During these uncertain times, we want to provide you our view on the current economic and market conditions, and how Mairs & Power is navigating these turbulent times.
On Feb. 19, the S&P 500 closed at an all-time high of 3,386. Not many days before, on Feb. 12, the Dow Jones Industrial Average (DJIA) set a new closing record of 29,551. Then the astounding 11-year bull market came to screeching halt. We are all too familiar with the reasons. The novel coronavirus and the COVID-19 illness it causes was the trigger, as the entire world came face to face with a pandemic whose length and breadth remain uncertain. The social distancing, shelter-in-place orders, closing of retailers and restaurants, and massive layoffs are wreaking havoc on the domestic and global economy. In addition, Saudi Arabia decided to start a price war for crude oil and then there is the additional uncertainty caused by the upcoming Presidential election.
We want to emphasize that the portfolios we build for our clients are designed with the goal of maneuvering through the storm. We can point to both our long history and the quality of the companies we hold. We also cite the underlying strength of the U.S. financial system, which the Federal Reserve (FED) has been acting very aggressively to support. The Federal government has passed a stimulus package of $2 trillion dollars, an unprecedented commitment to help support the economy.
As always, our main concern is with our clients and our employees. We hope all of you are staying safe and healthy. We have set up our office to make sure that we are available to you as we have always been. And we remain well positioned to help your portfolios ride out this storm.
A STRONG FOUNDATION
In our opinion, make no mistake, there will be a recession. Despite the responses and best efforts of the Federal Reserve, federal and state governments and businesses, we don’t see any way the economy can avoid two quarters of negative GDP (gross domestic product) growth, the technical description of a recession. But history suggests that this potential recession, while it might be very deep, is also likely to be relatively short. That has often been the case when a major disruption triggers a downturn. A good example is the Gulf War recession of 1990-‘91. The market sold off very hard. But the recession was short, and the market recovered fairly quickly. We expect that as the pandemic recedes, pent-up demand will help the economy snap back quickly. The underlining strength of the banking system and the aggressive actions by both the FED and federal government are also likely to help. Certainly there is a wide range of possible outcomes, including a longer downturn with a slower recovery being one of them.
Mairs & Power’s investment team has experience with past market downturns. Our team members have an average of 25 years of industry experience. We know how to navigate through these kinds of events, and will help our clients through this one as well.
Two of the factors that give us a great deal of reassurance during this market tumult are the government actions and the underlying strength of the banking system, particularly compared to 2008-‘09. Banks aren’t over levered now, as they were then. Capital levels are much higher, and stricter lending standards mean that loan portfolios are of much higher quality. In fact, they are strong enough that several of the larger banks have announced a “no lay-off” policy.
In addition, the FED has been engaging in multiple support actions. Cutting the federal funds rate to near zero has been just one of them. On March 19, for instance, the FED backstopped the market for unsecured promissory notes issued by businesses to meet short-term liabilities. That same day, it created a “liquidity facility” to ensure that money market funds could withstand sudden redemptions by investors. The central bank has indicated that it will use all its resources to ensure that the country’s financial system continues to function properly.
We closely monitor the underlying strength of the companies in which we invest. In early 2019, we undertook a rigorous study of the credit quality of the companies whose stock we hold. Our research revealed that the overall credit quality of our equity holdings is very strong. Of the 60 largest holdings, only a handful have credit ratings below investment grade. Those companies took on debt as a result of acquisitions they made, and we are comfortable that they can manage through the downturn with their current level of debt. We also expect the vast majority of companies in the portfolios to continue to pay dividends.
The overall credit quality of the bond holdings in portfolios is also very high. We select fixed-income securities that can provide risk mitigation safety during a volatile market period. We have stayed away from retailer bonds, and we haven’t purchased an energy bond in at least four years. While we hold a great deal of financial services bonds, those holdings are predominantly in shorter-term and higher-quality debt.
In other words, we were proactive, so now we don’t need to be reactive.
The quality of our equity holdings should provide our clients with a great deal of reassurance.
The Financial Services sector has been particularly beaten up in the market downturn. But as we noted earlier, the banks are fundamentally strong, and the FED’s supporting actions will do a great deal to keep those foundations in good repair. We expect all of our holdings in this sector to come through the downturn in good shape.
The Consumer Staples sector has been providing investors with a good deal of risk mitigation and support in this rough-and-tumble market. A prime example is Hormel (HRL). As of the end of March, this is one of our best-performing stocks year to date (YTD). Last year, in a strong market, it was one of the worst. Another of our long-time holdings is General Mills (GIS), which in March upgraded its earnings-per-share forecast for fiscal 2020, based primarily on increased supermarket sales due to consumers’ stocking up. While the company’s long-term growth outlook is below average, we have held this position. Now it can be used as a source of cash for potentially better long-term opportunities.
Healthcare and pharmaceutical stocks also have generally held up well. In fact, we’ve been trimming positions in some of these stocks little by little in order to take advantage of buying opportunities in some of the weaker performers, where we see potentially better opportunities for long term growth.
We remain vigilant for opportunities that might not be realized for several months or more. For instance, med-tech companies will see demand for elective procedures requiring their products decline in the short term. That, in turn, has brought down their stock prices. But those procedures will be done eventually. Zimmer Biomet (ZBH) is a good example of one such opportunity. We have holdings in ZBH and may add to it where it is warranted.
We are underweight the Energy sector, so the downdraft in oil stocks has not weighed heavily on portfolios’ performance. The energy companies we have invested in have been very strong financially, and we expect them to make it through this downturn.
WE ARE ALWAYS HERE FOR YOU
Yes, in our opinion, there will be a recession. And today, there is a lot of uncertainty. With uncertainty comes volatility, and it’s important not to overreact to bad news. We expect the situation to be clearer in three to six months. In the meantime, we will continue to think and act for the long term.
Serving our clients well remains our primary goal, and we are always available to you. Together, we will come through this storm. Mairs & Power remains dedicated to business as usual, even in these unusual times. Stay safe and healthy.
Mark L. Henneman
Chief Executive Officer
Mairs & Power, Inc.
The statements and opinions expressed are those of Mark Henneman, Chairman and CEO of Mairs & Power, Inc., as of the date of this posting, April 3, 2020. All information is historical and not indicative of future results and subject to change.
S&P 500 TR Index is an unmanaged index of 500 common stocks 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.
Dow Jones Industrial Average TR Index is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the NASDAQ.
Top 10 Fund Holdings (subject to change)