invasion of Ukraine, the Fed this time enters the crisis having already paused rate cuts, with inflation still running above its 2% target and unemployment ticking higher. The Fed’s hands are tied in a way they were not four years ago.
When history seems to be repeating itself, the natural question to ask is “How is it different today?” A few considerations:
1) The Global Economy Remains Less Oil-Dependent Than in the 1970s – But the Disruption Is Enormous
As I noted in my 1Q22 letter, oil intensity – measured as barrels of oil required to produce $1,000 worth of GDP – remains well below its 1973 peak, thanks to the growth of renewable energy and increased use of natural gas. However, the scale of today’s disruption is far larger than anything we’ve seen in decades. The 1973 oil embargo and even the 2022 Russia-Ukraine shock did not halt traffic through the world’s most critical oil chokepoint. Today, the Strait of Hormuz is effectively closed, stranding roughly 20 million barrels of daily oil flow. Kuwait has already cut production as a precautionary measure, and Iraq and the UAE are likely to follow. This is not a marginal supply disruption – it is a structural one, and the longer it persists, the more severe the economic consequences will be.
2) The U.S. Consumer Is Weaker Than in 2022
When I wrote about stagflation risks in early 2022, I pointed to the strength of U.S. household balance sheets as a key differentiator from the 1970s. Consumer spending accounts for roughly two-thirds of U.S. economic output, and at that time, households were flush with pandemic-era savings and benefiting from a roaring labor market. Today, the picture is more nuanced. While household debt payments remain a manageable share of disposable income, the consumer is showing clear signs of fatigue. Nonfarm payrolls declined by 92,000 in February, and the unemployment rate has risen to 4.4%. Consumer spending growth has slowed, and the much-discussed “K-shaped” economy – in which upper-income households drive the majority of spending while lower- and middle-income consumers pull back – has become more pronounced. The stock market, which has powered the wealth effect for higher earners, is now under pressure from the Middle East conflict and rising energy costs. If equity weakness persists, even the upper-income spending engine is at risk of stalling.
3) The Labor Market Has Softened Meaningfully
In early 2022, the unemployment rate stood at 3.6%, and the labor market was exceptionally tight. Today, the picture is more concerning. The unemployment rate has risen to 4.4%, job growth has turned negative, and hiring has become noticeably more selective. While this level of unemployment is still historically moderate, the direction of travel matters. The economy was already losing momentum before the Iran conflict began, with tariff-related uncertainty, AI-driven white-collar displacement, and lingering inflation all weighing on hiring. A sustained oil price shock on top of an already-cooling labor market significantly raises the risk of a more painful downturn.
4) Inflation Was Already Sticky – Now It May Reaccelerate
In 2022, I noted that a wage-price spiral appeared less likely given declining unionization rates. That assessment still holds, but the inflation picture has evolved in a different and concerning direction. Core PCE inflation was already running at roughly 3% before the Iran conflict, well above the Fed’s 2% target, driven by tariffs and persistent service-sector inflation. Oil prices surging past $100 – with credible forecasts of $120 to $150 if the Strait of Hormuz remains disrupted – will feed directly into transportation, manufacturing, and food costs. The International Monetary Fund has estimated that every sustained 10% rise in oil prices adds roughly 0.4% to inflation and reduces global growth by 0.15%. We are now looking at a 50%+ increase in oil prices in just over a week. The math is sobering.
The Federal Reserve’s Dilemma
This is where today’s environment differs most starkly from 2022. Four years ago, the Fed was embarking on an aggressive rate-hiking campaign, confident that a strong labor market and resilient consumer could absorb the tightening. Today, the Fed faces a genuine stagflation dilemma: inflation is running above target and may reaccelerate, while the labor market is weakening and economic growth is slowing. Cutting rates risks fueling inflation; holding rates risks deepening a downturn. In my view, the Fed will be forced to hold rates steady in the near term, accepting slower growth as the cost of preventing inflation from becoming unanchored. Markets were pricing in two to three rate cuts in 2026 before the conflict began. I would not be surprised to see zero cuts this year, or even a resumption of hikes if energy prices remain elevated.
The likely scenario, in my view, is a harder landing than consensus anticipates. Even before the Iran conflict, the economy was operating in what many economists have described as “stagflation lite” – growth too low and inflation too high for comfort. A prolonged oil shock could push us from “lite” into something more severe. Goldman Sachs had estimated recession probability at roughly 30% before the conflict; I believe that number is now meaningfully higher.
Market Update
In the days following the U.S.-Israeli strikes on Iran, global equity markets sold off sharply. Asian markets suffered the worst initial damage, with Japan’s Nikkei 225 falling more than 5% and South Korea’s KOSPI declining 6% in a single session. European indices followed, with the FTSE and DAX both opening significantly lower. The S&P 500 fell more than 1% at its lows on March 2 before staging a partial recovery, as investors debated whether the conflict would be short-lived. By the end of last week, however, the selloff had broadened as oil prices continued their relentless climb and February’s jobs report came in worse than expected.
While it’s impossible to predict how the Iran conflict will resolve, the most likely scenario in my view is a prolonged conflict with significant economic consequences. The administration has insisted the war will be over within weeks, but the escalating nature of the conflict – including Israeli strikes on Iranian oil infrastructure and Iran’s retaliatory attacks on Gulf energy facilities – suggests otherwise. Even if a ceasefire is reached quickly, the disruption to energy markets and supply chains may take months to fully unwind, as shuttered oilfields and damaged infrastructure require significant time to restore.
I anticipate that volatility will remain elevated through at least the middle of the year, and potentially longer if the conflict continues. The VIX has surged above 20, and gold has pushed near record highs above $5,300 – both classic indicators that the market is pricing in sustained uncertainty.
Portfolio Positioning
As I take these factors into consideration, below are three themes that I am emphasizing in my clients’ portfolios:
1) I Continue to Prefer U.S. Stocks Over International Equities
In my 1Q22 letter, I noted a preference for U.S. stocks over European stocks given Europe’s dependence on Russian energy. That logic applies with even greater force today. The Middle East conflict has disrupted energy supplies to Asia and Europe far more severely than to the U.S., which remains a net energy producer. Gulf state allies like Kuwait, the UAE, and Qatar have all seen production disruptions or outright shutdowns, and the ripple effects through Asian manufacturing economies will be significant.
2) I Favor High-Quality, Cash-Flow-Generative Companies
As I’ve noted in previous letters, rising interest rates and economic uncertainty favor high-quality companies that generate significant free cash flow. This preference has only become more important. Value stocks and energy names outperformed growth stocks in February, a trend that is generally favorable to how I have positioned portfolios. Companies with pricing power, low leverage, and the ability to fund dividends and buybacks from operating cash flow are best suited to weather a stagflationary environment. I remain cautious on highly valued growth stocks, particularly in the AI space, where the gap between capital expenditures and monetization continues to widen.
3) Commodities and Real Assets Remain a Critical Hedge
In 2022, I increased commodity exposure as a hedge against inflation and geopolitical risk. That positioning has proven its value again. Energy prices have surged, gold is near record highs, and agricultural commodities face renewed upward pressure as the conflict disrupts trade through the Suez Canal and broader Middle Eastern supply chains. I have maintained and in some cases increased commodity exposure across portfolios. For investors with appropriate risk tolerance, diversified commodity positions continue to serve as an effective hedge against both inflation and geopolitical uncertainty.
Summary
The parallels between today’s environment and the stagflation concerns I outlined in early 2022 are striking – but the current situation carries greater risk. In 2022, the consumer was strong, the labor market was historically tight, and the Fed had clear room to act. Today, the consumer is fatigued, the labor market is softening, and the Fed faces a genuine policy dilemma. An oil shock of this magnitude, layered on top of tariff-driven inflation and a cooling economy, creates a challenging combination for investors.
That said, I want to reiterate a message I’ve shared consistently through periods of geopolitical and economic stress: I recommend that we stay calm, patient, and diversified. Markets have historically recovered from geopolitical shocks, and portfolios built with quality, diversification, and appropriate risk management are designed to weather periods like these. I have positioned my clients’ portfolios to account for the risks facing the market, while also considering each investor’s risk tolerance, cash needs, and investment horizon.
As always, if you’d like to discuss any of the above themes and how your portfolio is positioned, you’re welcome to reach out anytime. Thank you for your continued support and confidence in Evolve Investing.
Best,
Peter Hughes, CFA