“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

Sir Rotheram has been murdered, found dead in his bathtub. Scotland Yard is completely baffled so they call the world’s most famous consulting detective, Sherlock Holmes. Holmes immediately notices the bath salts and requests that the police find where they are stored, and while at it look for footprints at all the windows. As Holmes dismisses the police he utters, “Data, data, data, I cannot make bricks without clay.”

After the police leave the room to find this supposedly valuable data, it becomes obvious to the audience that the bath salts hunt was a simple rouse to get the police out of the way while Holmes searches for more meaningful data, which turns out to be Sir Rotheram’s secret study in which he practiced his magical rituals. This data eventually leads to the capture of the movie’s primary villain, Lord Blackwood.

This movie scene has come to mind lately as one of my daily rituals has been disrupted by the government shutdown. We have our investment committee meeting every workday morning, and one of the agenda items is to review the economic data released by our government. We also review the economic data from around the world, but most of what we look at comes from right here at home. With the government shutdown, that data is not flowing.

What is the unemployment rate? We don’t know. How many filed for unemployment last week? No clue. Data, data, data…how are we to make bricks without clay? I will freely admit that my name is Chuck and I am an economic-data-aholic. It has been 20 days since my last economic data update. Having said that, this has actually been a nice reprieve, since much of the data flow from places like the Bureau of Labor Statistics is noise, not news, and we may be better off without it.

Of course, we are investors and not traders, so the daily flow of data is far less concerning to us. I can’t imagine the stress this blindness presents for those who program computers to trade on every utterance from government officials. Meanwhile, we get to focus on the data that actually counts: Corporate earnings. It never ceases to amaze me how many intelligent people lose focus on what we are actually doing when we invest in stock. They forget that stock is ownership in a company, and that in the long run, it is the business results of that company that matter.

This quarter’s corporate earnings reports have just begun so it is too early to tell, but thus far they have been good. Eventually this lack of economic data will be a problem as the economic environment does impact the business results of companies, but in the interim we are reminded that not all data is created equal. What really matters to investors are the business results of the companies in which they are invested. That will be our focus.

There are far more critical functions of government that need doing and we hope this shutdown will be over soon. In the meantime, it might be good to know that the missing data is closer to the location of bath salts than to the critical clues that lead to the capture of Lord Blackwood. A good analyst, like a good detective, knows that while data is the clay with which the bricks are made, not all data is created equal.

Warm regards,

Chuck Osborne, CFA

~Government Shutdown: What Do We Miss?

“The market is wrong.” A senior portfolio manager at my old firm made this adamant statement in response to learning that he was being moved off of the portfolio he had been managing for more than a decade. His portfolio was not keeping pace with the market, which, in this particular case, was defined as the S&P 500. He needed to add more technology stocks in his portfolio to boost the return and be more aligned with his benchmark. He refused because he believed those stocks were in a bubble and it would be ugly when that bubble burst. Senior management’s response was to do what they had done before with experienced portfolio managers, “promote” him so that he no longer had day-to-day investment decision-making responsibility.

I know what you are thinking:  In hindsight that proved to be a huge mistake, and this gentleman proved to be correct. Yes, but unfortunately for him, this conversation took place in early 1998 – two full years before that dot-com bubble finally burst. In the investment business there is little difference between being early and being wrong.

Are we in an AI bubble? Late last week I took an Uber home from the Atlanta airport after being gone several days. The very friendly driver asked what I did for a living. I hate that question, because it usually leads to a second question that isn’t really a question but a statement that the questioner wishes for me to reaffirm.

In this case, my Uber driver asked me what I thought about the valuations of AI companies. Fortunately for me, this gentleman didn’t even wait for my response before telling me the answer. According to my Uber driver, AI is wonderful technology but it is not the end game, they want to create actual human-level intelligence, which they will never do, so these stocks are all in a bubble that is going to burst and cause huge financial damage.

I never responded to anything the gentleman said, which turned out to be fine because he didn’t stop talking long enough for me to get a word in even if I wanted to. He was just as certain about us being in a bubble as that senior portfolio manager was all those years ago. He is even more wrong.

As Mark Twain supposedly said, “History doesn’t repeat itself, but it often rhymes.” We are not in the same place today that we were in the 1990s, but there are certainly similarities. AI is an exciting new technology with huge potential, much as the internet was 30 years ago.

However, the internet came at a time when value investing was king. Many of the internet startups were staffed by IT professionals who had found themselves unemployed when the tech giants of the day had massive layoffs in the early 1990s, while the AI movement came after a decade of large technology firms already dominating stock market returns. Most internet companies went public with little more than the promise of having “.com” at the end of their names, whereas AI has largely been driven by already established firms such as Nvidia and Microsoft.

AI has immediate productivity-boosting capabilities while the internet had potential. As a result, AI revenues have grown as fast, if not faster than, most of the stocks. This means that thus far there has been far less speculation than at the same moment in the 1990s. This is not a simple repeat of history, although there are lessons to be learned.

The one thing that drives all bubbles is human psychology. That has not changed, which means we likely will have an AI bubble. It is our nature to overdo; we overreact to news both good and bad, and we do it on repeat. However, if that does happen with AI, we are much more likely in 1997 or 1998 as opposed to 2000. Bubbles don’t burst when Uber drivers are talking about being in a bubble; they burst when everyone believes it is a brave new world.

Two years after that uncomfortable meeting with the senior portfolio manager, I had another one. This time it was me stepping out on a limb and suggesting that our current star portfolio manager was about to blow up. This portfolio manager had just won a “Manager of The Year” award from Morningstar and had appeared on Louis Rukeyser’s “Wall Street Week,” where he infamously suggested that valuations no longer mattered. That was February of 2000; the bubble burst in March, and thankfully for my career, I was proven correct. There is little difference between being early and being wrong, and it is too early for bubble warnings.

Warm regards,

Chuck Osborne, CFA

~Artificial Bubble?