Market Overview | Fourth Quarter 2021
The story of 2021 could be boiled down to a single word: resilience. Though the market experienced a few minor pullbacks during the year, it always rebounded quickly. The market’s performance reflected the durability of the overall economy, which remained remarkably strong despite supply shortages, hiring challenges, and COVID variants.
One key driver of the market’s resilience was corporate earnings, which have been astounding. In 2019, the S&P 500 earnings hit $163 per share. Then, the Pandemic hit and earnings dropped 15% to $138 in 2020. We had initially hoped that earnings might return to pre-Covid levels by 2022 but thanks to massive fiscal and monetary stimulus, earnings are expected to finish 2021 at $207, 27% above their 2019 peak.
There’s a perception that only tech stocks drove the market in 2021; however, we saw strength in Healthcare, Financials, Materials, Industrials, and Communications as well. In short, the market broadened out in 2021.
Given that breadth and those astonishing earnings numbers, it may not be surprising that the S&P 500 posted 70 record highs in 2021. For the fourth quarter and for all of 2021, the S&P 500 Total Return (TR) was up 11.03% and 28.71% respectively, the Dow Jones Industrial Average TR gained 7.87% and 20.95%, and the Bloomberg U.S. Government/Credit Bond Index returns were 0.18% and -1.75%.
Future Outlook
Most indicators of economic activity remain at levels that point to continued economic growth. For instance, December’s readings of the Institute of Supply Management (ISM) indices for manufacturing and services were both very strong at 61.1 and 69.1, respectively. Any number over 50 indicates growth.
The labor market has also provided evidence of the economy’s durability. In December, the unemployment rate dropped from 4.2% to 3.9%, close to the 50-year low of 3.5%. Not coincidentally, the U.S. Labor Department also reported that hourly wages in December rose 4.7% from the year before. Though rising wages are helping fuel inflation, we believe that these increases are long overdue. Business owners and shareholders have done extremely well over the past few decades. Now, we may be seeing workers benefiting more from economic growth.
Higher household incomes also fuel spending, boosting growth further. Helped by rising wages, consumer demand has remained strong for cars, appliances, and other durable goods. According to Mastercard’s SpendingPulse report, U.S. holiday season sales in 2021 rose 8.5% over the same period in 2020.
But consumers and investors remain fearful of continued inflation. In November, consumer prices increased at an annual rate of 6.8%, the highest jump in nearly four decades. With inflation running well above its target, the Federal Reserve (FED) has indicated that it will dial back monetary stimulus more quickly than previously expected. In December, the Fed announced an end to quantitative easing early in 2022, and the central bank suggested that we could see as many as three interest rate hikes this year. With the Fed no longer adding fuel to the economic fire, earnings growth will be more important in 2022 to keep the market moving higher.
The federal government has also been a major source of economic stimulus during the “pandemic boom.” However, we’re starting to see pushback in Washington from members of both parties relating to the infrastructure bill and other large spending programs. This suggests that the economy will need to stand more on its own in 2022 with less government support. We believe that the economy will continue to demonstrate resilience and rise to this challenge. We also believe the market will remain the strongest asset class for investors, and the only one that will keep pace with inflation. The market may cool down in 2022 after an extraordinary year, but the economic evidence leads to us to expect its performance to stay steady and strong.
Performance Review
In the fourth quarter, the Mairs & Power Growth Fund gained 10.77%, compared to 11.03% for the S&P 500 and 9.45% for its peer group as measured by the Morningstar Large Blend peer group. For the year, the Fund slightly outperformed the S&P 500 in 2021, with the Fund gaining 29.27% and the S&P up 28.71%. The Fund also performed well relative to the Morningstar peer group, which was up 25.36% for the year.
Most of our longer term macro bets continued to be headwinds in 2021, especially the fourth quarter. These bets include an underweight in Technology and overweight in Industrials and in small and mid-cap stocks. But our stock selection more than offset those headwinds, and the Fund came out ahead of its benchmarks.
Earlier in the year, it appeared as though our overweight of smaller caps relative to the index would finally benefit relative performance. But after a strong first quarter, these stocks began to lag, and they ended the year about 4% behind the S&P mid-cap index, which we use as a representative measure of smaller capitalization stocks. Valuations for small and mid-cap stocks continue to look very attractive, and we added a number of smaller companies to the portfolio during the year, including Inspire Medical (INSP, Financial), Polaris (PII, Financial), and Sleep Number (SNBR, Financial).
Over the last several years, we have reduced our underweight of Technology relative to the index. With that sector outperforming the broader index by over 5% in 2021, this shift lessened the negative impact to the Fund. Our Technology stock selection also has been quite strong, with portfolio names significantly outperforming index stocks in the sector. Nvidia (NVDA, Financial), up 96% for the year, was one of the largest contributors to the Fund’s relative performance. A provider of graphical processor units (GPUs) for the computer industry, Nvidia has experienced strong demand in its traditional markets as well as from data centers looking to add artificial intelligence capabilities.
Another headwind was our lack of exposure to the Energy sector. With the global economy’s reopening, Energy was the S&P 500’s top performing sector in 2021. We continue to be happy with our decision to not invest in Energy companies, since we see significant risks in their traditional business models.
Within the Consumer Discretionary sector, the Fund is underweight relative to the index, which helped relative performance for the year. Unfortunately, our stocks in that sector underperformed. Both Polaris (PII, Financial) and Sleep Number (SNBR, Financial), which we added to the portfolio in 2021, have lagged since our purchase. Still, we believe the gains these companies have made during the pandemic are more durable than the Street expects, and we have continued to add to our initial positions.
Industrials underperformed the index in 2021, and our stock selection underperformed the sector. Toro (TTC, Financial) and Graco (GGG, Financial) both hurt relative performance, but we believe these companies will recover when the cycle turns their way. Conversely, we chose to exit Proto Labs (PRLB, Financial), another Industrial stock that hurt relative performance, because its business strategy hasn’t worked out as we’d hoped. 3M (MMM, Financial) also detracted from performance, and we’ve significantly reduced our position in the company. The current management team has struggled to perpetuate 3M’s storied culture of innovation, and it also faces long-term environmental liability issues.
While our overweight position in Healthcare was a slight headwind, our stock selection was good, with Bio-Techne (TECH, Financial) and UnitedHealth Group (UNH, Financial) having particularly strong years in spite of a somewhat chaotic environment. Though we’ve trimmed our positions in both, we retain confidence in their durable competitive advantages.
The largest contributor to the Fund’s relative performance in 2021 was Google parent company Alphabet (GOOG, Financial). With ad spend continuing to shift online and the company increasing advertising space on its YouTube platform, Alphabet’s revenue grew substantially in 2021, and its stock was up 65% for the year. We continue to hold a significant position in the company, though we expect its growth to slow in 2022.
In the fourth quarter, the Fund added two positions:
One was Entegris (ENTG, Financial), which in December acquired CMC Materials, a company we’ve long held in the Mairs & Power Small Cap Fund. Both companies supply the semiconductor industry with high-end consumables like filters and slurries, which are extremely important in the production of today’s higher-density chips. While Entegris is headquartered on the East Coast, we’ve had good access to its management team, and we believe the company is making smart investments for the future.
Our other acquisition in the quarter was Salesforce (CRM, Financial), the undisputed king of customer relationship management software. Salesforce provides a one-stop shop for customers to monitor the entire lifecycle of their customers, from sales leads to customer service and support.
As a leading SaaS (software-as-a-service) provider, the company should continue to benefit as more and more businesses shift operations to the cloud. Salesforce is a company we’ve been following for several years. Though it has long demonstrated a durable competitive advantage in its space, we couldn’t get comfortable with its valuation. In the last few months, with interest rates bouncing up slightly, the prices of many SaaS companies were hit with losses, and Salesforce’s valuation became much more appealing.
Overall, we’re happy with the Fund’s 2021 performance. We evaluate every company we hold based on its competitive position and its relative pricing power to customers and suppliers. Looking ahead to 2022, we expect inflation to be a positive for our companies. It may take them some time to be able to pass on price increases, but they should be well positioned in the long term to do so.
One final note: By the end of January, you will have received by mail a proxy statement and a ballot from Mairs & Power asking you to vote on a proposed reorganization of the Growth Fund. This reorganization would transition the Fund into a series of Trust for Professional Managers (TPM). We expect that reorganizing into TPM would decrease the Fund’s expenses while allowing it greater access to legal, research, and operational resources. There would be no changes to the Fund’s investment objectives, principal investment strategies, principal risks, or portfolio management team. The boards of Mairs & Power and TPM have both unanimously approved this reorganization. We encourage you to also vote in favor of this reorganization, which will benefit you, the Fund shareholder.
All holdings in the portfolio are subject to change without notice and may or may not represent current or future portfolio composition. The mention of specific securities is not intended as a recommendation or an offer of a particular security, nor is it intended to be a solicitation for the purchase or sale of any security.
Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the Fund may be lower or higher than the performance quoted. For most recent month-end performance figures call Shareholder Services at (800) 304-7404.
