By: Brent Schutte, Northwestern Mutual
Stocks started the week on an upbeat note as the administration delayed a deadline to strike Iranian energy plants by five days, also announcing that the U.S. and Iran were in negotiations to end the conflict. As the new Friday deadline approached, the administration announced an additional 10-day pause, extending the timeline to Monday, April 6, at 8:00 p.m., to allow negotiations to continue. Despite these diplomatic efforts, the tech-heavy and “Magnificent Seven”-concentrated S&P 500 index of U.S. Large-Cap stocks finished lower for the fifth consecutive week, with oil prices and Treasury yields rising as investors pondered how long this conflict might continue and what its ultimate impact will be on the U.S. economy.
We have continuously described the U.S. economy as positioned in a “delicate balance.” This equilibrium has relied on heavy investment in artificial intelligence (AI) and by higher-income consumers, who have seen their wealth bolstered by rising equity markets over the recent past. However, future risks remain split between sticky inflation that is threatening to rise further, and labor markets that are showing increasing signs of weakness. This narrow and delicate balance has been further disrupted by the Middle East conflict, which threatens to lead to elevated energy prices, potentially increasing inflation while slowing growth, a combination of risks that has pulled equity prices lower.
While there was limited hard economic data this week, two important sentiment gauges, the S&P Global Purchasing Managers’ Index (PMI) and the University of Michigan Survey of Consumers, showed potential mounting risks to inflation, labor markets and economic growth. Flash PMI data from S&P— which provides an early estimate of economic activity ahead of the full report—released last week warned that the conflict in the Middle East has had a negative impact on economic growth while fueling inflation. Notably, the report found that employment had fallen for the first time in over a year as firms sought to reduce overhead.
Meanwhile, 47 percent of respondents from the University of Michigan survey cited high prices as a dominant factor eroding their personal finances, highlighting inflation’s growing negative impact on household budgets. Stock market volatility has also significantly weighed on consumer sentiment, as the S&P 500 has dropped nearly 6 percent since the onset of the Iran conflict in late February. Middle- and higher-income consumers with stock wealth have been “buffeted by both escalating gas prices and volatile financial markets in the wake of the Iran conflict,” exhibiting “particularly large drops in sentiment,” Surveys of Consumers Director Joanne Hsu noted. The report noted that continued turbulence in financial markets could generate additional downside risk for consumers with those assets, potentially dampening their willingness to spend.
The economy was already dealing with uncertainty surrounding the balance of high inflation and a weakening labor market prior to the Middle East conflict. Geopolitical risk, which always exists but is currently heightened, has added to these pressures, a reality reflected in financial markets over the past few weeks and one likely to continue in the coming months. This increasingly delicate balance, coupled with mounting questions about the overall impact of AI and the debt levels used to fund its expansion, has further clouded the long-term outlook for both economic growth and inflation.
In this environment, we continue to encourage investors to focus on “controlling the controllable” by leaning on diversification as the primary tool to navigate economic uncertainty and market volatility. Diversification has become a critical tool for managing concentration risk over the past several years, as a select group of Mega-Cap technology stocks tied to the AI trade have driven the majority of gains in today’s historically narrow market environment, dictating the movement of the entire S&P 500. While diversification cannot guarantee that one will not experience losses, it increases the probability that those losses will not be as large as they would be in a concentrated “all-eggs-in-one-basket” approach.
While the past few years have been marked by narrow markets that have reflected the narrow economy, the recent past has shown the benefits of diversification as uncertainty and risks have grown, a trend that has not been interrupted on a relative performance basis since the onset of the conflict.
We expect the market to continue to expand in the future. The previous drivers of market performance, U.S Large-Cap technology stocks and the Magnificent Seven heavyweights, peaked on October 29, 2025, and have fallen by 17 percent overall. This has pushed the S&P 500 lower, but by a lesser degree of 7.09 percent. Even more importantly, the equal-weighted S&P 500 index—which further reduces concentration risk away from technology and the largest seven stocks—is up 1 percent. During this period, 62 percent of the stocks in the index have bested the return of the headline index. This stands in stark contrast to the previous three years, during which less than 30 percent of stocks beat the index.
We also note that U.S. Small- and Mid-Cap stocks have remained up 3.1 percent and 2.1 percent, respectively, since late October. Interestingly, during this past month, these more economically and interest rate-sensitive segments of the market have slightly outpaced their Large-Cap S&P 500 counterparts. Additionally, a broad basket of commodities—an asset class we believe possesses significant diversification benefits—are up 26 percent. Another way to view the benefit of diversification is through the lens of drawdowns. While the S&P 500 index is 8.7 percent off its 52-week high, the average stock in the index is down 20 percent, and the median is down 18 percent. This suggests the potential benefit of owning the broader index rather than attempting to select a few individual stocks.
As long-term-focused investors, we continue to believe that the U.S. economy and markets will broaden, just as they have after every other narrow period in history. The exciting part for patient investors is that the parts of the market we believe will benefit from this broadening—Small- and Mid-Cap stocks—remain relatively inexpensive and underinvested. This is where we see opportunity, and why we encourage you to continue with a steady hand and adhere to a long-term approach. Concentration may tempt, but diversification endures.
About the Author:
Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.
