a very difficult, desperate, or dangerous situation, often involving severe financial distress or critical circumstances; a state of extreme trouble or a precarious position; favourite band of this writer
Whether you are (or were) a Venezuelan politico, a software engineer, or anyone who relies on the safe passage of hydrocarbons through a narrow channel in the Persian Gulf, the first quarter of 2026 was one of grave consequence. For investors, the implications of recent weeks and what might lie ahead undoubtedly seem just as harrowing.
Though it now feels like an eon ago, it was only in January that the US government executed its South American smash and grab, an operation that we were told would flood the world with newly liberated heavy oil and, as a happy bonus, simultaneously fill the coffers of the American treasury. While this initially appeared to be a dire turn of events for Canada, global energy players were circumspect of the plan and majors like ExxonMobil ultimately said “no gracias” when presented with the grand opportunity to re-enter the Bolivarian republic where so much capital had gone to die in the past. As a result, the barrel price of crude receded by only a few percent following the incursion, and the promise of a Venezuelan energy dividend was largely forgotten.
While this was happening, the effect of artificial intelligence (or at least of large language models) was hitting parts of the market like a runaway semi-truck, as ground-breaking tools were suddenly being released at a breakneck pace, including applications which would supplant everything from legal services to cybersecurity and, perhaps most importantly, the arduous human task of writing computer code. In a “shoot first, ask questions later” response, investors sold any software operator that might see its business model or margins challenged, with previously venerable names such as Salesforce, Adobe, and Intuit (maker of popular products such as Quickbooks and TurboTax) plunging by more than 30% from where they began the year.
In our Canadian equity portfolio, Thomson-Reuters was hit by the same rogue wave, as investors exited the stock ahead of any potential disruption to its various business lines. Having significantly reduced our position in the technology and media conglomerate in 2025, however, we used its AI-driven selloff to re-up our allocation to the company in early February.
As you might imagine, we’ve been thinking a lot about AI disruption in general and software stocks in particular in recent weeks. Yes, many of these firms will face new challenges for which they weren’t prepared, but some will be more insulated than others and select incumbents will approach AI not as a threat, but as an opportunity to improve and expand their traditional offerings. It’s likely that companies which provide access to proprietary, regulated, or difficult to source data won’t be easily displaced, and ones benefitting from network effects or which integrate a valued service offering into their technology product should be similarly shielded. At the same time, while the dramatic and rapid price drop in many of these names has created a tantalizing shopping list (see chart on previous page), we’re also extremely wary of entering a position that looks cheap today, but which could find itself under continued assault in the months and quarters to come.
Round 2
Lest anyone suppose that the year’s first two months had provided sufficient action to keep investors on their toes, the US administration decided to launch its second military operation of the quarter by bombing Iran and, in the process, igniting an economic inferno that could have lasting implications. While headlines focus on the blockage of oil traffic through the Strait of Hormuz (accounting for about 20% of world supply), the tertiary impacts of the war might be even greater, with major LNG plants severely damaged and crucial feedstock for everything from fertilizer manufacturing to semiconductor fabrication strangled at the point of production.
Unfortunately, irrespective of near-term developments, it’s likely that the conditions faced today will be with us for some time and a new risk premium may be indefinitely imbedded into the price of energy. If the US declares “victory” tomorrow and retreats from the region, it may wind up ceding control of the Strait to Iran, allowing it to either throttle or tariff oil and gas transport as it sees fit. Alternatively, if American ground forces are deployed in an attempt to remove what remains of the Iranian regime, it’s virtually certain that the operation will be protracted, unpredictable, and bloody. As many have written, Iran has been preparing for such an invasion for more than 20 years and the country’s vast and varied terrain would only compound operational complexity.
Of course, a negotiated settlement is also possible but, to use White House vernacular, it’s far from certain who would “hold the cards” in such talks. It might be that the best that the US could hope for at this point would be to craft something similar to the 2015 nuclear agreement that the same administration tore up shortly after taking office the first time. Given recent developments, however, it seems unlikely that Iran would now agree to such a comprehensive retreat.
No cuts, no glory?
Energy costs impact virtually every product on store shelves and so it’s reasonable to expect that the spike in oil prices will begin to show up in the consumer price index. And so, just as the US government may have painted itself into a military and political corner in the Middle East, it has also tied the hands of the US Federal Reserve, which is mandated to promote both maximum employment and stable prices.
While the state of the job market is beginning to suggest that a policy rate cut is appropriate (e.g. the US Department of Labor recently reported that job openings dropped to their lowest level in six years), expected inflation could make the Fed reluctant to ease. In fact, as depicted by the chart below, the futures market now assigns greater odds to a 2026 rate increase than it does to a cut.
A higher than previously expected interest rate backdrop could have several implications worth considering. First, up until now, the equity market has undoubtedly been anticipating a looser monetary setting and so a change or even pause in this tack has the potential to impact stock valuations, especially for pricier names or those further out the risk spectrum. Second, the cost of funding capital projects that rely on debt could be pressured, especially if corporate bond spreads also widen. And finally, higher policy rates would complicate the US government’s apparent plan to finance the ballooning federal debt at the short end of the yield curve, thus making it even more difficult to reign in the ever-expanding budget deficit.
In light of these considerations, we’re doubly committed to targeting companies which are able to finance projects with internal cash flow and avoiding those whose valuations assume extraordinary growth or the success of previously untested business lines.
Nobody knows
Though the S&P 500 just posted its worst quarter since 2022, the damage to stocks has been relatively modest to date given the myriad issues described above and several other challenges which we don’t have room to cover here (cracks in the private debt market would be at the top of this list). The relative resilience of indices so far this year undoubtedly reinforces the fact that markets have typically cared much more about profits than conflicts and, as it happens, analyst estimates for S&P 500 earnings for the coming 12 months are actually up 3.6% since the war began.
How political, military, and economic events unfold from here is anyone’s guess, a notion that was typified by Federal Reserve Chairman Jay Powell’s response when he was asked about the impact of higher energy prices: “The thing I really want to emphasize is that nobody knows. The economic effects could be bigger, or they could be smaller; they could be much smaller or much bigger. We just don’t know.“ And, just as it’s extremely difficult to forecast exactly how an oil surge will transmit through the economy, it’s also impossible to predict how or when the Middle East conflict will end and what markets will do with whatever materializes.
Whether it was at the depths of the financial crisis, or during the covid shutdown, or in the various run-of-the-mill bear markets that took place in between, sticking with a portfolio of strong companies run by focused management teams has ultimately proven to be the optimal course for the long-term investor. Despite the real possibility that stocks will fall further in the days ahead, we’re confident that patience and fortitude will once again be rewarded as we eventually pass through this tumultuous period.