The first quarter of 2026 was characterized by a challenging equity market environment, with U.S. indices experiencing declines amidst significant sector disparities. Geopolitical tensions, notably the military conflict in Iran, exacerbated inflation fears, leading to a cautious stance from the Federal Reserve regarding interest rate adjustments. Despite these macroeconomic pressures, substantial investments in AI infrastructure and a resilient job market continued to drive robust corporate earnings. This commentary examines the performance of the Ithaka US Growth Strategy, highlighting the factors influencing its returns and providing an in-depth look at Intuitive Surgical.
The prevailing market narrative centered on the dichotomy between the booming AI sector and other segments, which faced more subdued conditions. This imbalance, coupled with the anticipation of the 2026 midterm elections and a leadership transition at the Federal Reserve, suggests that market volatility is likely to persist. Amidst this complex backdrop, the Ithaka Group maintains its disciplined investment philosophy, focusing on identifying high-quality companies with strong long-term growth potential, sound management, and competitive business models in expanding markets.
Market Trends and Artificial Intelligence's Influence
In the first quarter of 2026, U.S. stock markets experienced a downturn, with significant variations in performance across different industries and investment approaches. The Dow Jones Industrial Average, S&P 500, and Nasdaq all registered losses, reflecting a general shift towards more conservative investment strategies. This cautious sentiment was primarily driven by rising crude oil prices due to the ongoing military conflict in Iran, which renewed inflation concerns and prompted the Federal Reserve to hold interest rates steady. Despite these challenges, the market witnessed sustained growth in AI infrastructure spending and a strong employment market, contributing to a fifth consecutive quarter of double-digit earnings growth for the S&P 500. The quarter's overarching theme was the overwhelming dominance of AI-related investments, as evidenced by a substantial increase in venture capital funding for AI companies.
The sustained influx of capital into artificial intelligence, with Crunchbase reporting $242 billion in venture capital funding in Q1 2026, underscored its pivotal role in market dynamics. Hyperscalers are planning massive investments, with an estimated $500 billion earmarked for AI-specific capital expenditure in 2026. However, concerns are emerging about the AI supply chain's capacity to support such rapid expansion. Beyond AI, investors are closely watching the upcoming 2026 midterm elections and the impending change in Federal Reserve leadership, with Kevin Warsh expected to take the helm. These factors, combined with ongoing geopolitical instability, are likely to sustain market volatility. The Ithaka Group remains committed to its investment discipline, concentrating on companies with strong compounding potential, guided by prudent management, and benefiting from long-term secular trends and robust business models.
Ithaka Group's Performance and Portfolio Adjustments
During the first quarter of 2026, the Ithaka US Growth Strategy experienced a negative return of 15.5% (gross of fees), underperforming the Russell 1000 Growth Index by 570 basis points. This shortfall was largely attributable to stock selection, which accounted for 540 basis points of negative relative performance, alongside a 30 basis point negative impact from sector allocation. Only 10 of the 31 stocks held throughout the quarter, representing 30% of the portfolio's names and 36% of its total weighting, managed to surpass the benchmark. The portfolio achieved positive relative returns in the Materials and Processing and Consumer Discretionary sectors, primarily due to strong fundamental performance in a single holding within each sector. Conversely, the Technology sector was the largest detractor, with widespread underperformance across 5 of its 17 positions, driven by fears of AI disruption and slowing enterprise spending for software-as-a-service companies. The Financials sector also contributed significantly to underperformance, as next-generation financial platforms faced pressure from a risk-off environment, while MedTech holdings within Health Care saw compressed valuations. Despite strong fundamental momentum, the sole holding in Producer Durables experienced multiple compression, further impacting overall returns.
The top contributors to the portfolio's performance included Howmet Aerospace, Netflix, and Veeva Systems, with Howmet's stock rising due to strong earnings and strategic acquisitions, and Netflix benefiting from its decision to withdraw from a proposed merger, enabling stock buybacks and content investment. Veeva Systems also saw positive stock price movement before its exit from the portfolio in mid-January. Conversely, major detractors included ServiceNow, Microsoft, Robinhood Markets, Shopify, and Meta. Microsoft and ServiceNow faced investor anxiety regarding AI infrastructure costs and the potential for AI to disrupt software application layers, leading to significant multiple compression. Robinhood's performance was negatively impacted by a cryptocurrency market sell-off and slowing retail trading volumes. During the quarter, the Ithaka Group initiated a new position in Vertiv, while exiting positions in Veeva Systems and Visa. These adjustments resulted in an increased trailing 12-month turnover rate of 24.4% and a trailing 3-year average annual turnover of 17.4%, reflecting a proactive approach to portfolio management amidst dynamic market conditions.
