Market Commentary
Back to the Future
The 1985 sci-fi classic Back to the Future follows Marty McFly as he is accidentally sent back in time thirty years in a time-traveling DeLorean. While we may not have flux capacitors or time-traveling cars quite yet, we are seeing advancements in quantum computing and robotaxis that offer a glimpse of the future, while rising oil prices and high interest rates hark back to the days of bell-bottoms and shag carpet. Q3 followed a similar pattern to Q1 as geopolitical turmoil in the Middle East and renewed inflation concerns pushed interest rates higher. Unlike Q1, when equity markets pulled back, stocks proved relatively resilient in Q3 despite a sharp increase in rates. The 10-year Treasury yield reached a multi-decade high of 5.3%, reflecting concerns about persistent inflation and rising government debt.
U.S. equity performance was mixed. The S&P 500® and Nasdaq gained 2.0% and 2.5%, respectively, while the equal-weight S&P 500® declined 2.2% and the Russell 2000 fell 7.5%. AI infrastructure and semiconductor stocks gave back some of their strong first-half gains, with semiconductors declining 11.4%. Meanwhile, software stocks rebounded 13.4%, as measured by the S&P Software & Services Select Industry Index, as companies began demonstrating greater opportunities to monetize AI rather than simply facing the risk of disruption.
Large-cap technology was led by Meta (+28.7%) and Microsoft (+37.5%). Meta introduced its new personal AI agent, Muse, which can browse the web, send emails and make online purchases. Microsoft similarly rebounded, helped in part by enhancements to its business productivity assistant, Copilot. These assistants illustrate how AI may increasingly execute tasks on users’ behalf and drive meaningful productivity gains.
Energy was a major driver during the quarter, both for sector returns and inflation expectations. WTI crude oil rose 30% as U.S.-Iran peace talks broke down, reversing much of its 31% decline during the Q2 truce. Higher oil prices added to inflation concerns and helped push interest rates higher, with the 2-year Treasury yield rising 73 basis points during the quarter and the 10- and 30-year Treasury yields reaching their highest levels since 2002. Against this backdrop, the Federal Reserve raised rates by 25 basis points in September and may increase rates again before year-end.
Sector performance reflected these crosscurrents. Energy (+16.5%), Technology (+7.1%), Healthcare (+6.0%) and Communication Services (+3.5%) led the market, while Utilities (-13.0%), Industrials (-9.9%), Real Estate (-6.3%) and Consumer Discretionary (-5.2%) lagged.
The market withstood elevated oil prices and rising interest rates, supported in part by strong corporate earnings, particularly among large technology companies including Google and Meta. Unemployment remained low at 4.2% in September despite weaker-than-expected hiring. Inflation, however, remains elevated, with core PCE rising 3.0% year over year, well above the Federal Reserve’s target. Energy prices remain a concern, as a prolonged period of elevated prices could add further inflationary pressure. Economic growth has remained resilient despite geopolitical and interest-rate headwinds, with Q2 GDP revised to an estimated 2.2%. Growth is expected to accelerate in Q3 to an estimated 3.7%, according to the Atlanta Fed’s GDPNow model.
Following a strong Q2, the market consolidated in Q3 as investors questioned the durability of AI spending and weighed the impact of higher energy costs and interest rates. Interest-rate-sensitive sectors were particularly weak, while investors rotated toward companies generating sustainable free cash flow. Higher rates also pressured valuations, particularly among long-duration equities. Despite narrow market breadth, we remain committed to diversification and broad portfolio exposure rather than attempting to time short-term market rotations. Healthcare provides a good example. After falling out of favor earlier this year, biotechnology, pharmaceutical and diagnostics companies have rebounded as investors increasingly recognize the potential for AI to enhance areas such as drug discovery. These rotations can occur quickly, reinforcing the importance of remaining invested and maintaining diversified exposure.
While we remain vigilant for signs of slowing consumer spending or credit deterioration related to higher interest rates, we remain constructive on companies with strong free cash flow and durable secular tailwinds. We believe companies positioned to benefit from long-term trends such as AI can continue to generate attractive growth even in an environment of elevated oil prices and interest rates.
Performance Attribution
Our top three contributors to performance for the quarter were as follows:
Microsoft Corporation (MSFT 4.98% of the holdings of the fund) benefited from continued strength in cloud computing and accelerating adoption of artificial intelligence across its product portfolio. Microsoft Cloud revenue increased 29% year over year to $54.5 billion in its most recently reported quarter, while Azure and other cloud services revenue increased 40%. Growth continues to be supported by demand for AI infrastructure as well as increasing adoption of Microsoft 365 Copilot, where paid seats surpassed 20 million. Microsoft remains well positioned as enterprises increase spending on cloud infrastructure and incorporate generative and agentic AI capabilities into their existing technology platforms.
Apple Inc. (AAPL 6.40%) reported its strongest June quarter on record, with revenue increasing 16% to $109.4 billion and diluted EPS increasing 29%. Results were broad-based, with iPhone, Mac and Services each achieving June-quarter revenue records and double-digit revenue growth across all geographic segments. Investor sentiment also improved following the introduction of Apple’s latest artificial intelligence capabilities, including an updated Siri, reinforcing expectations that AI-enabled products and services can support future device upgrades and further expand the company’s ecosystem.
NVIDIA Corporation (NVDA 5.30%) continued to benefit from extraordinary demand for accelerated computing infrastructure as spending on artificial intelligence remains a major priority for hyperscale cloud providers and emerging AI companies. Fiscal second-quarter revenue rose 106% year over year to $96.2 billion, while Data Center revenue increased 117% to $89.0 billion. Demand remains strong as multiple frontier AI labs, cloud providers and enterprises continue to expand computing capacity, reinforcing NVIDIA’s leadership position across GPUs, networking and the broader AI infrastructure ecosystem.
Holdings within the portfolio that were negative contributors to performance were as follows:
Qnity Electronics, Inc. (Q 1.54%) was a negative contributor despite continuing to report strong underlying operating results. Second-quarter sales increased 22% year-over-year to approximately $1.4 billion while adjusted earnings increased 53%, prompting management to raise its full-year revenue, EBITDA and EPS guidance. The company remains well positioned within semiconductor manufacturing, advanced packaging and high-performance computing; however, following substantial appreciation earlier in the year, the stock experienced valuation-related pressure and profit taking during the quarter despite continued strength in underlying demand. The position was subsequently sold in mid-September to raise cash for new ideas discussed below.
Caterpillar Inc. (CAT 1.38%) reported record second-quarter sales and revenues of $20.5 billion, an increase of 24% year-over-year, while adjusted EPS increased significantly to $8.17. Strong order rates and a growing backlog reflected broadening demand across the company’s major businesses, including infrastructure and power-generation markets. Despite strong operating results, the stock weakened as higher interest rates, elevated energy costs and concerns regarding the durability of the broader industrial cycle pressured economically sensitive companies during the quarter. We continue to view Caterpillar’s exposure to infrastructure spending and growing power requirements associated with data-center development as attractive long-term growth opportunities.
Tapestry, Inc. (TPR 1.32%) reported solid operating results, led by continued strength at the Coach brand, but the stock sold off sharply following fiscal 2027 guidance that implied a meaningful deceleration in revenue growth. Management guided to mid-single-digit revenue growth compared with approximately 14% growth in the prior year, disappointing investors following a strong advance in the shares leading into the earnings report. In addition, continued weakness at Kate Spade remains a concern, with the brand expected to generate a modest operating loss as management continues to invest in its turnaround. While these issues create near-term execution risk, we remain constructive on the company given the strength of Coach, healthy margins and cash flow generation, and management’s track record of brand stewardship and capital allocation. We believe management has the ability to address the Kate Spade shortfalls and improve growth over time, although the pace of that recovery will remain an important factor to monitor.
Activity During the Quarter
Activity during the quarter reflected our continued confidence in companies with strong long-term fundamentals and exposure to the expanding adoption of AI, balanced against the risks posed by higher interest rates and energy prices. New positions were established in Ulta Beauty (ULTA .87%), Micron Technology (MU 1.38%), ServiceNow (NOW 1.92%) and Lam Research (LRCX 1.03%). Ulta broadens our exposure beyond technology through a leading beauty retailer with an established loyalty program and improving operating momentum. Management raised its full-year sales and earnings outlook following second-quarter results, supporting confidence in the company’s execution despite a challenging consumer environment.
Micron was purchased during the semiconductor pullback to participate in the growing memory requirements of AI computing, supported by high-volume shipments of its latest high-bandwidth memory products. ServiceNow complements our infrastructure investments through enterprise software that helps customers automate business processes and improve productivity. Subscription revenue increased 24.5%, while AI offerings surpassed $1 billion in annual contract value, providing evidence of increasing AI monetization. Lam Research adds exposure to semiconductor manufacturing investment, where increasing chip complexity supports demand for its equipment. The company reported record June-quarter revenue, operating margins and earnings per share, with management identifying AI-driven demand as a key growth driver.
We added to Tapestry (TPR 1.38%), Alphabet (GOOGL 4.96%) and Microsoft (MSFT 4.93%). Tapestry’s pullback provided an opportunity to increase exposure to continued strength at Coach while acknowledging slower consolidated growth expectations and ongoing challenges at Kate Spade. We remain confident in management’s ability to address these shortfalls, supported by the company’s cash generation and record of capital returns. Alphabet was increased given its financial strength and opportunities to monetize AI across search, advertising, and cloud computing. Second-quarter revenue increased 24%, and operating margins expanded to 34%, while management reported that AI features were driving search query growth. Microsoft was added to on continued strength in cloud computing and enterprise AI adoption, with annual Azure revenue surpassing $100 billion and Microsoft 365 Copilot exceeding 30 million paid seats. These investments reflect our view that AI spending is translating into measurable business benefits.
Positions in McDonald’s (MCD .88%), DuPont (DD .91%), Lowe’s (LOW .94%) and Qnity Electronics (Q 1.54%) were sold to fund opportunities with more attractive long-term growth potential. McDonald’s continued to generate positive comparable sales, but modest U.S. growth and management’s emphasis on improving domestic execution supported a reassessment of its growth prospects relative to other opportunities. DuPont’s narrower sales outlook and delays in its Middle East water business highlighted uncertainty around near-term growth, supporting the reallocation toward companies with stronger secular tailwinds. Selling Lowe’s reduced exposure to interest-rate-sensitive home-improvement spending, as cautious consumers and softer demand for larger renovation projects prompted management to lower its comparable-sales outlook. Qnity was sold in mid-September to raise cash for new ideas despite continued strength in its underlying business, as discussed in Performance Attribution.
A tax roll was also completed in TJX Companies (TJX 2.19%) as part of portfolio tax management, consistent with our continued investment view of the company. Overall, these changes reflect our commitment to diversification and remaining invested while selectively reallocating capital toward companies positioned to sustain growth through a more challenging interest-rate environment.
At quarter end, the model portfolio was overweight Industrials, Financials, and Materials while underweight Technology. We are in line with our benchmark in the remaining sectors. The current dividend yield of the portfolio is 1.2%, which remains slightly greater than the S&P500’s yield of 1.1%.
Call Option Implementation Overview
Volatility remained relatively contained during the third quarter, easing through July and August before rising in September as renewed Iran tensions, higher oil prices, and increasing Treasury yields heightened inflation concerns. The Federal Reserve’s September rate increase prompted another equity pullback, but volatility subsequently moderated as oil prices and yields eased. Despite these intermittent setbacks, the S&P 500® gained approximately 2% for the quarter as confidence in earnings and AI-related growth helped offset geopolitical and interest-rate uncertainty.
The relatively calm VIX readings masked substantially higher volatility among individual equities and weakening market breadth, with approximately 60% of S&P 500 constituents trading below their 200-day moving averages at quarter end. Elevated individual-stock implied volatility generally supported richer covered-call premiums, giving portfolio managers flexibility to write calls against a smaller proportion of holdings or select strikes further out-of-the-money while targeting income comparable to prior quarters. This flexibility places greater emphasis on upside capture, allowing more participation in stock recoveries should lower rates, declining oil prices, or progress toward a war settlement improve sentiment. The model portfolio generated net option premium at an annualized rate of 3.0%, with average call strikes positioned 17.0% out of the money, compared with 14.6% last quarter, and an average of 82 days to maturity, providing greater room for stock appreciation while continuing to generate income.
Protective Put Positioning
During the quarter, the Fund used put spreads to help cushion equity market declines while maintaining exposure to potential market gains. Put spreads provide protection over a defined range of declines. Selling a put at a lower strike price alongside the purchased put reduces the cost of protection but limits its maximum benefit.
The average notional value of the Fund’s put protection represented 31% of the portfolio during the quarter. This measure reflects the scale of the hedging positions rather than the percentage of portfolio losses they would offset. Hedging positions detracted 0.39 percentage points from the Fund’s return for the quarter and 1.58 percentage points year-to-date.
We evaluate hedging as part of the Fund’s overall risk management, balancing the cost of protection against its potential to reduce losses during market stress. Put spreads do not eliminate downside risk, and their effectiveness depends on the magnitude and timing of market declines.
Outlook
The market continued its upward trajectory during the quarter despite headwinds from higher interest rates, geopolitical turmoil, elevated oil prices and questions surrounding the sustainability of AI spending. Although market leadership remained narrow, previous laggards such as software stocks picked up where semiconductors and AI infrastructure stocks left off. The economy remains on solid footing, while earnings growth continues to surprise to the upside. Importantly, the benefits of AI investment are beginning to broaden beyond the companies directly benefiting from infrastructure spending to the enterprises adopting and monetizing AI. New agentic AI assistants and the returns on AI investment evident in hyperscaler results provide early signs of this transition.
While we recognize that continued geopolitical uncertainty surrounding Iran and rising interest rates could create stressin credit markets, we balance these risks against our belief that we are still in the early stages of realizing the benefits of AI investment. We also note that the market appears reasonably valued at 18.5x 2027 consensus earnings estimates, supported by robust earnings growth.
Although recent market participation has been narrow, we remain committed to diversification and believe strong long-term risk-adjusted returns come from remaining invested through periods of heightened volatility. We continue to take advantage of pullbacks to add to companies with strong long-term fundamentals while prudently trimming positions that appear extended following sharp upward moves.
IMPORTANT DISCLOSURE INFORMATION:
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The performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. For performance current to the most recent month end, please call 833-601-2676. |
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. Diversification does not ensure a profit or guarentee against loss. 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.
Investing involves risk, including the possible loss of principal. Investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. There is no assurance that the Fund will achieve its investment objective. Investments in options involve risks different from, or possibly greater than, the risks associated with investing directly in the underlying securities. Large-capitalization companies are generally more mature and may be unable to respond as quickly as smaller companies to new competitive challenges, such as changes in technology and consumer tastes, and may not be able to attain the high growth rate of successful smaller companies, especially during extended periods of economic expansion.
Investments in options involve risks different from, or possibly greater than, the risks associated with investing directly in the underlying securities.
Definitions:
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.
In-the-money options: Refers to an option that has intrinsic value because the strike price is favorable compared to the current market price. For a call option, the stock's price is above the strike price; for a put option, the stock's price is below the strike price.
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.
Option premium: Price of an option contract.
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.
Portfolio percentage written: Refers to the number of call contracts written (or sold) versus the number of shares held in the portfolio. One contract is equivalent to 100 shares.
Premium: Price of an option contract.
Premium generation: Collecting proceeds from the sale of a call option.
Put contract: Refers to a contract that gives the holder the right, but not the obligation, to sell an underlying asset. In this case, the underlying asset is the S&P 500 Index.
Put protection: Implementing a protective put by purchasing a put option vs a long underlying equity position or a 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
Roll qualification: A situation where closing out an existing option and writing a new option.
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.
Simple: The return generated from the sale of a call option relative to the price of the stock.
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.
Total Income generation: The income generated through the sale of the call option contracts, which generates cash and is counted as income for the portfolio.
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. It measures investors’ expectations for market volatility over the next 30 days and is often viewed as a gauge of investor sentiment or fear.
When the VIX is below 20, it generally indicates a calm market environment with lower expected volatility and a higher level of investor confidence.