Does anyone else know what it is like to have teenagers in your house? The only way parents survive the drama is with the knowledge that these volatile creatures were once their adorable little boys and girls, and will one day be endearing humans once again.

When I take a deep breath and remind myself that our little girl is still in there somewhere, I remember back to when my daughter’s favorite show was a Disney cartoon entitled, “The Lion Guard.” There was one episode in particular when the Lion Guard was trying to help a zebra whose herd was under attack by hyenas. The zebra’s reaction was to panic and run. I can still see my daughter dancing around the house singing, “Panic and run, panic and run!” It made for a cute children’s show, but obviously panic is not really a good investment (or life) strategy. One wouldn’t know that if he was paying close attention to the markets today.

If there is one strategy in investing that is universally preached, it would be diversification. We all know that we shouldn’t put all of our eggs under the same layin’ hen (at least you do if you read the First Quarter 2024 issue of The Quarterly Report). We have to diversify our investments. The theory of diversification rests on owning assets that have low (maybe even negative) correlations with one another. For example, stocks and bonds: The idea is that when stocks sell off, investors should go towards the perceived safety of bonds and therefore bonds will increase in value as stocks decrease in value, helping to reduce the volatility of one’s portfolio.

Asset allocators, whose job it is to figure out how exactly investments should be mixed together to optimize risk and return, obsess over correlations. It does work, most of the time. However, there is one problem: In times of true market distress, all correlations go to one. In plain English: When something really scares the market, such as a financial crisis or a war in the Middle East, all well-conceived investment strategies turn into “panic and run.”

Since the first attacks on Iran on February 28, the S&P 500 is down approximately 4 percent.  On February 27 (the day before the attack), the 10-year U.S. Treasury had a yield of 3.97 percent. In other words, the interest rate on a 10-year loan to the U.S. government was 3.97 percent. On March 24, that interest rate is now 4.4 percent. As a reminder, bond yields and bond prices have a see-saw relationship. When yields go up, it means prices have gone down. So, investors are selling stocks and they are selling bonds.

Maybe they are only selling U.S. bonds since we started this war? Nope, the German Bund (German for bond) had a yield of 2 percent on February 27 and now yields 3.03 percent.

I know what you are thinking: Gold is the safe haven, that is where smart people put their money today. Nope, gold was $5,230 per ounce the day before the attack and it is now $4,375 per ounce. Should I keep going?

In times of crisis, correlations go to one and diversification is not of great help. So, what are investors to do? It is at times like this that investors need to know what they own and know why they own it. Great investors are owners of companies, not traders of stocks. While Wall Street is in full panic and run mode, selling almost everything, out here in the real world, life goes on. Apple is still selling phones. Alphabet is still helping people Google the latest information. Have you seen the lines at the airport? Delta is still flying people (or leaving them if they didn’t get through security in time).

Sometimes the best way to handle a storm is to batten down the hatches and just sail through it. This too shall pass. That is the mantra for the day in the market and in all those households with teenagers. The war will end and we will get on with our lives, at least that is what my wife and I keep telling ourselves.

Warm regards,

Chuck Osborne, CFA

~Panic and Run!

“Han Solo:  How we doin’?
Luke: Same as always.
Han Solo: That bad huh?”
~ “Star Wars, Return of the Jedi”

I was reminded of this fictional conversation as I drove to work this morning. We were already in one of those no-win moods on Wall Street, and now we can add unrest in the Middle East to the long list of worries.

Casual market observers may wonder what I mean as the headline S&P 500 has not been that bad, but as I always say, it is what happens underneath the surface that tells the real story. We are in a full-blown bear market for software company stocks, thanks to the narrative that people and enterprises will just use AI to create custom software. These stocks have been badly beaten up as a result.

The full narrative goes a little something like this: AI is taking over the world, humans will no longer have jobs, and no one will use pre-packaged software to do work on a computer. This narrative exists in concert with another that has AI company stocks down because “companies are spending too much on AI and they will not be able to get a return on these investments because AI is overhyped.”

These narratives contradict one another, but when was it ever necessary for the market to make sense?

The average index investor has missed all of this fun because we have seen a large rally in industrial company stocks and the stocks of consumer staples. Coca-Cola is up more than 35 percent over the last month, and Deere & Company is up approximately 40 percent year to date. Nothing runs like a Deere, but that is a remarkable short-term gain for a company that is still experiencing a downturn in its actual business. I have lived in Atlanta my entire adult life, and few things are as refreshing as an ice-cold Coke on a hot day, but this is 2026 and sugary soft drinks don’t scream future.

Now we have to add war in the Middle East to the situation. So, how we doin’? Same as always. But is it really that bad?

In the real world, away from Wall Street’s narratives, technology companies are doing really well. This includes both software companies and AI companies. Can AI write code and therefore replace the need for software? Maybe, but that’s like saying a coffee maker will replace the need for Starbucks. Sound ridiculous? Just because something can be done, does not mean it will. People choose to go to Starbucks rather than making coffee at home, and people and enterprises will likely choose to buy software rather than developing it themselves because they would rather have their AI agents working on making their actual business more productive than building software that they could just purchase. Let’s put it this way: If the business didn’t see the value in hiring human coders, then why are they going to want to train AI agents for that purpose?

Does this mean AI is overhyped? No; business leaders will likely use AI to get the most out of the software they already have, which would greatly enhance productivity. One thing I know for certain: technology leaders are not the right people to ask about the future of AI. They are brilliant, but they are too close to the situation to see the big picture and they don’t understand how non-tech (often non-brilliant) people think.

What about Iran? What is happening in the Middle East today is more important than anything in the stock market. However, it is our role to discuss impacts on investments. In the short term this may finally be the trigger for a correction. No one likes market corrections, but they are a healthy part of long-term bull markets. We are overdue, and this would likely help correct some of the absurdities we have discussed. In the longer term it is not likely to have a large impact on the market.

Irrational short-term trading and war in the Middle East? I think Luke was right: this is the same as always.

Warm regards,

Chuck Osborne, CFA

~If The Iranians Don’t Get Us, The Machines Will…?

“He’s making a list, and checking it twice, gonna find out who’s naughty or nice. Santa Claus is coming to town!”

So, have we been naughty or nice? Will we finish the year with a little Santa rally, or will we end up with a lump of coal? Its hard to say.

In preparing for this annual Christmas Insight I reviewed what I wrote the last few years. While I have promised not to use AI in our writing, it is tempting to cut and paste those previous December Insights. Like 2023, this has been a strange year, especially in the second half. Take small-company stocks in the Russell 2000 index: At the end of the third quarter, stocks of companies in that index that are losing money were outperforming the stocks of companies in that index that make money by more than 30 percent.

This phenomenon led to the narrative that we are in an AI bubble, which in turn has led to a strange quarter where seemingly company after company reported better-than-expected financial results only to watch their stock prices drop as a result. One such example is Duolingo, which grew revenue at 41 percent and earnings at more than 1,000 percent to then see its stock drop 25.5 percent the day they announced these results. Doesn’t seem to make sense? It doesn’t have to make sense. Markets allocate capital over the long term better than any other method, but in any given short-term period, all kinds of crazy things can occur. This is why prudent investing requires patience, which was our theme in 2023.

In both 2023 and 2024 there was lots of talk about the market being expensive. It still is expensive if one simply looks at the top-down index view. There are some differences, however. The S&P 500 has been very top-heavy; the valuation is skewed by the very high price of the largest few companies. In 2023, we were describing these as the Magnificent Seven. In 2024, we talked about large-growth companies in general being very expensive relative to earnings. Based on our proprietary work, they were two standard deviations above average, which in plain English means they reach prices this high only 5 percent of the time.

In both years we pointed out that there are several areas in the market that were not at these really high prices, and that observation has played out over the last few years. As we finish 2025, value stocks have rallied. The stocks portion of our income strategy, which is meant for investors who are either very conservative and/or in retirement and needing income, is up more than 23 percent, net of fees, year to date through December 17. These are the most conservative value stocks that we own and they have outperformed not only the S&P 500 but also our most aggressive strategies. Last year it was the opposite. I have said it before, and it bears repeating: We did not wake up on January 1, 2025, and forget how to invest for growth, nor did we not know anything about income strategies in 2024. This is how markets work; there is a give and take.

One of the companies we own in our income strategy is Rio Tinto, a mining company that mines several different minerals but primarily iron ore. Rio’s stock price is up 19.78 percent over the last three months and 37 percent year to date through December 17. Its stock price alone (not including the sizable dividend) is up 32 percent total over the last three years. In other words, the stock price was down approximately 5 percent going into the year and not even that great until the last three months. This is how stocks actually move and what makes investing so difficult; they stay relatively flat for long periods and then jump. This behavior is what fools investors into believing they can time things that cannot be timed.

In 2023, it was the Magnificent Seven. In 2024 it was technology, more broadly and AI. Now we are seeing value finally get into the act. So, what will Santa bring us this year and how will this play out in 2026? Honestly, I am not sure, but I do know one thing: the market is running out of places where lower prices can be found. Based on this run, large value stocks have joined their large growth cousins in being unusually expensive.

I suspect that the New Year will bring a rally in technology and AI-related stocks, which have been selling off as of late, and perhaps a drop in the value stocks that have rallied. After that, it will depend on the economy. High prices alone do not cause markets to drop, but high prices combined with disappointing results will. Can the economy hold up and allow corporate earnings to grow into these valuations? That is the question of 2026.

In the meantime, we wish you all a very Merry Christmas and a Happy New Year!

Warm regards,

Chuck Osborne, CFA

~Which List Are We On?

Many people believe that the stock market is always correct, that it efficiently allocates capital based on the latest data and that every change has a rational reason. Just last week we had wonderful results from Nvidia and then received an overdue jobs report that was much better than expected; the market rose in the morning, then dropped like a rock. The pundits jumped in and quickly told us that Nvidia’s results were just too good and therefore proof that we are in an AI bubble, while the better-than-expected jobs report just means that the Fed will not lower rates. So good news is bad news. It all makes sense, right?

Wrong. As Nassim Nicholas Taleb pointed out in his book “Fooled by Randomness,” we are often fooled by randomness. (Taleb has wonderfully descriptive titles for his books.) Day-to-day activity in the stock market is random; people buy and sell stocks for all sorts of reasons. Index funds buy because they have to look like the index. People sell stocks to buy that house they wanted, pay bills in retirement, pay a tax bill, make charitable donations, and for hundreds of other reasons that have nothing to do with that morning’s economic news.

The market doesn’t get it right every single moment. To quote the wisdom of Agent K (Tommy Lee Jones’s character in “Men in Black”), “A person is smart. People are dumb, dangerous, panicky animals and you know it.” The market is made up of people. So, what are we to do?

I think Benjamin Graham said it best: “You are neither right nor wrong because the crowd disagrees [or agrees] with you. You are right because your data and reasoning are right.” Prudent investors cannot simply agree with the market all the time, nor can they just be contrarian and claim that it is always wrong. They must do their own work. What is actually happening at the companies whose stock we own? Over the last few weeks, the news has been good and the market reaction has been bad. These things happen in the short term; in the longer term, the market does do a good job of getting it right. Patience is in order.

It is Thanksgiving, and I am extremely grateful. In keeping with our tradition, here is my list:

~ I am thankful that we base our investment decisions on sound fundamentals instead of irrational short-term market moves.
~ I am thankful for our country, which with all its faults is still the best place to live.
~ I am thankful that college basketball has begun, and that Wake Forest is finally testing itself in the non-conference schedule.
~ I am thankful for all of my new team members at Gallagher and the bright future we have.
~ I am thankful my wonderful wife, who has fully recovered from last year’s hip replacement.
~ I am thankful for my son and my daughter, both of whom are growing into wonderful human beings.
~ I am thankful for my family, immediate and extended.
~ I am thankful for all of my friends.
~ Of course, I’m always thankful for Mama’s pumpkin cheesecake, though she is no longer here to enjoy it. I don’t think she will mind me eating her slice.
~ Finally, I am thankful for you, our clients and friends. Your trust in Iron Capital and now Gallagher is our greatest asset and we value it every day of the year.

Happy Thanksgiving!

Chuck Osborne, CFA

~Does the Market Always Get It Right?

I know we are past Halloween, but everyone seems to be scared of an AI bubble. It seems to be the only thing people can talk about in investing circles. So, are we in an AI bubble?

Of course we are, but that is not the right question. If one wants a useful answer, then she must ask useful questions. In the late 1990s I was part of an investment team that was running an asset allocation strategy, and the lead manager was convinced that we were in a technology stock bubble. Based on our work we moved away from large growth technology and went heavily into real estate; if we could have then time traveled forward a decade, he would have looked like a genius. Unfortunately, he made that call several years before the bubble burst.

In the meantime, people remember famous quotes from the era. Fed Chair Alan Greenspan famously warned of “irrational exuberance.” We all remember that, but do we remember that he said that in 1996, four years before the tech bubble burst? There was lots of talk about bubbles in the 1990s. NASDAQ, the home of most of the high-flying technology companies at that time, had more than a dozen corrections during the 1990s. (A correction is a drop of 10 percent or more.) Every single time there were people out there saying the bubble was bursting, and they were wrong every time.

What they were really saying then, and what many are saying now is, “I am not invested in the internet (AI today) and I’m relieved there is a correction because I have missed out on all those returns.” They will continue to do that for as long as they can stand it. Then, the very same people will ultimately give in to their fear of missing out (FOMO) and change their tune.

One of my colleagues at Invesco during that era had great success investing in technology firms. He declared that valuations no longer mattered, and once told me that “small value” was an oxymoron. His fund then dropped 49 percent in value in 2001. The small value category was the best place to be in the market for the next decade. He lost his job, but not before demonstrating how people talk before a bubble bursts.

The right question is not whether we are in an AI bubble, but where are we in the inflation process of that bubble? The answer to that question is that we are far closer to the beginning than we are to the end. How do we know? Because everyone keeps talking about being in a bubble. When that stops and they start saying things like “this is a new world,” “valuations don’t matter,” or “every other investment makes no sense,” that is when the bubble is about to burst.

Warren Buffett did not go on the internet bubble ride, and you don’t have to go on the AI ride. However, if you choose that path, you had better be sure that you are as psychologically strong as Buffett. During that time articles were written describing how he was washed up and could no longer succeed in the new world. He didn’t care, and he came out just fine. Likewise, had my colleague not been fired and been allowed to ride out the decade of the 2000s, he would have been fine as those tech stocks did ultimately pay off. He was not allowed to be out of sync with the market that long; few investors can. That is really Buffett’s secret: After a good ten-year run in what today would be called a hedge fund, he bought Berkshire Hathaway and fired his clients. He can ride through long periods of being out of sync.

Most of us have to live somewhere in the middle. AI is a bubble and eventually it will burst, but that is most likely years away. Instead of guessing, we believe that one should remember that it is better to be an owner of companies than a trader of stocks, and diversification is our friend. There is no law that says one can own only AI or energy but not both.

Finally, at the end of 2002 I left Invesco to start Iron Capital. Shortly thereafter my girlfriend (now wife) and I were at a dinner party where one of the other couples asked, “Do you think we are in a housing bubble?” That was approximately 2004, and we were, but that was the wrong question…

Warm regards,

Chuck Osborne, CFA

~Bubble, Bubble Toil and Trouble