Both Hands on the Wheel

Michael Grant

The first quarter of 2026 has delivered on the more turbulent half of our forecast while confounding its more orderly assumptions. Operation Epic Fury was not in our script, but it was in our framework. We argued that the equity bull market would encounter significant headwinds in Q1, that peak reflation was approaching and that volatility would rise. All of this has come to pass, though the catalyst has been more dramatic and unexpected.

We had anticipated an interim peak for US equity benchmarks in the first quarter followed by a correction of 10%+ through the summer, with the best opportunities for reinvestment emerging ahead of the midterm elections in autumn. The Iran war has precipitated and dramatized the correction that one could have reasonably judged probable. It has not transformed a correction into a bear market, but it has narrowed the margin for error considerably.

Market behavior since the inception of Epic Fury is instructive: there has been no disorderly collapse. The investment community continues to treat the energy shock as temporary and the geopolitical disruption as containable. We share this view as a base case, but it will take time for investors to develop conviction here. The first fortnight of April is a critical juncture and we see material downside support in the 6000–6200 area for the S&P 500 Index.

Why did Trump act now? Our answer is the convergence of the political calendar and strategic conviction. This was his last window to deploy military force on a significant scale before the mid-term elections erode his congressional margin. Trump has been consistent on the Iranian threat for years, never a believer in diplomacy as anything but a mechanism for delay. For a president conscious of legacy, the dismantling of a uniquely malignant regime carries obvious appeal.

The minimum objective of Epic Fury—the removal of Iran's nuclear and ballistic missile capability—appears close to completion. The wider objective is a pacified Iran that no longer projects an external threat, while regime change in the Western liberal sense was always a chimera. What likely emerges is a fractious internal struggle among competing factions whose primary motivation is the preservation of power and wealth. Pandora's box has been opened.

A ceasefire of some kind remains likely, but equally artificial and impermanent. Internal confusion within Iran—the absence of identifiable leadership willing to expose itself—paradoxically facilitates such an arrangement. No formal negotiation is required when there is ambiguity about who speaks for the regime. Washington can call it a ceasefire; Iran’s leadership regime need not contradict. The deeper resolution will take longer—our assumption is three months.

The economic nature of the shock is the most important analytical point for investors. The Iran war has delivered a stagflationary impulse at precisely the moment when the macro environment is ill equipped to absorb it. US inflation was already stuck near 3% and 10-year Treasury yields have broken above the 4.30% ceiling. Central banks are disarmed: unable to ease into an energy shock without entrenching inflationary expectations.

The critical threshold is well understood: WTI crude sustained much above $100/barrel for months raises recession risk. This is the number that matters and is the constraint that will shape the pace and terms of any diplomatic resolution. The market has been pricing a temporary disruption, not a structural one. That assumption is reasonable as a base case, but it is fragile and the margin for error narrows with every week that the Strait of Hormuz remains compromised. Much of this should be viewed in the context of the new post-Covid investment regime. During the years of the Great Moderation, exogenous shocks were deflationary. Today, inflationary impulses are persistent and frequent. The Iran war is symptomatic: amplifying the characteristics of a decade already defined by higher structural inflation, fiscal excess and geopolitical fragmentation. Our diagnosis of peak reflation is validated and accelerated at the same time.

On the broader geopolitical map, the Iran confrontation is one episode in a more extended Sino-American cold war. Iran supplied China with cheap energy and a lever of influence. Simultaneously, the Trump administration has been systematically curtailing Chinese influence in Central and South America; Venezuela is a case in point. The logic is consistent: constrain the supply lines and compress the geographic reach of Chinese strategic ambition.

March has brought into sharp relief the difficulty of constructing a genuinely defensive portfolio in this regime. Bonds have failed as a hedge—yields have risen as equity prices have fallen. Gold and silver have proven unreliable: too widely owned and fashionable to function as refuges in a stagflation shock. The correlation between bonds and equities that underpinned the classic 60/40 allocation for decades cannot be relied upon when inflation is the predominant concern.

The immediate winner has been energy, but this may prove tactical rather than durable. We prefer the derivative themes in energy infrastructure, strategic defense and their industrial adjacencies—large capital goods companies exposed to the rearmament and reindustrialization agenda. The world of perpetual geopolitical conflict makes these not merely tactical but structurally relevant for the remainder of the decade.

The comparative resilience of select large-cap technology is unsurprising given the AI tailwinds. Here, the elevated short interest and option protection accumulated since last October have provided a technical cushion. Crucially, the AI trade has been cleansed of its most speculative momentum. The fast money has exited, and what remains is less vulnerable to the kind of momentum unwind that has afflicted banks, small caps and other reflation proxies.

One analytical casualty of recent weeks is the rotation trade. The thesis that market leadership had passed to value, smaller caps and non-US markets has not survived its first serious test. Since the inception of Epic Fury, the comparative defensive qualities of US benchmark indices have been unmistakable. The US dollar has reasserted its reserve status. The euro peaked at $1.2050 on January 27—in retrospect, the high-water mark of the reflation derivative trade.

The momentum toward Europe and other developed markets based on relative valuation has taken flight with remarkable speed. The strategic vulnerabilities of Europe are again on full display. The conditions for a sustained rotation away from American supremacy—benign US reflation, a weakening dollar, improving global growth expectations—have been materially undermined. Diversification remains a valid long-term principle, but the timing is wrong.

Critically, the US labor market remains a structural underpinning that is still underestimated. It is a materially different animal from its pre-Covid incarnation—less cyclical, less prone to rapid job destruction, more resilient to moderate shocks. Employers who secured good workers through the post-Covid years are reluctant to release them. This is one reason why a US recession, absent WTI sustainably above $100, remains an unlikely outcome in 2026.

Some visibility will emerge through the April reporting season; healthy corporate earnings are why 2026 should be viewed as a correction within a volatile range rather than a bear market. The direction of interest rates is a greater risk than profit growth. This implies rotation across sectors and styles rather than material downside (>10%) for US benchmarks. To wit, more than 50% of Russell 3000 Index members are down more than 20% in 2026.

If geopolitics continues to worsen, the S&P 500 should find major support between 6000 and 6200. The buy-the-dip reflex prevalent at the beginning of the year has been extinguished and positioning is more balanced. Investors are reluctant to fully capitulate because hints of sustained dialogue will be consequential. Through this crisis, the comparatively constructive tone of market behavior is correctly reflecting the cumulative probability of the resumption of tanker flow in the Strait as much higher than recession probability.

The mid-term elections in autumn remain the probable catalyst for a more constructive investment posture. Prior to that, both the geopolitical trajectory and the macro backdrop are likely to remain unsettled. This is not a moment for bold repositioning in either direction—both positive and negative surprises will be forthcoming. Our emphasis is on discipline and the preservation of optionality. Both hands on the wheel.