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Bill Frels' Mairs and Power Fund Inc. 2Q Letter

September 07, 2011
10qk

gurufocus

354 followers
Reflecting continuing economic weakness in the second quarter, the Balanced Fund produced a

disappointing investment return of only 0.5% during the period. By comparison, the Dow Jones

Industrial Average and Standard & Poor’s 500 Index showed roughly similar respective returns

of 1.4% and 0.1%. However, the benchmark composite index (60% S&P 500 and 40% Barclays

Gov’t/Credit Bond Index) performed slightly better with a 1.0% return. The Fund performed in

line with a peer group universe of other balanced funds reported by Lipper in the Wall Street

Journal, which also turned in a similar average return of 0.5%. For the entire first half, the Fund

achieved a return of 5.7% compared to somewhat better respective returns of 8.6% and 6.0% for

the DJIA and S&P 500. However, the composite index and the Lipper Balanced Funds Index, a

peer group universe of comparable balanced funds, both produced a somewhat lower average

return of 4.7% for the same period.

Economic growth during the second quarter continued to be relatively weak with recently

reported real Gross Domestic Product showing only a slight 1.3% increase (preliminary basis)

compared to an even weaker 0.4% gain in the first quarter. The disappointing performance

resulted primarily from a negligible improvement in consumer spending due largely to

continuing high unemployment as well as a declining level of confidence. Business spending

continued to show reasonable growth with non-residential fixed investment rising at a 6.3% rate.

Government spending slipped a slight 1.1% with all of the decline occurring at the state and local

levels. Although down somewhat from recent periods, exports continued to be an area of

strength, rising 6.0%.

Interest rates remained relatively stable during the quarter with Federal Reserve policy

continuing to be highly stimulative. While longer term rates did slip modestly as most

economists pushed out their forecasts for higher rates due to the continuing economic weakness,

the overall bond showed only minor changes during the period.

The disappointing stock market performance mirrored the overall economy despite the fact that

most corporations reported better than expected earnings growth. Reflecting the growing

concerns over economic growth, the more defensive sectors of the market such as consumer

staples, health care and utilities performed the best, while the more cyclically sensitive areas

such as basic industries, capital goods, energy and technology performed the worst. A notable

exception was the financial sector where loan losses and increased government regulation have

reduced the growth potential for most companies. Among individual holdings in the Fund, the

best performers included American Express (+14.4%), H. B. Fuller (+13.7%), Johnson &

Johnson (+12.3%), Graco (+11.4%) and Baxter Int’l (+11.0%), while the poorest performers

included Bank of America (-17.8%), TCF Financial (-13.0%), Corning (12.0%), Wells Fargo

(-11.5%) and JPMorgan Chase (-11.2%).

Recent Events

The stock market has recently experienced significant weakness (-14% over the first part of

August) along with heightened level of volatility primarily in response to growing fears of a

“double dip” recession. These concerns developed rather quickly in response to weaker than

expected economic reports, together with the sharply divided debate over raising the debt ceiling

and implementing budget cuts. The lack of substantive progress toward reducing the Federal

budget deficit also led Standard & Poor’s to reduce the U. S. Treasury’s AAA credit rating to

AA+. At the same time, European debt problems resurfaced with respect to Italy and Spain after

an even worse situation in Greece seemed to have been resolved, at least for the time being.

Future Outlook

Although the U. S. economy most certainly has experienced a recent slowdown, such an

occurrence is not without precedent in past recoveries following recessions, especially those

brought on by a crisis of one kind or another. The case can also be made that while the current

recovery coming out of the 2007-2008 recession has been slower than past recoveries, it may

also be of longer duration than most past recoveries. In any event, indicators such as recent

employment trends, home sales, retail sales and strong corporate balance sheets all seem to

suggest continued slow but, nevertheless, steady growth. While sluggish European growth

remains a problem, we believe the question of sustainability of a faster rate of growth in such

countries as China, Indonesia, India and Brazil is the more important issue when assessing the

prospects for future economic growth in the U.S.

Given the recent commitment of the Federal Reserve to keep interest rates low, it seems that

monetary policy will remain highly stimulative over the foreseeable future. Because of the

apparent ineffectiveness of quantitative easing, the Fed also seems unlikely to undertake any new

initiatives unless the economy does, in fact, slip into a recession. Consequently, no significant

changes in the bond market are expected, at least over the near term.

Considering such factors as 1) the continuing strength of corporate earnings growth, 2) a

historically low level of interest rates and 3) reasonable valuation levels (12x estimated 2011

S&P 500 earnings), the stock market appears to be quite attractive. However, volatility may

remain at elevated levels for some time to come in light of continuing economic uncertainties

both here and abroad.

William B. Frels

President and Lead Manager

Ronald L. Kaliebe

Vice President and Co-Manager

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About the author:

gurufocus
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 1.4/5 (7 votes)

Comments

windplayer13
Windplayer13 - 3 years ago
Coming from a manager of $3.7 Billion, I would expect something more substantial.

Please leave your comment:


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