Market Commentary

“To be, or not to be, that is the question” is from William Shakespeare’s Hamlet. In the scene, Prince Hamlet contemplates the pain and unfairness of life versus the alternative. Following a positive albeit bumpy fourth quarter, the quote sums up investor concerns as it relates to the potential for further rate cuts by the Federal Reserve. The quarter began with the S&P 500® trading off nearly 1% in October as 10-yr Treasury rates spiked by nearly 50 bp for the month as investor concerns grew about inflation’s stickiness and the reduced likelihood of additional near-term rate cuts. The market jumped 5.7% in November following the election as investors factored in a more business friendly administration. Returns were concentrated with much of the gains coming from the Magnificent 7 and other companies expected to benefit from a more favorable regulatory environment. The roller coaster continued In December as the quarter ended with the S&P 500® down 2.5% for the month following more hawkish language by the Federal Reserve. This change in language was undoubtedly impacted by November economic data, including non-farm payrolls, which came in better than expected at 227,000, and inflation, as measured by the CPI, which accelerated to 2.7% y/y, with the core CPI at 3.3% y/y. The yield curve further steepened with the 2/10 Treasury curve, ending the quarter at +33 bp. In addition to inflationary concerns, investors are also weighing the potential for lower taxes and more deregulation against the possible inflationary impact from tariffs and more stringent immigration policy.

After setting all-time highs in early December, the market experienced a slight pullback following more hawkish commentary from the Federal Reserve at the December meeting. The expected number of rate cuts in 2025 dropped from 100 bp to 50 bp as a result. The yield on the 10-yr treasury increased by nearly 80 bp during the quarter, which weighed on interest rate sensitive sectors, including Materials (-12.8%). Real Estate (-8.8%) and Utilities (-6.2%). Other underperforming sectors include Healthcare (-10.7%), which was negatively impacted by concerns over government pressure on health insurance and prescription drug pricing; Consumer Staples (-3.8%), which have difficult comparisons following price increases last year, Energy (-3.2%) and Industrials (-2.7%). Outperformers during the quarter included Consumer Discretionary (+14.1%), Comm Services +(8.6%), and Technology (+4.7%). We believe that the market could broaden again following better clarity on tariffs and immigration.

Portfolio Equity Positioning

The portfolio sector weightings through the 4^th quarter remained representative of our views throughout 2024 of maintaining secular growth exposure while also maintaining and/or increasing weights to cyclical recovery opportunities. As such, additional investments were made within Financials, Industrials, and Discretionary sectors to participate in emerging themes such as AI adopters, US reshoring, and merger and acquisition revival. One cyclical opportunity was found with Wells Fargo (WFC, 2.4% of total portfolio value), which was reweighted to a full position after being partially called away. Focus is on its improving financial performance due to net interest income growth and efficiency improvement with reduced expense base through investment in technology and digital platforms with an emphasis on enhancing customer experiences. The company emphasized a balanced approach to organic growth opportunities and continuing shareholder returns through buybacks. Dover (DOV, 1.9%) was purchased after reporting solid earnings growth driven by strength in clean energy and thermal connector systems. Overall organic bookings increased by 5%, along with solid free cash flow growth. TJX Cos (TJX, 2.3%) was reweighted to a full position after reporting solid earnings growth with strong 4^th quarter guidance that included 3% comp store sales growth reflecting strong operational execution. TJX also announced a 7% comp increase in TJX International division with plans to expand into Spain.

On the sell side of the ledger, the difficult decision was made to exit ConocoPhillips (COP, 1.1%) due to our expectations of a weakening oil demand market and desire to gain more exposure in the natural gas market. In addition, the decision was made to harvest tax losses to minimize any potential taxable distributions.  

Call Option Premium

As was expected, volatility levels (as measured by the VIX Index), continued to move in wider ranges than the 1^st half of the year. Early in the quarter, investors were buoyed by solid labor numbers, mild inflation reports, solid consumer spending, and China stimulus. However, the market trended downward into the election as investors were unimpressed by earnings reports and became more concerned about valuations. Volatility briefly spiked above 23 before trading off due to election outcome euphoria which promised much better growth policies while the fed also added an additional rate cut. However, in mid-December, the Fed’s summary of economic projections (SEPs) showed expectations for rate cuts in 2025 dropping to two from four, while CPE inflation estimates were raised to 2.5% from 2.1%. The S&P Index immediately fell 3%, and volatility spiked to above 28. By the end of the month, volatility had subsided back to the lower end of its traded range at roughly 15. With that, our premium generation in the quarter averaged 1.1% (4.3% annualized) at initiation. The brief pullback in November and mid-December afforded the opportunity to roll in-the-money call positions at acceptable returns to higher strikes with more upside participation in a strong market environment. Each call option position is evaluated as to its roll qualification based on our analysis of the underlying stock potential and the option pricing based on implied volatilities. With the fluctuation in market volatility, opportunities are often presented to take action on existing positions if needed. For the quarter, the net premium generated after consideration of rolls was 1.0% (4.1% annualized), while the average days to maturity of the call options at initiation was 93 days, with 10.2% upside to the strike prices, and the portfolio average percentage written was 53%.

Protective Put Positioning

The notional value of put contracts ranged from 15% to 60% of the total portfolio value, ending the quarter at the higher coverage level of 60%. The total position consisted of structural (10%-20% protection) and tactical (above 20% protection). Given market uncertainties around the new administration and timing of several policy implementations, it was felt that a better opportunity to monetize the tactical portion of current spread positions was still ahead. For the quarter, put contracts detracted from total portfolio performance by -.08% and -.84% for the year. It is our intent to limit yearly put costs to under 2% in any calendar year.

Outlook

Following two years of 20%+ returns for the market, we see the potential for a market pullback and greater volatility in the first half of the year particularly if 10-year Treasury rates continue to move up near 5%. That said, we believe there could be further upside in the market if inflation resumes a downward trajectory and the Fed continues with rate cuts. We believe further upside will be driven by earnings growth given the current market multiple, which could continue to surprise to the upside if economic growth continues. We believe that cyclical sectors, including Financials, could do very well in 2025 given the steepening of the yield curve and the potential for increased investment banking and M&A. We continue to manage a diversified portfolio that includes both secular growers and value stocks. We will look to take advantage of any pullbacks to add to under-valued stocks and will trim over-extended positions.

IMPORTANT INFORMATION:

Past performance is no guarantee of future results. As with any mutual fund investment, there is a risk that you could lose money by investing in the Fund. The Connors Hedged Equity Fund is distributed by Ultimus Fund Distributors, LLC. (Member FINRA) Connors Investor Services and Ultimus Fund Distributors, LLC are separate and unaffiliated.

This information is for use with concurrent or prior delivery of a fund prospectus. Investors should consider the investment objective, risks, charges, and expenses of the Fund(s) before investing. The prospectus and the summary prospectus contain this and other information about the Fund and should be read carefully before investing. The prospectus may be obtained by calling 844-ACFUNDS (844-223-8637).

This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions, or forecasts provided herein will prove to be correct. Opinions are subject to change without notice.

Definitions:

Investments in options involve risks different from, or possibly greater than, the risks associated with investing directly in the underlying securities.

Delta: The amount option is expected to move for $1 change in stock price.

Call option: A call option is a financial contract that gives the buyer the right, but not the obligation, to purchase a specific asset at a predetermined price within a specific time period.

Covered call: Selling a call option on an underlying long-held security.

Notional: In derivatives markets, such as futures and options, the notional value is the value of the underlying asset that the contract is based on.

Out of the money: Out of the money refers to a call option with a strike price that is higher than the market price of the underlying asset, or a put option with a strike price that is lower than the market price of the underlying asset.

Put protection: Implementing a protective put by purchasing a put option vs a long underlying equity position or broad index that is not necessarily held.

Rolling in the money (ITM) call option: A trading strategy that involves closing an existing ITM call option and opening a new one. The new option has a different expiration date or strike price

S&P 500® Index: A market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. Unlike mutual funds, the index does not incur expenses. If expenses were deducted, the actual returns of this index would be lower.

Strike Price: The predetermined price at which a specific security may be purchased (for a call option) or sold (for a put option) by the option holder until the expiration date of the options contract.

VIX Index: The ticker symbol and the popular name for the Chicago Board Options Exchange's CBOE Volatility Index, a popular measure of the stock market's expectation of volatility based on S&P 500 index options.

Volatility: A statistical measure of dispersion of returns.

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