Past
Commentaries
12/31/2025
Current Commentary
Most of this commentary is comprised of my remarks at the 25th annual Brae Head Christmas luncheon on December 17th.
John Bogle’s conviction was that the best way to invest was to buy a low-cost index fund. He built Vanguard Funds around that strategy.
My conviction has long been that the market is full of lousy stocks. When you buy the index you’re buying those lousy stocks. Why not just buy the best companies in or out of an index? Almost 50% of NASDAQ stocks have still not recovered to their 2021 highs. Over 30% of small cap stocks are zombies, i.e., they don’t have enough cash flow to cover their debt service.
The market is becoming a commodity of indexes and funds that are sold (or “placed”) by intermediaries for the companies that sponsor and package them. This long-term trend to intermediation could help consolidate bankers’ influence over the markets. Most portfolio managers and investment advisers don’t know what’s actually in the funds that they put in client portfolios. They know what the fund company wants them to know about the funds – what their objectives are, what sectors they represent, what their strategy is. It’s more marketing than investing.
The vast majority of “portfolio managers” and investment advisers construct portfolios of Exchange Traded Funds (ETFs), mutual funds, indexes or annuities. All these products are derivatives of individual securities – selected by a professional employee of the fund company. Most portfolio managers don’t analyze companies. They are intermediaries for fund companies who employ analysts.
You are fairly unique investors in that you have direct access to your own analyst, your own manager. You control your own investments free of intermediaries (“disintermediation”). You own a conglomerate of exceptionally profitable companies - more profitable than the market average. Your portfolio pays you a higher dividend than the market average. And you paid less than the average market price.
Warren Buffett runs Berkshire Hathaway, a holding company for a conglomerate of companies. Berkshire Hathaway stock (BRK.B) pays no dividend. Its return on equity (ROE) for 2024 was 14.7% BRK.B stock has doubled in the last five years.
Review your portfolio in your quarterly report. If you look at the equity component of your portfolios, net of cash and money market positions, you have consistently outperformed the broader market indexes. For most of you, your portfolios have more than doubled in the last three years. More importantly, you have consistently outperformed inflation, which is to say you have increased your purchasing power.
Market Conditions
The S&P 500 trades at 31 times earnings today (the P/E ratio). It’s only been higher 4 times: March 1999 (34); December 2002 (46); May 2009 (124); and December 2020 (36). The dividend yield is presently 1.14%, just about the lowest it has ever been (which was 1.11% in August 2000).
Earnings have been good: S&P net income was 12.9% in ’24; should do 13.3% in ’25. The complacency in light of such high valuations is disturbing. Stocks appear priced without regard to risk, as if favorable conditions like record earnings growth, policy support, and low volatility will last forever. According to hedge fund company Bridgewater Associates, growth expectations haven’t been this optimistic since 1929, with the brief exception of the dot-com bubble in 1999.
I recently came across a chart from CFRA Research showing all Year To Date (YTD) price changes for the S&P 500 during mid-term election years (MTEY) since 1946. The chart shows annual drawdowns for every MTEY, averaging -17.97%. The good news is that from 10/31 of the MTEY to 10/31 a year later the S&P 500 has an average gain of 16%, rising 100% of the time. 2026 is a MTEY.
| MID-TERM YEARS | ANNUAL DRAWDOWNS | MID-TERM YEARS | ANNUAL DRAWDOWNS | MID-TERM YEARS | ANNUAL DRAWDOWNS |
MID-TERM YEARS | ANNUAL DRAWDOWNS |
| 1946 | -26.60% | 1966 | -22.20% | 1986 | -9.40% | 2006 | -7.70% |
| 1950 | -14% | 1970 | -25.90% | 1990 | -19.90% | 2010 | -16% |
| 1954 | -4.40% | 1974 | -37.60% | 1994 | -8.90% | 2014 | -7.40% |
| 1958 | -4.40% | 1978 | -13.60% | 1998 | -19.30% | 2018 | -19.80% |
| 1962 | -26.40% | 1982 | -16.60% | 2002 | -33.80% | 2022 | -25.40% |
| Source: CFRA, S&P Global |
Almost all of the growth we’re seeing is due to the AI revolution. After filling computers with information for 40 years we have taught machines how to edit and deliver that information in a grammatical format (Large Language Models). It is fantastically productive. The capital expenditures being made in pursuit of dominance - and survival - in this new world are inevitable but unsustainable. This is Joseph Schumpeter’s theory of creative destruction in real time. This is a race to the moon times 100.
There is clearly circular capex spending without much end-user revenue in sight yet. For example NVDA invests in CoreWeave (a cloud provider) which uses the money to buy NVDA chips. Major cloud providers like Amazon, MSFT, and GOOGL provide funds to AI labs like OpenAI or Anthropic who then use the funds to run their programs on the providers’ cloud services.
Not all these investments can pay off. There will be winners and losers. Some will produce, some will produce nothing. Winners and losers. Capitalism. The best will out. IBM CEO Arvind Krishna recently stated that even the best possible returns on these investments cannot justify their capital expenses. The arithmetic is simply not there.
Exactly a year ago I gave you my analysis of NVDA, inferring a reasonable price of $180 by 2026, which is where it is today. The only reason for prognosticating about one specific position is because NVDA has grown to an unusually large percentage of our portfolios. We’ll continue to hold NVDA.
Challenges and Opportunities
My biggest concerns are three: power generation, cybersecurity, and quantum computing.
Geothermal energy is expanding. Over the last several months we’ve been buying Ormat, a utility with geothermal turbines running in several locations. They recently engaged Schlumberger, the worlds largest and most sophisticated drilling company to assist in engineering shafts 5 and 6 miles deep. I’m positioning SLB in suitable portfolios, 14 P/E, 3% dividend, increases every year, (35% of eps, doubled in the last 4 years), 14% net income, 22% ROE. Exceptionally well managed – no pun intended!
The power requirements of new data centers are largely being met on-site with solar and battery banks but also with generators powered mostly by natural gas. Small modular reactors (SMRs) are coming but I haven’t identified a reasonable investment yet.
Cybersecurity is a permanent, critical concern. Apart from MSFT, we own 2 of the 3 best cyber specialists: Palo Alto Networks (PANW) and Qualys (QWLS). QWLS is cheaper at 25 P/E than PANW at 100, and more profitable, but languishes, telling me there are product issues I don’t understand. The biggest cyber specialist is Palantir (PLTR), which does most of its business with the federal government and its agencies. It’s priced at 400 times EPS. No stock I have ever looked at has survived a 400 P/E. It’s priced at 185. I wouldn’t buy it at 50. And then there is Crowdstrike (CRWD) a major player with great revenue growth but no profits.
Quantum computing threatens the entire data processing universe. It is powerful enough to hack anything, bitcoin, blockchain, passwords, current encryption tech. And it’s coming, maybe 2 years maybe 10. The strongest developer may be IBM, much improved under Arvid Krishna, with an army of engineers and an established customer base. It doesn’t excite me enough to overcome a P/E of 36 and a highly leveraged debt to equity ratio of 200%.
I haven’t addressed the economy because I don’t think it is very relevant to corporate earnings right now. GDP will finish ’25 at something over 2%. Third quarter was a surprising 4.3%. A positive harbinger? Perhaps GDP surpasses 3% in ‘26. There is speculation that the Fed may lower rates again next year. The Fed is again expanding its balance sheet, instituting $40B of Quantitative Easing two weeks ago. Money supply year-over-year is approximately 5%, double our GDP. These actions are inflationary and they appear to me a deliberate strategy to service debt with cheaper dollars.
Finality
NYC’s new mayor Zohran Mamdani finished his victory speech with this: “There is no problem too big - or too small - that government cannot fix.”
My city is long gone.
Kind Regards,
Dennis M. O’Connor
