Market Update – February 2026

With the last week of February approaching, we are firmly in the middle of what has been an eventful first quarter of 2026. While some of the headlines we discussed in our previous market update have taken a backseat for now (such as the U.S.’s calls for control of Greenland), others remain top of mind and additional new narratives have emerged.

Among the most notable developments capturing investor attention is the continued dispersion beneath the surface of U.S. equity markets, the ongoing rotation toward small- and mid-cap stocks and non-U.S. equities, and a sharp divergence in sector performance that has left the S&P 500 nearly flat despite meaningful upside and downside moves across many individual stocks.

At the same time, the bond market has strengthened as Treasury yields have drifted lower, reflecting a mix of moderating inflation data, shifting expectations for Federal Reserve policy, and renewed demand for safe-haven assets amid geopolitical uncertainty.

Adding to the complexity has been heightened volatility surrounding the AI investment theme, particularly as rising hyperscaler CAPEX guidance has fueled both optimism and concern over the sustainability of the current tech cycle as AI-driven disruption becomes increasingly tangible.

Against this backdrop, earnings season has remained a clear bright spot, with corporate profits continuing to grow at a healthy double-digit pace and further reinforcing the resilience of the U.S. economy. Meanwhile, geopolitical concerns, most notably the evolving tensions between the U.S and Iran, have reintroduced meaningful risks, underscoring that while markets remain supported by fundamentals, the broader environment continues to demand a disciplined and risk-aware approach.

Market Summary

The market dispersion we described in last month’s newsletter remains the dominant trend of 2026’s first quarter. While the U.S.’s premier large cap stock index, the S&P 500, is nearly flat on the year at ~0.7%, there has been notable divergence in individual stock and sector performance both under the surface and in comparison to other market regions and market cap levels.

The standard S&P 500 index is a market capitalization weighted index, meaning each stock’s individual weighting within the index is weighted according to its proportion of market cap contribution to that of the overall index. Essentially, the larger the company, the larger its relative percentage weight within the index.

In comparison, the S&P 500 Equal Weighted Index takes the same constituent companies as the S&P 500 and weighs all 500 stocks equally within the index. This equal weighted index has outperformed its market cap-weighed counterpart year-to-date, returning more than 6% on the year.

This fairly significant return differential is even more apparent when examining the returns of the S&P 500 on a sector basis; the index’s top weighted sector, information technology, which makes up nearly 33% of the overall market cap weighted index, is down -3.5% on the year compared to real estate, the index’s smallest weighted sector (less than 2%) which is up ~8%.

Below, we have adjusted our typical sector return summary to include their relative weight in the S&P 500 as a way to further display how pronounced this year-to-date rotation has been.

February has also seen small and mid-cap stocks continue to outperform. Compared to an S&P 500 that is essentially flat on the year, the Russell 2000 (small cap) and Russell Midcap indices have returned ~7.2% and ~6.3% respectively.

Regionally, the year-to-date trend of foreign equities outperforming has persisted as well. Developed market equities excluding the United States (MSCI EAFE) and emerging market stocks (MSCI Emerging Markets) have returned ~8.7% and ~11.2% each.

A modest decline in the dollar relative to foreign currencies (exhibited by the DXY index) has been a slight tailwind aiding non-U.S. stocks. The DXY, currently at 97.68, has retraced its year-to-date low of 95.55 but remains down on the year from a 98.25 starting point.

For the bond market, a strong February has helped fuel a positive start to the year. The Bloomberg US Agg Total Return Index is now up ~1.2% on the year. Helping this rally has been a decline in the 10Y Treasury Yield, which at ~4.09% has seen a 4-basis point decline in yields from the year’s start and has recovered from a high of nearly 4.31% in late January.

The yield curve overall has seen some notable shifts in the early innings of 2026. In what can be described as a “twist” in the curve, rates on the shortest end (1-12 months) have risen from where they ended 2025, while rates further out (2-30 years) have seen declines.

U.S. Treasury Yield Curve (1M-30Y Maturities) Current and 2025 End Lookback- Bloomberg

Some potential economic drivers of this move could be a combination of a stronger than previously anticipated economic outlook (higher short-term growth and positive improvement to the labor market outlook), which implies less chance of multiple interest rate cuts in 2026, or at least a delay in when those cuts occur. On the longer-end of the curve, the reasoning may be less economic and more driven by behavior.

While recent inflation data has shown continued improvement in the CPI, inflation expectations (per US Breakeven Inflation rates on TIPS) have moved higher year-to-date. A higher growth outlook and higher inflation expectations would suggest long-term rates that move higher. However, given recent rising attention to geopolitical tensions and equity market volatility, investors may be moving money into “safe haven” assets such as treasuries pushing yields on those assets lower.

A Note on Software Volatility and AI Disruption

Directly related to the recent heightened volatility and dispersion between market segments has been the evolving investment narratives orbiting the AI development theme. Those narratives most recently notably being the impacts of rising capital expenditures (CAPEX) among the “hyperscalers” and the uncertainty surrounding those not only projected to benefit, but also those that may be negatively impacted. As with any innovative technological development, there is an anticipated likelihood of AI driven disruption across various industries.

Most notable in recent weeks has been a dramatic selloff in software companies corresponding with the increasingly publicized advent of Claude Code, an extension of Anthropic’s Claude AI. For years, software has been an industry of focus for both equity and fixed income investors alike due to an earned reputation of companies with attractive quality characteristics such as having strong competitive moats due to barriers to entry and inelastic demand, and for those companies having high profitability with strong pricing power.

Investors had perhaps taken this for granted, believing the sustainability of the current business model had a high probability of continuation into perpetuity.

The competitive moats of these businesses have been largely defined by a high barrier to entry (quality coding is a desirable skillset that is difficult to learn) and inelastic demand due to high switching costs and software having become essential infrastructure for so many businesses across virtually every industry. The demand inelasticity has afforded software companies the latitude to raise prices at rates that surpass normal inflation with little risk of losing customers.

Among the most apparent proven capabilities of AI at this early stage is its adept ability to produce sophisticated code. An ability that continues to strengthen with each update to available models. But perhaps even more impressive than the coding abilities of these models is their increasing ability to clearly and quickly interpret simple descriptive language and translate these requests into usable code.

Claude Code has taken this further, providing an agentic AI coding tool that can accomplish tasks such as developing applications through the user’s written descriptive commands. In what has been colloquially termed as “vibe coding”, users are able to translate everyday language into what increasingly is becoming closer to sophisticated software development.

It is important to note that equity markets, while often largely efficient, have a history of initially going too far in both their overreaction and underreaction to financially impactful developments. The early reaction through software stock prices, and the prices of those publicly traded private equity companies that invest and finance them, is clearly that these evolving AI coding capabilities have become an emergent risk to the software industry’s business model; for reference, the iShares Expanded Tech-Software ETF (Symbol: IGV) has fallen ~-22% on the year.

In the simplest terms, the more available and capable these advanced coding tools become, the easier, hypothetically, it is to develop competitive software tools and the easier it is to enter the industry as a viable competitor. When more competitors enter any industry, there is a risk of rising “commoditization” and the prevailing distinguishing feature among offerings becomes who provides the lowest cost solution. An erosion of competitive moats and a receding of pricing power puts the perpetual margin expansion thesis that dominated software at risk.

However, there is a case that this overreaction from an investment perspective could go too far. For instance, how many companies really want to develop and manage their own in-house software for data management and workflows?

There are longstanding relationships between SaaS providers and their customers that built an additional moat of trust in the reliability and attentive service provided over many years. Not to mention that SaaS companies experience serving those customers provides a decade’s built wide array of knowledge into their business, service, and security needs.

Unwinding the built in infrastructure and finding a replacement for these key functions ingrained in businesses, if it were to ultimately occur, would likely be a multi-year transition. Furthermore, SaaS companies themselves have heavily invested in AI and are likely to continue to be leaders in incorporating it as a core feature of their platforms.

The most likely outcome after the fog lifts is that a mix of both disruption and entrenchment of winners and losers. Those that are able to utilize AI effectively will be set to capture further market share and will outcompete those who do not evolve.

The question will be whether the long-term terminal value of the industry as a whole sees a structural downgrade, in our minds it is too early to tell whether this is true but the valuations given the carnage of the past months’ market movement could present a rare opportunity to position in high quality companies. As seen below, the price-to-free cash flow (P/FCF) multiple for the global software universe has seen a substantial discount over the past two years and is well below 2021 levels.

Price-To-FCF Multiple on BI Global Software Val Index (2021-Present)- Bloomberg

Economic Update

In a major central bank related development, Kevin Warsh was announced as the next Chairman of the Federal Reserve and is expected to take office this spring at the conclusion of Jerome Powell’s term. While Warsh’s confirmation process could face political headwinds, particularly as some Senate Republicans (including Senator Thom Tillis) have suggested confirmation should be delayed until the Justice Department concludes its investigation into Powell, it appears highly likely that Warsh will ultimately be confirmed.

Warsh has been explicit in his view that the federal funds rate should be lower, signaling a continuation to a more dovish tilt to the Federal Reserve’s interest rate posture. However, he has also historically expressed concern that the Federal Reserve’s balance sheet remains too large. This suggests he may simultaneously advocate for tighter quantitative policy even if he supports lower short-term rates.

In our view, this represents a modest but meaningful shift toward a more accommodative interest-rate environment, as Warsh would add another pro-cut voice to the Federal Open Market Committee. If the Fed were to reduce its balance sheet, the impact may be less easy to predict; there’s a chance of this resulting in further steepening and an expansion of term premia in longer-term bonds as a higher quantity of bonds enter the open market.

Given his prior criticisms of the Fed, including skepticism toward extreme “data dependency” and past asset purchase programs, it will be important to monitor how effectively he builds consensus among the other governors and regional Fed presidents. The potential balance sheet reduction agenda in particular may be difficult to build a supportive coalition around.

One additional dynamic to watch is whether Powell will remain on the Board of Governors after stepping down as Chair, or whether his departure from the lead position will coincide with his exit from the Fed entirely. The distinction matters, as Powell’s continued presence could influence internal policy debates and continuity in Fed leadership.

At this stage, we continue to anticipate further rate cuts ahead, with our base case still calling for approximately 2–3 cuts during 2026 as inflation gradually moderates and growth begins to normalize. The primary risk to this outlook remains inflation. In particular, investors should pay close attention to whether consumer demand reaccelerates following tax refund season, especially if refunds come in higher than expected due to the prior extension and expansion of tax cuts.

Adding to inflation uncertainty has been a growing divergence between inflation “realized data” and inflation “expectations.” Backward-looking measures, including CPI (headline and core) as well as private inflation gauges such as Truflation, continue to trend downward, reinforcing the narrative that underlying pricing pressures are cooling.

However, inflation expectations embedded in financial markets tell a different story. U.S. breakeven inflation rates have risen year-to-date across the curve, from 1-year through 30-year maturities. This divergence will be important to monitor, as it may reflect investor concern that stronger growth, easier monetary policy, or renewed fiscal stimulus could cause inflation pressures to reemerge later in the year.

Whether this is simply a temporary interruption in the disinflation trend, or an early warning sign of inflation re-acceleration, remains a key question for markets. Inflation expectations have historically resulted in higher future realized inflation, a cycle that can feed on itself producing further inflationary risks.

Meanwhile, U.S. growth expectations have modestly fallen compared to earlier this year but remain strongly positive. February has seen a notable convergence between the Atlanta Fed’s GDPNow model and broader consensus forecasts for fourth quarter 2025 GDP growth.

Through late January, GDPNow projected an exceptionally strong growth rate exceeding 5%, far above the more moderate expectations given by Blue Chip economist surveys. While that estimate has since cooled meaningfully, GDPNow still points to above-trend growth of approximately 3.6%.

The government’s advanced estimate for Q4 GDP will be released this Friday, with the median economist forecast currently calling for a solid 3.0% reading, which is down from the prior quarter’s strong 4.4% pace. Notably, estimates suggest last year’s 43-day government shutdown may have reduced quarterly GDP growth by approximately 0.8% to 2.0%, exemplifying the disruption from the longest government shutdown in U.S. history.

The labor market also delivered mixed signals in the latest round of reports. On the positive side, January non-farm payrolls came in stronger than expected, with 130,000 jobs added versus consensus expectations of a 65,000 job increase. The unemployment rate also declined modestly from 4.4% to 4.3%, defying expectations for an unchanged reading.

However, the more consequential headline came from the final benchmark revision, which reduced estimated 2025 payroll growth by 862,000 jobs. This revision significantly alters the reality of last year’s labor market strength, suggesting that job growth in 2025 was meaningfully weaker than previously reported.

Taken together, the revised figures indicate that the labor market added only 181,000 jobs over the prior year, while the unemployment rate drifted higher from roughly 4.0% to 4.3% between January 2025 and January 2026. Several factors appear to have contributed to the labor market’s relative stagnation. Federal government employment declined by roughly 277,000 jobs, heightened tariff uncertainty led many companies to pause hiring plans, and immigration flows slowed significantly relative to prior years. These factors reduced labor force expansion and altered preexisting employment dynamics.

Additionally, manufacturing job losses continued, extending what has now become a multi-year downtrend in industrial employment. On the positive side, layoffs in general have not yet picked up to a rate of heightened concern.

Overall, the U.S. economy remains resilient, but the balance of risks has shifted concerns towards the labor market side of the pendulum. Growth is still tracking above trend, inflation data is improving, and the Fed appears to be either gradually shifting toward easier policy or at least is firmly positioned to dovishly pivot if needed. However, rising inflation expectations, labor market revisions, and the evolving economic environment produce meaningful uncertainty that will continue to shape market outcomes in the months ahead.

Earnings Update

With 416 of the S&P 500 having reported results so far, the tone of this earnings season has remained constructive and has been broadly an encouraging outcome for the stock market. In aggregate, corporate results continue to point to healthy fundamentals, with the index tracking toward roughly 9% year-over-year sales growth and 12.2% earnings growth based on results reported to date.

FactSet’s broader “blended” view of the quarter similarly reflects earnings growth in the teens for the index and underscores that this would mark the fifth consecutive quarter of double-digit earnings growth. This is an important signal that profit expansion has proven more durable than many investors expected.

Sector performance has been notably uneven, with leadership concentrated in a few areas. On absolute earnings growth, Industrials have been a standout (34.9%) alongside Technology (22.75%). On the revenue side, Technology is also leading (15.6% sales growth), with Communications Services showing strong top-line momentum (12.37%). Utilities have been an underappreciated bright spot on revenues as well, with 11.82% absolute sales growth.

This is a reminder that sector leadership this season hasn’t been exclusively growth sector related. At the other end of the spectrum, Health Care has posted the weakest earnings growth (0.22%), highlighting that the season’s strength has not been broad-based across all defensive and cyclical segments.

The most notable upside on earnings relative to expectations has come from Industrials, which has delivered the largest earnings upside surprise (a beat of 23.49%).

On the revenue surprise front, Utilities led the market with the highest sales surprise (8.68%). Meanwhile, success has not been universal. Real Estate, which posted the weakest earnings surprise at -0.15%. In aggregate, the S&P 500’s earnings “beat rate” and magnitude of surprises have been historically in line, which helps explain why the market’s reaction has increasingly shifted away from “beat/miss” and toward guidance and forward commentary as the more important driver.

Within this backdrop, the Magnificent 7 have delivered solid, though not blowout, results so far. With six of seven reported and NVIDIA still pending, the group is collectively running at approximately 17.78% earnings growth and 15.44% sales growth, with an earnings surprise of 5.53% and sales surprise of 1.9%.

That compares to the broader S&P 500’s roughly high-single-digit earnings surprise and 1.9% sales surprise, underscoring that the “Mag 7” are still growing faster than the index but are not necessarily producing dramatically larger surprise factors this season.

Market sensitivity has instead been highest around management commentary on AI-related capital spending CAPEX). Even small changes in expected investment pace, mix, or return timelines have driven outsized single-stock moves and contributed to broader AI-linked volatility in equities. With NVIDIA’s report still ahead (currently expected February 25), this “capex narrative” remains a key near-term catalyst for both mega-cap tech leadership and overall market sentiment.

Overall, the key message from earnings season is that fundamentals remain supportive. Profits are expanding, revenues are growing, and results continue to clear what were elevated expectations coming into the quarter. Importantly, FactSet’s reporting indicates the index is tracking toward another double-digit earnings growth quarter, extending a notable multi-quarter streak, which reinforces the view that the market’s longer-term direction is still being anchored by earnings power, even as near-term price action remains headline and guidance sensitive.

U.S. Iran Tensions

Relations between the United States and Iran remain at a critical and highly volatile juncture, with diplomatic and military dynamics unfolding rapidly. In recent indirect nuclear talks held in Geneva, negotiators from both sides reported modest progress on guiding principles but failed to reach a substantive agreement. This left sizeable gaps, particularly over Iran’s nuclear enrichment and ballistic missile program, that both countries’ leadership have yet to bridge.

Experts characterize the situation as balanced on a thin line between diplomacy and conflict, with market participants noting that a lack of breakthrough has kept geopolitical risk elevated. Meanwhile, Tehran has signaled willingness to provide a written proposal aimed at addressing U.S. concerns, although key sticking points remain unresolved.

At the same time, the United States has significantly bolstered its military presence across the Middle East, deploying two aircraft carrier strike groups and additional fighter jets to underscore its readiness and deterrent posture amid rising rhetoric from both sides. Iran has responded with naval drills in the strategic Strait of Hormuz and joint exercises with Russian forces, highlighting its own readiness to defend national interests and signal resistance to coercive pressure.

These developments have rippled through global markets. Oil benchmarks recently hit multi-month highs on concerns that any escalation could disrupt shipments through the Strait of Hormuz, which is a vital conduit for global energy flows.

Regional and global powers, including Russia, have called for restraint and diplomacy, even as the potential for further military escalation remains a central risk scenario. Odds on prediction markets, such as Polymarket, have risen significantly with the implied probability of a U.S. strike on Iran within months increasing in recent days.

The impact of geopolitical events on markets has historically been very difficult to predict. On average, volatility in the short-term is to be expected if a strike were to occur, but impacts as time extends past 6 months returning to normal average S&P 500 return levels, as seen in the table from JP Morgan below:

There remains potential for diplomacy to reach a conclusion that avoids further conflict in the region, but tensions certainly appear to be at their highest levels since the U.S.’s strike on Iranian nuclear sites in the region last June.

Conclusion

Despite the growing list of crosscurrents, including geopolitical uncertainty, shifting inflation expectations, evolving Federal Reserve leadership, and volatility tied to the rapidly changing AI investment landscape, we believe the broader foundation supporting markets remains intact. Corporate earnings continue to expand at a healthy pace, economic growth remains resilient, and fixed income markets are once again offering meaningfully positive yield and diversification benefits.

While short-term market outcomes are often driven by headlines and sentiment, long-term returns are ultimately anchored by fundamentals such as earnings growth, productivity, and disciplined capital allocation. For investors, this reinforces the importance of maintaining a diversified, risk-aware portfolio aligned with long-term objectives rather than reacting to momentary volatility. In our view, staying anchored to a individualized risk-aware strategically aligned portfolio framework remains the most reliable path to navigating uncertainty while still capturing the market’s long-term wealth-building potential.