2026 has already proven to be a pivot point away from the artificial intelligence (AI) rally theme toward a broader diversification theme. Certainly, AI remains a focal point for the markets given the ongoing investment into technological infrastructure. However, more discerning investors will find that the first quarter of the year has rewarded those who intentionally included investments away from the tech behemoths.
As we move into the second quarter, the narrative has shifted from “growth at any price” to a disciplined focus on Earnings Per Share (EPS) resilience and Forward Price-to-Earnings (P/E) ratios. Below, we break down the year-to-date (YTD) performance across the major asset classes and how their valuation profiles have evolved.
U.S. Large Cap Stocks: The Valuation Reset
YTD Performance: +0.3% (S&P 500)
U.S. Large Caps, particularly the tech-heavy growth cohorts, have faced the brunt of the 2026 volatility. After entering the year with a forward P/E ratio near 22.0x, the S&P 500 has undergone a necessary “de-rating.”
- Valuation Shift: The forward P/E has compressed to approximately 19.8x. This brings the index closer to its 5-year average of 19.9x, though it remains slightly elevated compared to the 10-year average of 18.9x.
- EPS Outlook: Despite the price drop, the fundamental floor remains solid. S&P 500 earnings for Q1 2026 are projected to grow by 13.2% year-over-year. This marks the sixth consecutive quarter of double-digit earnings growth, suggesting that the market’s decline is driven more by multiple compression (investors paying less for each dollar of profit) rather than a collapse in corporate health.
U.S. Small Cap Stocks: A Catalyst Emerges
YTD Performance: +6.6% (Russell 2000)
In a reversal of recent trends, small caps have outperformed their larger peers so far this year. The Russell 2000 has benefited from a “value rotation” as investors flee the expensive multiples of the “Magnificent Seven” in favor of domestically focused companies with more modest valuations.
- Valuation Shift: Small caps entered 2026 at a significant discount to large caps. While large-cap P/Es expanded rapidly in late 2025, small-cap multiples remained subdued. YTD, we have seen a slight expansion in small-cap P/Es as capital rotates into the sector, though they still trade attractively relative to large-cap stocks.
- EPS Outlook: Small-cap earnings remain more sensitive to interest rates. With the Federal Reserve signaling a “higher for longer” stance due to persistent 3% inflation, EPS growth for the Russell 2000 is expected to be more modest than large caps, hovering around 7 to 9% for the full year.
Developed International Stocks: Continuing the Trend
YTD Performance: +5.6% (MSCI EAFE)
Developed international markets (Europe, Japan, Australia) have been the standout performers of 2026 after coming off an already impressive 2025. A combination of a weakening U.S. Dollar and a fiscal response to energy disruptions in Europe has revitalized interest in these markets.
- Valuation Shift: International stocks remain the “value play” of the global equity market. The MSCI EAFE currently trades at a forward P/E of approximately 14.5x, a significant discount compared to the US. This “valuation gap” has finally begun to attract significant inflows.
- EPS Outlook: Earnings growth in Japan has been particularly strong, driven by corporate governance reforms and a weak Yen boosting exports. European earnings have been more volatile but have surprised to the upside in the financial and industrials sectors.
U.S. Bonds: Providing Ballast
YTD Performance: +0.4% (Bloomberg US Aggregate Bond Index)
After years of behaving erratically due to inflationary volatility, fixed income has returned to its traditional role as a portfolio stabilizer. As stocks fell in Q1, bonds rose, providing much-needed cushioning for diversified investors.
- Yield Environment: The 10-year Treasury yield is currently hovering around 4.29%. While yields have fluctuated, the bulk of total returns is now coming from “coupon income” rather than price appreciation.
- The Valuation Perspective: In the bond world, “valuation” is often viewed through real yields (nominal yield minus inflation). With the 10-year yield at 4.3% and inflation at 3.3%, a 1.0% real yield offers a decent return in line with the historical average over the past 10 years.
The Bottom Line
The “everything rally” of 2025 has given way to a discerning market in 2026. High-multiple growth stocks are being repriced to reflect increasingly uncertain growth projections for the AI complex. However, with corporate earnings still growing at a double-digit clip for large caps and international markets offering good relative value, the long-term outlook remains constructive.
In this environment, quality matters. We continue to favor a diversified approach throughout periods of ongoing geopolitical volatility.
