Diamond Capital Management's Market Commentary
March, 2026
Andrew Khosrofian, CFA, CAIA
Vice President & Portfolio Manager
Executive Summary:
- Q4 GDP slowed to 1.4% due to government shutdown, full-year 2025 growth at 2.2%.
- 2026 perseverance: Expansionary ISM PMIs and improving manufacturing signals point to near-term economic lift. +126K January jobs beat but February’s -92K job miss adds caution.
- Markets broadening, equal-weighted S&P 500 and Russell 2000 outperforming, with hope Iran operation stays contained, preserving Fed labor focus.
Following two consecutive quarters of robust real GDP growth at 3.8% (Q2) and 4.4% (Q3), the U.S. economy decelerated sharply in the fourth quarter of 2025, with real GDP expanding at just a 1.4% annualized rate, well below consensus expectations of around 2.8%. Although the trade balance improved for a third straight quarter and consumer expenditures continued to support expansion, the prolonged government shutdown caused federal outlays to plummet, subtracting roughly 0.9% from headline growth, and pushed the GDP implicit price deflator to 3.7%. This unusual inflation dynamic in the government sector contributed to full-year 2025 real GDP growth of just 2.2%, falling short of expectations of 2.5-2.7% under more typical Q4 conditions.
Recent economic data offers several encouraging signs amid the broader slowdown: both the ISM Manufacturing PMI and Services PMI remained in expansionary territory, exceeding expectations. Together, these leading indicators signal a sustained expansion in key sectors, and the positive momentum extends to coincident and lagging measures as well. The rate of change in industrial production, a coincident indicator, is improving, and capacity utilization, a lagging indicator, sits at cycle lows, offering substantial room for expansion. These developments collectively suggest a potential near-term economic boost as manufacturing contributes more positively to broader growth.
The labor market continues to be shaky amid softer trends in income and consumption growth. Nonfarm payrolls rose by 126,000 in January, beating consensus forecasts and providing some resilience, but February vastly underperformed with a contraction of 92,000 jobs, far below expectations, with unemployment increasing slightly to 4.4%. Credit spreads in the non-software corporate sector have stayed tight, reflecting continued investor confidence in credit quality despite the cautious backdrop.
Finally, equity markets reflect this healthy sector rotation away from IT and communication services. The equal-weighted S&P 500 and the Russell 2000 have each outperformed the market-cap-weighted S&P 500 over the past six months, underscoring stronger participation across a wider range of stocks beyond mega-cap tech. Investors and policymakers alike remain hopeful that the U.S. military operation in Iran does not evolve into a prolonged conflict and exerts only a contained impact on global energy prices and inflation, thereby enabling the Federal Reserve to maintain its focus on supporting labor market relief without undue disruption from external shocks.
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