| THALASSA CAPITAL Quarterly Investment Letter | Q1 2026 March 25, 2026 |
We write our new quarterly letter at a moment of uncommon complexity. The first quarter of 2026 has been defined by a geopolitical shock of significant magnitude — the escalation of Middle East hostilities and the effective closure of the Strait of Hormuz — which is reshaping energy markets, central bank policy, and investment strategy in real time. We have spent considerable time reviewing the latest research from our external partners and monitoring developments carefully. This letter summarizes our assessment of the environment and explains how we are positioning portfolios to protect and grow your capital in the months ahead.
THE OIL SHOCK: WHAT HAS HAPPENED AND WHY IT MATTERS
The proximate cause of this quarter’s volatility is the ongoing conflict in the Middle East, which escalated sharply in early March following Operation Epic Fury. Drone and missile strikes directly targeted energy infrastructure, and traffic through the Strait of Hormuz — a chokepoint for roughly one-fifth of global oil trade — has been effectively halted. Production shut-ins have surged to an estimated 12 million barrels per day, approximately double the level just weeks earlier. As a result, oil and natural gas prices have risen to record highs, with cumulative gains since the conflict began approaching 50% for oil and 95% for natural gas.
This is not merely a financial market disruption. The Strait of Hormuz is a critical artery for Asian manufacturing — the world’s dominant supplier of goods — which relies heavily on Middle East oil. A prolonged closure risks broad supply chain disruptions affecting chemicals, plastics, autos, electric vehicles, construction materials, and more. We are watching these developments with significant attention.
KEY DATA POINT
Each sustained 10% rise in crude oil prices shaves roughly 15–20 basis points from real GDP growth. With oil at current levels, the implied drag on the U.S. economy alone is material, and the effect on energy-importing economies in Europe and Japan is considerably larger. (Source: JP Morgan)
Both J.P. Morgan and PIMCO — two of the world’s most respected investment research institutions, whose latest outlooks we have reviewed closely — describe this shock as stagflationary in nature: it pushes inflation higher while simultaneously weighing on growth. Markets have responded by pricing a more hawkish path for interest rates, tightening financial conditions globally and creating the challenging backdrop we navigate today.
CENTRAL BANKS: BETWEEN A ROCK AND A HARD PLACE
The policy response to this energy shock stands in sharp contrast to 2022, when Russia’s invasion of Ukraine triggered a similar supply disruption. At that time, central banks faced a demand shock layered on top of the supply shock — pandemic savings were still being deployed, labor markets were historically tight, and governments had injected trillions into the private sector. The resulting inflation proved persistent, and central banks were forced into one of their most aggressive tightening cycles in decades.
Today, the starting conditions are meaningfully different, and this distinction matters for how we think about portfolios. Fiscal policy is tighter across most regions. Labor markets have loosened considerably. Policy rates are already at neutral to slightly restrictive levels. The global economy no longer has a large reservoir of excess savings to amplify inflationary pressures. As a result, this energy shock is more likely to transmit through lower real incomes and weaker growth than through a sustained wage-price spiral.
That said, central banks remain in a genuinely difficult position. Despite the growth headwinds, the inflationary impulse from higher energy prices cannot be ignored — particularly after the credibility damage of the post-pandemic inflation episode. The Federal Reserve held rates steady at its March meeting, with the median dot plot still projecting a single cut in 2026, but the distribution has shifted meaningfully hawkish, with seven of the committee’s members expecting no cuts at all this year. In Europe, both the ECB and the Bank of England have pivoted sharply, and we now anticipate two rate hikes from each — in April and July — taking the ECB deposit rate to 2.50% and the Bank of England base rate to 4.25%.
Our view is that markets may be somewhat over-pricing the hawkish response. If the energy shock proves temporary, and if growth deteriorates as leading indicators suggest it may, central banks could ultimately ease more aggressively than currently priced. The front end of U.S. rates, in particular, looks inexpensive relative to reasonable scenarios for Fed policy.
MARKETS: A ONE-FACTOR REGIME
One of the most striking features of cross-asset markets this quarter has been their extraordinary synchronization. A statistical analysis of daily returns across eight major asset classes — U.S. equities, emerging market equities, gold, the U.S. dollar, EM currencies, investment-grade credit, high-yield credit, and global government bonds — shows that a single factor (oil prices) now explains approximately 55% of total return variation, up from just 35% in mid-January. This “one-factor regime” is consequential: it means that traditional diversification across asset classes provides less protection than it normally would.
In practical terms, markets have rewarded energy-related positions and penalized exposure to energy importers. European equities, Japanese equities, and EM assets (outside commodity exporters) have been hurt disproportionately. The U.S. dollar has strengthened meaningfully, reflecting its role as the preeminent safe-haven asset when both bonds and equities face headwinds simultaneously. Gold, somewhat counterintuitively, has declined approximately 15% since the conflict began — reflecting the drag from a stronger dollar and rising real rates, though we believe this repricing is likely temporary if the inflationary impulse continues.
J.P. Morgan has revised its year-end S&P 500 price target down to 7,200 from 7,500, reflecting the more constrained upside from elevated energy prices and persistent geopolitical risk. We concur with their assessment that the near-term risk to equities is less about an earnings recession and more about multiple compression — investors reassessing what they are willing to pay for future earnings in an environment of higher rates and slower growth. Gross leverage in hedge fund positioning remains near the 95th percentile historically, suggesting that any further deterioration could trigger more meaningful de-risking.
OUR POSITIONING AND STRATEGY
Against this backdrop, we advise staying invested but with increased downside protection, emphasize quality and liquidity, and position to benefit from the divergence between energy exporters and importers. The following describes our current approach across asset classes.
Equities
We favor lower-volatility, higher-quality companies that are more resilient to both an inflationary shock and a potential growth slowdown. We advise reducing High Beta, Speculative Growth, and Value/Cyclical factors — all of which carry higher oil and growth sensitivity. Within the U.S., we favor sectors that benefit from the current environment:
- Defense and Cybersecurity, which benefit from elevated geopolitical risk and rising defense budgets globally.
- Traditional and Alternative Energy, the clearest direct beneficiary of the supply shock.
- Utilities and Materials, which offer inflation-hedging characteristics and more stable cash flows.
- Hyperscalers in Technology, whose AI-driven revenue streams are relatively insulated from energy cost pressures.
Fixed Income
High quality bonds have re-emerged as a genuinely attractive asset class, and we are taking advantage of this environment. Current yields across the maturity spectrum offer meaningful income while providing portfolio insurance against scenarios where growth disappoints and central banks ultimately ease. PIMCO’s research makes a compelling point that equity ownership as a share of household financial assets is near an all-time high while fixed income ownership is near record lows — creating a compelling rebalancing opportunity.
In the U.S., we favor a modest overweight duration, with a preference for more balanced exposure across the yield curve rather than concentrating at any single maturity. We see particular value in Treasury Inflation-Protected Securities (TIPS) and agency mortgage-backed securities, which offer attractive real yields and high credit quality.
Credit
We are selectively positioned in credit, with a strong preference for quality and liquidity. In investment-grade corporate credit, we favor U.S.-domiciled issuers over European ones, given the direct energy cost exposure of European companies. We are cautious on high-yield, particularly lower-rated issuers who face multiple headwinds simultaneously: rising energy input costs, tighter financial conditions, and the broader growth slowdown.
We want to highlight an important structural development in private credit markets that deserves your attention. After nearly a decade of strong returns and rapid growth — the private credit market has roughly doubled in the last six years — signs of late-cycle stress are becoming visible. Shadow default rates are rising in corporate direct lending. Smaller and mid-size companies, the primary borrowers in this market, are acutely vulnerable to rising energy costs and AI-driven disruption. Publicly traded Business Development Companies (BDCs) are currently trading at significant discounts to net asset value, which we view as a market signal worth heeding.
CLOSING THOUGHTS
We want to be candid about the level of uncertainty embedded in the current environment. Markets are in a regime where a single geopolitical variable — the duration of the Hormuz closure — will disproportionately determine near-term outcomes. In such an environment, our primary obligation is to protect capital while maintaining the flexibility to act decisively when the fog begins to lift.
We draw some comfort from history. Supply-driven oil shocks, while painful in the short term, are ultimately resolved — either through diplomatic negotiation, demand destruction, or supply-side adaptation. The current shock will be no different. What distinguishes successful investors through such periods is not the ability to predict the exact resolution but the discipline to maintain quality, liquidity, and the capacity to act when dislocations create opportunity.
We also want to emphasize that, unlike in 2022, the fundamental structure of the economy is not amplifying this shock. Fiscal policy is tighter. Labor markets are not overheated. Policy rates are not far from neutral. These factors meaningfully reduce the risk of a structural, multi-year inflation regime and increase the probability of a more contained, cyclical adjustment.
We remain committed to the investment philosophy that has guided this portfolio from the beginning: patient, disciplined, research-driven capital allocation with an unwavering focus on risk-adjusted returns. We are grateful for your continued trust and partnership.
Respectfully yours,
Davide Accomazzo
Chief Investment Officer
Youri Bujko
Chief Executive Officer
IMPORTANT DISCLOSURES: This letter is provided for informational purposes only and does not constitute investment advice, a solicitation, or an offer to buy or sell any security. Past performance is not indicative of future results. All investments involve risk, including the possible loss of principal. The views expressed herein reflect the current opinions of Thalassa Capital LLC and are subject to change without notice. References to J.P. Morgan and PIMCO research are for informational context only; Thalassa Capital LLC has no affiliation with either institution. This letter is intended solely for the use of the person to whom it is addressed and may not be reproduced or redistributed without prior written consent.