As the year began, many companies were battling a decline in energy prices, commodity prices and a strong dollar. Then, during the third quarter China started to show more incremental weakness in its economy as well, intensifying the weakness in agriculture and commodity prices. The market reacted and the dizzying one-day swing of more than 1,000 points in the Dow Jones Industrial Average on August 24th delivered the event that had been worrying investors, a market correction -- technically a 10% move off of recent highs. The correction was widespread, resulting in negative third quarter returns across every sector except consumer staples and utilities. Only consumer discretionary and healthcare remains in positive territory year-to-date.
While the long anticipated correction allowed the market to stop holding its collective breath, the rapidity and volatility reminded us, if we needed reminding, that short-term market swings can be wildly unpredictable. We’re glad we are playing the long game.
It has been a difficult quarter and year for many investors. The third quarter ended with the S&P 500 Total Return (TR) down -6.44% for the quarter, and -5.29% for the first nine months of the year. Both the Dow Jones Industrial Average TR and the S&P Small Cap 600 TR mirrored the broader market, with the Dow down -6.98% for the quarter and -6.95% for the year and the Small Cap index down -9.27% for the quarter, and -5.49% year-to-date. Our other key benchmark, the Barclay’s Government/Credit Bond Index Return was up slightly in both periods, +1.20% for the quarter and +0.90% year-to-date.
As industrial investment has slowed with lower energy and agriculture commodity prices, the industrial and materials sectors have significantly underperformed the broader market indices this year. Export-oriented companies as well as U.S. focused companies in those sectors have also faced currency translation pressure as the dollar has appreciated significantly versus nearly all foreign currencies.
This currency dynamic puts domestic companies in the difficult position of either cutting prices to match international competition or losing market share. We believe these currency and commodity headwinds will dissipate over time and companies in those sectors should outperform, but are uncertain on the timing.
Future Outlook
Four years have elapsed since the last correction in 2011 and the market’s run coming
out of the recession is now more than six years old. Many investors naturally have been
asking if the third quarter signaled the end of the bull market. We don’t think so.
Despite near term headwinds, we continue to believe that stock performance longterm
is built on business results. We see the U.S. economy continuing to outpace other
major economies around the globe which should be good for stocks of U.S. companies.
In addition, while earnings for the S&P 500 are down this year, the expectation is for
moderate earnings growth to resume next year. Recent economic data supports our
view. Consumer confidence is near peak levels and in better shape than the headlines
suggest. Gross Domestic Product (GDP) growth was revised upward in the second
quarter, reflecting stronger than expected consumer spending. The dollar/Euro
relationship has been stable since March, and if that stability continues, we see that
particular headwind faced by exporters ending early next year.
A recent research report out of Wells Capital Management pointed out that commodity
price collapses have occurred midway through three of the last four economic recoveries
since 1970. The report’s author, Chief Investment Strategist Jim Paulsen, notes that the
recent fall in the S&P GSCI Spot Commodity Price Index is similar to past recoveries.
He argues that weak commodity prices fuel continued economic expansion by shifting
pricing power to manufacturers, ending the dramatic shift away from capital goods
stocks. Paulsen’s note also illustrates a key tenet of the Mairs & Power investment
approach – patient, long-term investing through market cycles.
Growth Fund Performance Review
For the third quarter and first nine months of the year ending September 30, 2015, the Mairs & Power Growth Fund was down -8.18 % and -8.68% respectively, compared with the benchmark S&P 500 Total Return (TR) Index, which was down -6.44% and -5.29% and the peer group Lipper Multi Cap Core Funds Index, which was down -8.19% and -6.07%, for the three month and nine month periods respectively.
The largest individual contributors to underperformance in both the third quarter and the first nine months were in the technology and industrial sectors. The industrial sector remains under pressure from the macro-economic factors described above. The Fund’s technology holdings are primarily serving the commercial and industrial markets while consumer tech stocks continue to outperform. Cray (CRAY, Financial), Donaldson (DCI, Financial) and Emerson Electric (EMR) were all bottom performers in both periods. We view the industrial sector as inexpensive by historical standards, and we expect these stocks to recover to a more normal trading range. Our technology holdings should benefit as well when the industrial sector rebounds.
The Fund’s underweight posture toward the energy sector, which remains the worst performing sector, was a significant positive contributor to relative performance in both the quarter and year-to-date. The largest individual positive contributors to performance were primarily consumer-facing companies, including Hormel (HRL, Financial), Toro (TTC, Financial) and Fiserv (FISV, Financial) which were all top contributors in both periods.
C.H. Robinson (CHRW, Financial) was a top performer in the quarter and a stock that illustrates our investment approach, where we seek out good companies with a sustainable competitive advantage over the long term. The company is well positioned in both consumer and industrial markets and should benefit as the industrial sector picks up. As the “just-in-time” movement of materials and finished goods grows more complicated, manufacturers and retailers are increasingly outsourcing their purchasing and distribution logistics to external companies. C.H. Robinson is an asset-light third party logistics provider focused on technology. The recent west coast longshoreman’s strike gave the company an opportunity to demonstrate the value of its technology investment to its customers. C.H. Robinson is able to keep customers informed on the movement of goods and, if it anticipates a delay, can suggest alternative routing and transportation options to keep its customers’ materials flowing. We look for the company’s valuation to move back toward its historic range as the industrial sector recovers, and we see evidence that the re-acceleration is on the horizon.
Mairs & Power has always managed investments with tax implications in mind. The Medtronic acquisition of Covidien earlier this year, as well as capital gains realized in some other holdings, created taxable events for owners of the Growth Fund that will be somewhat larger than what has been true historically – although still within the range of capital gains reported by many of our peer funds.* Shareholders will be receiving the tax information when the Fund mails out Form 1099 reports mid-February of next year. Also, shareholders can check our website, www. mairsandpower.com, in mid-November for our estimated capital gain distributions.
Mark L. Henneman
Lead Manager
Andrew R. Adams
Co-Manager
The Fund’s investment objective, risks, charges and expenses must be considered carefully before investing. The summary prospectus or full prospectus contains this and other important information about the Fund, and they may be obtained by calling Shareholder Services at (800) 304-7404 or visiting www.mairsandpower.com. Read the summary prospectus or full prospectus carefully before investing.
* Mairs & Power does not provide legal, tax or accounting advice to its clients. All investors are encouraged to consult with their legal tax or accounting consultants.
The stocks mentioned herein represent the following percentages of the total net assets of the Mairs & Power Growth Fund as of September 30, 2015: Baxter International Inc. 1.28%, CH Robinson Worldwide, Inc 2.43%, Covidien 0.00%, Cray Inc. 0.94%, Donaldson Co., Inc. 2.60%, Ecolab, Inc. 4.70%, Emerson Electric Co. 2.55%, Fiserv, Inc. 1.97%, General Mills, Inc. 3.10%, H.B. Fuller Co. 2.26%, Hormel Foods 3.27%, Medtronic, Inc. 3.41%, Pentair Ltd., 2.27%, Schlumberger Ltd., 2.68%, Target Corporation 3.05%, Toro Co. 3.25%.
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, visit www.mairsandpower.com or call Shareholder Services at (800) 304-7404.
- Periods less than one year are not annualized.
- Performance information shown includes the reinvestment of dividend and capital gain distributions, but does not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares.
- The S&P 500 Total Return (TR) Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. It tracks both the capital gains of a group of stocks over time, and assumes that any cash distributions, such as dividends, are reinvested back into
the index. It is not possible to invest directly in an index.
- Lipper Multi-Cap Core Funds Index measures the performance of the 30 largest mutual funds that invest in a variety of capitalization ranges, without concentrating 75% or more of their equity assets in any one market capitalization range over an extended period of time, as determined by Lipper, Inc. It is not possible to invest directly in an index.
All investments have risks. Mairs & Power Growth Fund is designed for long-term investors.
The Fund’s share price can fall because of weakness in the broad market, a particular industry, or specific holdings. Investments in small and midcap companies generally are more volatile. International investing risks include among others political, social or economic instability, difficulty in predicting international trade patterns, taxation and foreign trading practices, and greater fluctuations in price than United States corpo-rations.
This commentary includes forward-looking statements such as economic predictions and portfolio manager opinions. The statements are subject to change at any time based on market and other conditions. No pre-dictions, forecasts, outlooks, expectations or beliefs are guaranteed.
ALPS Distributors, Inc. is the Distributor for Mairs & Power Funds.
