Quarterly Review: Stocks Pull Back from Highs as Markets Are Tested

After a calm start to the year, stocks took a downward turn late in the first quarter as investors around the world weighed the impact of geopolitical events, notably the war in Iran. In the US, the S&P 500 was down at the end of the first quarter after hitting record levels earlier in the year when measured in US dollars.¹ Equity returns in developed markets outside the US and emerging markets were better than in the US, despite the instability in the Middle East. In the bond market, US Treasuries were almost flat, with the benchmark 10-year yield slightly rising to 4.3%.²

Through March 31, the S&P 500 Index fell 4.3% and the tech-heavy Nasdaq lost 7.0%. From the perspective of a Euro investor, the S&P 500 lost only 2.5% as the US dollar strengthened by 2% over the quarter. Technology companies pulled back from recent highs amid ongoing concerns about the impact of AI on certain industries, with software stocks in particular declining.³ Trade developments also remained in focus as the US Supreme Court said certain tariffs imposed by the administration using emergency powers weren’t legal.⁴ Market reaction to that ruling was largely muted, perhaps reflecting expectations already priced in about which way the court would rule.

Market volatility rose and oil prices spiked after the US and Israel struck Iran in late February, with hostilities continuing in Iran and elsewhere in the Middle East into March. The impact on crude supplies helped push oil prices notably higher.⁵ Amid growing concerns about energy, it is worth remembering that global equity returns have not been correlated with the level of oil prices (see Exhibit 1). While the cost of oil may have some impact on markets, it is just one of many factors that investors consider when looking at market performance.

Global equities, as measured by the MSCI All Country World Index (net dividends), fell 1.3% in the first quarter when assessing returns in Euro. Stocks in developed markets outside the US fared better, gaining 1.0%, as measured by the MSCI World ex USA Index (net dividends). The MSCI Emerging Markets Index (net dividends) fared even better, returning 1.8%.⁶ Global equity markets remain near long-term highs, even in the face of geopolitical challenges; over the past few years, stock markets have had positive returns despite numerous conflicts around the world.

Along with the fear and hardship always associated with armed conflict, there can be concern for investors over potential impact on investment performance. But it’s important for investors to be cautious about making asset-allocation changes in response to such events. Markets are forward-looking, and prices move in response to changes in information. When unexpected developments arise that investors deem to be poor for markets, markets often drop. But the flip side is markets always set prices for positive expected returns. Once the news gets reflected in market prices, investors can still expect positive returns even amid worrisome circumstances.

The US Federal Reserve held the federal-funds rate steady in a range between 3.5% and 3.75% at meetings in January and March.⁷ Fed members continued to disagree over which posed the bigger threat—persistent inflation that might argue for higher rates, or a sluggish labour market that may call for lower ones. In February, the US core consumer price index, which excludes more-volatile food and energy items, rose 2.5% from a year ago, slightly above the Fed’s target rate of 2%.⁸

During the first quarter, US Treasury returns were almost flat, with the benchmark 10-year Treasury rising from 4.18% to 4.30%.⁹ The broader, Euro-hedged bond market declined, with the Bloomberg US Aggregate Bond Index down 0.5% and the Bloomberg Global Aggregate Bond Index, a broad benchmark of sovereign and corporate debt, falling 0.6%.¹⁰

Value stocks, or those with low relative prices, and small caps had a strong start to the year in the US, a shift from their underperformance in 2025. Large cap stocks with growth characteristics, or higher relative prices, were particular laggards in the US and globally.¹¹ Relative returns for US small caps broadly, small value stocks, and large value stocks all flipped from negative to positive over 12 months when the end date moved from December to February, despite 10 of the 12 months being identical in both samples.¹² This is why trying to time markets is so perilous: Missing these kinds of outsize periods for the premiums can put a dent in your performance. In March, as global events rattled markets, value and small caps took a hit, reinforcing the notion that premiums can be volatile. Elsewhere, high profitability stocks were outpaced by low profitability stocks in global developed markets, while the opposite was true in emerging markets.¹³

In the first quarter, the US stock market remained concentrated, from a historical perspective, in a small group of mega cap companies, as reflected by their considerable weight in the S&P 500.¹⁴ Emphasising small and value stocks is one way to offset the trend of big companies having an outsize influence on overall returns.

Since small caps are a meaningful part of the global market, they can be an integral part of a diversified portfolio. These are companies from a variety of sectors, and many have the potential for significant returns. After all, some of the largest and most successful companies of today were small caps once upon a time. A broadly diversified allocation to the small cap market can help long-term investors capture future winners from today’s smaller firms. Along with patience and discipline, diversification can help investors weather challenges, whether geopolitical, economic, or otherwise.

3 Lessons from Investing’s “Moneyball” Moment 

Above the Fray: US Market Not Partying Like It’s 1999

Index Descriptions

The Fama/French Indices reflected above are not “financial indices” for the purpose of the EU Markets in Financial Instruments Directive (MiFID). Rather, they represent academic concepts that may be relevant or informative about portfolio construction and are not available for direct investment or for use as a benchmark.

Results shown during periods prior to each index’s inception date do not represent actual returns of the respective index. Other periods selected may have different results, including losses. Backtested index performance is hypothetical and is provided for informational purposes only to indicate historical performance had the index been calculated over the relevant time periods. Backtested performance results assume the reinvestment of dividends and capital gains. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP.

Fama/French Developed High Profitability Index: Provided by Fama/French from Bloomberg data. Includes stocks in the upper 30% operating profitability (OP) range in each region; companies weighted by float-adjusted market cap. Rebalanced annually in June. OP for June of year t is annual revenues minus cost of goods sold; interest expense; and selling, general, and administrative expenses, divided by book equity for the last fiscal year-end in t – 1.

Fama/French Emerging Markets High Profitability Index: July 1991–present: Fama/French Emerging Markets High Profitability Index. Courtesy of Fama/French from Bloomberg and IFC securities data. Includes stocks in the upper 30% operating profitability range in each country; companies weighted by float-adjusted market cap; rebalanced annually in June. OP for June of year t is annual revenues minus cost of goods sold; interest expense; and selling, general, and administrative expenses, divided by book equity for the last fiscal year-end in t – 1.

Fama/French Developed Low Profitability Index: July 1990–Present: Fama/French Developed Low Profitability Index. Courtesy of Fama/French from Bloomberg securities data. Includes stocks in the lower 30% operating profitability range in each region; companies weighted by float-adjusted market cap; rebalanced annually in June. OP for June of year t is annual revenues minus cost of goods sold; interest expense; and selling, general, and administrative expenses; divided by book equity for the last fiscal year end in t – 1.

Fama/French Emerging Markets Low Profitability Index: July 1991–Present: Fama/French Emerging Markets Low Profitability Index. Courtesy of Fama/French from Bloomberg and IFC securities data. Includes stocks in the lower 30% operating profitability range in each country; companies weighted by float-adjusted market cap; rebalanced annually in June. OP for June of year t is annual revenues minus cost of goods sold; interest expense; and selling, general, and administrative expenses; divided by book equity for the last fiscal year end in t – 1.