Market Commentary
The Only Constant in Life is Change
The paraphrased quote is attributed to the Greek Philosopher Heraclitus. The quote illustrates his concept of Universal Flux, where everything is continuously transforming with no permanent state. The movements in the stock market were a prime example of this principle in Q4. While the market was up for the third consecutive quarter, gaining 2.35% as measured by the S&P 500® Index, the path was not without bumps. The market sold off 4.5% from October highs in November as concerns grew that a Fed cut in December was no longer a foregone conclusion. Dovish Fed comments in late November triggered a rally that continued into late December. On the positive side, earnings remained better than expected, AI growth remains strong, the Fed eased rates by an additional 50 basis points (bp), and Quantitative Tightening (QT) ended in December. GDP growth also surprised to the upside, coming in at 4.3% in the third quarter, the highest in two years. Growth should remain robust in 2026, given fiscal stimulus and tax cuts provided by the One Big Beautiful Bill Act (OBBBA). On the negative side, AI capex concerns have increased as investors question the return on invested capital (ROIC) and free cash flow (FCF) from substantial AI spending, as hyperscalers are reinvesting most of their FCF in addition to raising debt to fund continued capital equipment spending. The Labor market has weakened, affordability concerns remain, further Fed rate cuts may be on pause, and bullish investor sentiment may be a contrarian indicator. While trade concerns have lessened with a one-year extension of the trade truce with China, geopolitical concerns remain elevated, particularly after the capture of Nicolas Madura in Venezuela, as well as events in Iran and continued conflict in Ukraine. The market broadened during the quarter, with the Dow outperforming the Nasdaq and S&P 500. Performance divergence amongst the Magnificent 7 grew as GOOGL (+28%), AAPL (+6.8%), and AMZN (+5.1%) were strong while META (-10.1%) and MSFT (-6.6%) lagged in Q4.
The market broadening is illustrated by the Dow outperforming both the S&P and Nasdaq. We believe this is likely to continue in 2026. The broadening was driven by several factors. First of all, lower interest rates from Fed rate cuts and liquidity provided by ending quantitative tightening are particularly stimulative to cyclical sectors. Secondly, on the AI front, investors are questioning the return on investment associated with the significant capex needed for AI. We believe that focus will shift to investment in inference this year as enterprises begin to leverage the power of large language models (LLMs) to improve efficiency, lower costs, and drive incremental revenue. We see the next wave of AI benefiting software, services, and non-technology companies across all sectors that are able to leverage the power of AI. Tax cuts provided by the OBBBA should provide an additional tailwind in the new year. We see these drivers enabling solid GDP growth and higher corporate earnings.
Economic growth continued to surprise to the upside, accelerating to 4.3% in Q4 following 3.8% growth in Q3. Momentum is expected to carry into Q1, with the Atlanta Fed’s GDPNow currently estimating growth of 5.1% for the quarter. The labor market continues to be slower, with 50,000 jobs added in December, though the unemployment rate remains low at 4.4%. Inflation remained somewhat sticky in December, with the CPI coming in at 2.7%. The Fed cut rates by an additional 25 bp at its December meeting, given labor market weakness. However, the likelihood of a pause in rate cuts has increased as GDP growth has been remarkably strong, and inflation remains above the Federal Reserve’s target rate. Market performance during the quarter was led by Healthcare (+11.2%) and Communication Services (+7.0%), while Real Estate (-3.7%), Utilities (-2.1%), and Consumer Staples (-0.7%) were the weakest sectors. The other sectors had positive returns but lagged the Market in Q4. Following another strong quarter and increasing investor optimism, which is often a contrarian sign, we see the potential for some market consolidation early in the year before the Market resumes its upward trajectory.
Performance Attribution
Our top three contributors to performance for the quarter were as follows:
DuPont (DD) reported a solid third quarter with 6% organic sales and operating growth, enabling management to raise its full-year earnings guidance, reflecting optimism about the company’s future performance and profitability. New product development and opportunities in industrial water purification within China speak to its strategic growth and expansion efforts. The company also approved a $2 billion share repurchase authorization and declared a $0.20 per share quarterly dividend as a commitment to shareholder returns.
Caterpillar (CAT) reported a 10% increase in sales for the third quarter, reaching an all-time high, driven by higher volumes in its primary segments. The company now expects full-year 2025 sales to be higher than anticipated due to record backlog and stronger order rates. In addition, the improvement in operating margins wasable to offset the bulk of the tariff impact, which came in at the high end of the company’s estimates. Much of the strength is driven by strong orders in the power applications (mini-turbines) within the data center space related to cloud computing and generative AI.
Tapestry (TPR) for the second straight quarter was one of the top performers for the portfolio, reporting a significant increase in revenue by 16%, expanding operating margins by 200 basis points, and increasing earnings per share by 35%. In addition, management raised guidance as confidence grew in its ability to deliver continued growth. In terms of brands, Coach saw a 21% increase in revenue as the revival of this key brand continues to take shape. The company announced significant shareholder returns with a quarterly dividend of $0.40 per share and a $500 million share repurchase.
Holdings within the portfolio that were negative contributors to performance were as follows:
Oracle (ORCL). Oracle’s swing in performance from a top positive return contributor last quarter to the lowest negative contributor this quarter had nothing to do with the firm’s reported numbers as it highlighted a surge in Remaining Performance Obligation (RPO) by 433%, portending possible strong future revenue potential. Rather, concerns were elevated around the ability of its largest cloud customer (Open AI) to secure funding for its massive capex spending needed to serve projected customer demand for AI applications. Would future demand and cash flow be significant enough to cover capex over a reasonable time period? In the case of Oracle, questions surfaced relative to the reported RPO number as to its realization, given the questions around Open AI’s funding concerns and ability to generate a positive return in a reasonable time period. In addition, investors began to balk at Oracle’s elevated debt load, particularly given the lower margin profile of this business.
Abbott (ABT) reported solid 7.5% organic sales growth driven by strong performances in Medical Devices and pharmaceuticals. Some weakness was experienced in its Diagnostics segment as conditions in China proved to be somewhat challenging. In addition, loss of market share in the pediatric segment was a negative for the stock; however, management feels that this could reverse over the next two quarters of 2026.
Eaton (ETN): The company reported strong growth in several segments, including Latin America and aerospace. The most significant growth was in the data center market, with orders up 70% in this segment. Although management reiterated guidance for 2025, investor concerns center around the inability of management to increase guidance higher, given data center and electrical grid tailwinds, challenges have persisted in the vehicle and e-mobility segments, with declines in revenue.
Activity During the Quarter
As enterprises begin to adopt AI features and applications, IT services providers will be in strong demand. Accenture (ACN) is one of the largest IT services companies and is focused on growing its business in this space. Having been out of favor given DOGE initiatives and investor focus on hardware, it trades at a very attractive valuation with strong returns on capital while paying a 2.4% dividend yield. The company reported 5% revenue growth with advanced AI bookings nearly doubling and current AI revenue hitting $1.1 billion for the quarter, showcasing leadership in AI integration. Boeing (BA) was added to the portfolio early in the quarter as its turnaround progress makes headway and begins to show results. The company reported a 30% revenue increase with a record backlog of $535b. Most importantly, free cash flow has increased positively and is projected to grow significantly as plane production accelerates in the coming quarters. On the sell side, ORCL was removed, given the concerns discussed above, and replaced with ACN. In addition, Costco (COST) was sold, given concerns over slipping membership retention and given its elevated valuation. Repurchase of the company will be considered, given any meaningful pullback in share price. Other notable positioning included additions to Amazon (AMZN), Wells Fargo (WFC), and Williams (WMB) while trimming Morgan Stanley (MS) and Eaton (ETN). To begin the year, we are overweight Industrials, Real Estate, Financials, and Energy, while underweight Technology, Communication Services and Consumer Staples. We are in line with our benchmark in Health Care and are looking to grow our exposure here in the next couple of weeks. The current dividend yield of the portfolio is 1.4%, which remains greater than the S&P 500’s yield of 1.1%.
Call Option Premium
Market volatility (VIX Index) remained somewhat subdued in the quarter with brief spikes higher in mid-October and mid-November. Worries over excess debt issuance related to AI capex buildout, the
ongoing U.S. government shutdown, and debates on Fed rate cuts briefly agitated the market. Investors shook off those worries and began pricing in additional rate cuts, once again helping the market to accelerate higher while volatility fell. In this environment, premium generation remained solid as individual equity implied volatilities remained consistently higher relative to that of the S&P 500. Opportunities to roll in-the-money options were presented at various points in the quarter from which strikes were moved out on the calendar and up in strike price. This process enables the portfolio to maintain original cost basis in the stock, thereby minimizing tax impact, while also allowing for upside participation in an upward-trending market. Each call option position is evaluated as to its roll qualification based on our analysis of the underlying stock potential for positive price movement, as well as option premium potential based on implied volatilities and delta. Premium generation on a net basis (net of premium paid on the buy-back) was .8% simple and 3.1% annualized, while the average days-to-maturity of the call option at initiation was 90 days, with 12% upside to the strike prices. The portfolio was roughly 47% covered on average for the quarter.
Outlook
The market rally continued in Q4 for a third consecutive quarter despite a somewhat bumpier path. There are multiple drivers for further upside in 2026, including a potential broadening of the market from higher economic growth and tax cuts. Despite our generally positive view of the market, we do see the potential for a brief market consolidation early in the year, given the generally bullish investor sentiment despite potential for greater volatility from geopolitical events and the reduced likelihood of additional Fed rate cuts in the near-term. We continue to invest for the long-term and believe that maintaining a diversified portfolio is the best way to remain invested in the market while attempting to reduce volatility during any potential market pullbacks. We remain disciplined in taking profits following sharp spikes in stocks and look to add to positions of undervalued equities to enhance the risk/reward profile of the overall portfolio.
Important Disclosure Information
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Connors Investor Services, Inc. “Connors”), or any non-investment related content made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from Connors. Please remember to contact Connors, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently. Connors is neither a law firm, nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice. A copy of the Connors’ current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request. Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your Connors account holdings correspond directly to any comparative indices or categories. Please Also Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your Connors accounts; and, (3) a description of each comparative benchmark/index is available upon request.