Q1 2026 income investing update: Navigating market crosscurrents

CONTRIBUTORS

Edward D. Perks, CFA

Chief Investment Officer
Franklin Income Investors

Navigating market volatility through diversification

The first quarter of 2026 brought notable market volatility amid geopolitical tensions, particularly the Iran conflict, and shifting sentiment. A diversified approach across a wide range of income-generating assets helped investors navigate these conditions.

Fixed income strategies

Rising interest rates and widening credit spreads created compelling opportunities in fixed income in the first quarter, particularly in investment-grade corporate debt and high-yield bonds. Although the year began with a focus on what we consider attractive income from bond-market carry,¹ evolving conditions driven by inflation concerns and geopolitical uncertainty renewed total-return opportunity. This prompted us to look into increased deployment into fixed income assets.

We continued to emphasize diversification across fixed income sectors, from Treasuries to agency mortgage-backed securities to investment-grade corporate bonds to high-yield bonds. We maintained slightly less interest-rate risk with a shorter duration of around 4.5 years. We skewed higher in credit quality, favoring higher-grade securities and focusing on individual-issuer fundamentals, specifically in the nearer-term maturities of public companies.

Equity market opportunities

During the first quarter, equity markets experienced volatility and dispersion. Performance broadened beyond mega-cap stocks toward average stocks, a trend that began even before the Iran conflict. So far in 2026, sector performance varied widely, with energy, materials and utilities performing well. Conversely, consumer discretionary, financials and technology faced pressures, such as uncertainty around the impact of artificial intelligence. This backdrop prompted us to be more active in our portfolio positioning, maintaining diversified exposure across equities, with a focus on health care and opportunities from the decline in financials.

Additionally, the technology sector pullback reset valuations in certain areas, creating what we considered to be attractive entry points. Combined with elevated implied volatilities,² we thought these conditions made technology companies compelling candidates for equity-linked notes.³

Looking ahead

The market environment of 2026 continues to present both challenges and opportunities for income investors. As markets evolve, we believe a diversified and active approach remains essential for navigating uncertainty, while pursuing long-term investment objectives.

Endnotes

The carry of a bond is the combination of its face value and any remaining unamortized premiums or discounts.
Implied volatilities reflect investors’ perceptions of uncertainty or risk associated with the future movements of assets.
Equity-linked notes combine fixed-income investments with potential returns linked to the performance of equities.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.

Equity securities are subject to price fluctuation and possible loss of principal. Investments in equity-linked notes often have risks similar to their underlying securities, which could include management risk, market risk and, as applicable, foreign securities and currency risks.

Diversification does not guarantee a profit or protect against a loss.

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