Positioned for Upside, Protected for Volatility
I hope you are enjoying the spring months and April showers that bring May flowers. This not only goes for the weather but for the stock market correction and the events happening in the Middle East.
In my last review I touched on markets not liking uncertainty, and investors being pushed to the sidelines. Investor selling was driven by whether AI spending will generate expected earnings, the war in Iran, and ambiguity of the outcome of the mid-term elections.
I continue to believe the market has a good chance of being up at the end of the year, and we did lock in some hefty profits and initiated defensive positions, which resulted in quarterly gains in the mid to upper single digits for the quarter.
On the other hand, during the first quarter of 2026, the S&P 500 Index lost 4.6%, the NASDAQ Index lost 7.1%, the Russell 2000 Growth Index lost 2.9%, and the iShares Barclays 7-10 yr. Treasury Bond ETF (IEF) lost 0.7%.[1]
Over the years the Middle East has been a wild card and the unstable situation most likely will continue, even after the war is settled. Due to this uncertainty, the markets may continue to be volatile and under pressure as it corrects from its lofty levels.
In an effort to determine market direction, I am focusing on energy prices, AI sustainability and profit growth, and private credit. As the economy chugs along, there will be companies able to grow and make profits. That is where I concentrate my investment research. The three factors I just mentioned will determine my aggressiveness in allocating money into or out of the market.
Despite the importance of interest rates on financial markets, I am not overly focusing on it at this time. I believe interest rates will not change materially for the remainder of the year as the Fed will take a wait and see attitude due to the highly volatile input readings from tariffs, energy prices and employment.
Some say that one-third of GDP growth stems from AI spending. This growth may well continue into the future and be a boon for the economy, but it has not been even handed. Aggressive growth comes at an aggressive expense, and all can’t compete at the same level, so there will be losers. The AI spend by the four largest tech giants, Google, Microsoft, Meta, and Amazon, collectively have increased over the years and is estimated at $630 billion this year. That is a big bet.
Analysts’ earnings projections are being extrapolated from this growth and large number, but I’m afraid many are not digging deep enough into the situation. From my view, the growth acceleration will decrease in the future as costs and funding become major obstacles. Many tech giants have used a considerable amount of their cash flow or reserves to fund the expansion and may have to rethink their strategy.
As evidence, note that the five major AI hyperscalers (large cloud service providers), Amazon, Google, Meta, Microsoft, and Oracle issued $121 billion in U.S. corporate bonds last year, versus an average $28 billion per year between 2020 and 2024, according to a January report by BofA Securities. The once Wall Street darling and top five hyperscaler, Oracle, is struggling to compete. It has been spotlighted after it ratcheted its borrowings up to $108.1 billion while exhibiting negative free cash flow. As of this writing, Oracle has lost 58% of its stock value from its Sep 2025 high.
Investors must be vigilant about outcomes for the next Oracle and contagion to their supply companies as orders may be cut or cancelled. In the first quarter some of the drop in stock prices stemmed from the realization that many AI names are overpriced for their underlying risk. Similarly to the early 2000s internet buildout, many AI companies will look and be priced vastly different as this nascent story matures. I am attempting to lock-in profits when prices become ridiculous in comparison to the expectation of reward.
Tied into the AI buildout is the use of private credit by the software and technology service industry. Private credit refers to privately negotiated loans provided by non-bank institutions—such as private equity firms, hedge funds, and specialized investment managers. There is no public market for private credit, making it fairly illiquid. In the event that perceived or actual risk increases, it may be difficult for investors to have their money returned. Private credit began to gain popularity after the 2008 financial fallout which increased banking regulations and made borrowing more difficult for riskier companies.
If the private credit funding market dries up, it will be much harder for many companies to fund themselves, which may initiate a chain reaction of slowing growth and earnings. Since the stock market is priced on earnings, a deeper correction may occur. I have been waiting for a weaker market to flush out speculators and provide opportunities for my investors.
A parallel to just before the 2008 banking crisis, when everything was seemingly fine, a fellow University of Chicago M.B.A. alumnus, Howard Marks, recently stated “There’s a saying in the banking business that the worst of loans are made in the best of times.
Also note that former Federal Reserve Chair Alan Greenspan and his successor Ben Bernanke were prominent figures who suggested the U.S. economy was stable shortly before the 2008 financial crisis. I will be watching for cracks in the financial system due to fallout from private credit and how it may affect market liquidity.
If banks and other financial institutions come under pressure and need to shore up their own finances, less funding will be available to borrowers, which likely will be a drag on the markets and economy.
Energy prices have escalated due to the war in Iran, but I think it should reverse before the summer travel season and is a small price to absorb to offset having the nuclear capabilities of an aggressive terrorist nation removed.
Geopolitically, the environment is messy and changing very quickly, but this means to me that the situation will not drag on as the media and some portray. Once a path to an end appears, the markets normally rebound due to a level of uncertainty being removed.
If one steps back and reflects on past wars and economic obstacles, we have survived, not stopped going to the store for groceries, going to work, using computers, or skipping holiday gatherings. Even after COVIDs major disruption, we adjusted and went on. There are brighter days ahead.
Again, I believe today that the market will be higher for the year, but there may be near-term weakness. The investing landscape is changing, and I am excited about the upcoming earnings reporting season for confirmation of revenue and earnings growth by owned companies and for new opportunities.
Very truly yours,
Martin L. Yokosawa
[1] These returns are price based and exclusive of dividend reinvestment. Return data provided by QUODD Financial, ETFreplay.com, and Yahoo Finance
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