As we move into the second quarter of 2022, we invite you to listen in as our Chief Investment Officer, Andy Adams, gives an update on the state of the market, the status of Mairs & Power Funds, and where we see investment opportunities.
It's been a volatile start to 2022 for the market. With the war in Ukraine, growing inflation, and rising interest rates, an ascendent stock market has seen a pullback from the highs of 2021. But for now, most economic indicators continue to look positive.
Inflation is the biggest talking point as we enter the second quarter. The topic is front of mind for nearly all our companies these days. The market is focused on whether that inflation will result in a recession as the Federal Reserve (Fed) raises rate and ends its stimulative bond buying program. Historically, this has been a tricky task to get just right.
Hitting a 40-year high of 8.5% in March compared to last year, inflation is impacting companies in our portfolios across nearly all their cost inputs, such as raw materials, labor, or freight. At the same time, supply chain disruptions caused by COVID-19 and Russia’s invasion of Ukraine are only causing further upheaval. Companies that focused for years, if not decades, on lean manufacturing and just-in-time inventories are now re-evaluating those strategies and their geographic locations to help ease stress on supply chains.
This should bode well for the domestic economy and smaller companies that are more focused on the U.S. and have less complicated supply chains. Those companies should also face less of a headwind from recent strength in the dollar relative to other currencies. However, for multinational companies, this could be a more challenging environment as their goods become more expensive relative to international competitors.
Regarding the stock market, valuations have come down in the last several months of this year but are still about 10% or more above long-term averages. With the massive rebound in the stock market in 2020 and 2021, company fundamentals haven’t kept up. Over the long term, stock prices follow corporate revenues, earnings, and dividend payments, and it will take some time for those measures to catch up.
While first quarter results were, on average, positive for the market, and consensus estimates moved up slightly after the quarter, analysts are taking a pause before increasing their forecasts. This is a notable change compared to previous revisions the last couple years, at least partially due to the uncertainty caused by high inflation and the impact rising rates will have on the economy.
As a result of all these factors, we expect the market will be jumpy this year as the risk of a recession gets more press. It would not be surprising if stock prices don’t move all that far from where they sit today, supported by another year of revenue, earnings, and dividend growth. After all the near-term volatility, the resulting valuation multiples could fall were more in line with historical levels.
Portfolio construction at Mairs & Power is driven by bottom-up stock selection more so than by top-down economic analysis. Our expertise lies in getting to know companies well and building portfolios based off that knowledge. We talk to the executive management teams of many Fortune 500 companies and receive insights on the domestic and global economies.
While we take a long-term view with our funds, relative performance did lag in the first quarter. Energy is a small sector in the indexes, so it’s rarely the driving factor in relative performance for our funds. However, oil price inflation (more than 70 percent higher year-over-year) was enough for the sector to make an impact in the short term.
During the last year or so, we have eliminated all holdings in the energy sector. We knew this might cause short-term swings in relative performance, but given our long-term philosophy and outlook, it makes sense. We still believe the sector will struggle long-term as demand continues to slow due to a transition to renewable energy.
Apart from those companies impacted by oil prices, our portfolio has handled inflationary pressures well during the last few months. Some delay was expected in passing on price increases from companies that use longer term contracts, but our analysis of each company’s competitive position relative to its customers and suppliers helps us navigate the current environment. This positions the funds well to absorb inflationary pressures over the long term, despite the negative first quarter shock caused by oil and gas.
Again, as the Fed continues to fight inflation with rate increases, the stock market will likely remain jumpy during the next several months. Our portfolio of companies hold strong competitive positions and pricing should perform well in this environment, as well as over the long term.
Fund Reorganization Passes
We wanted to let you know about an update on our proxy vote for fund reorganization. At a shareholder meeting held on March 30, 2022, the shareholders of the Growth Fund, Balanced Fund, and Small Cap fund approved a proposal to transition each Fund from the Mairs & Power Funds Trust into a series of Trust for Professional Managers (TPM). We thank all the Shareholders for their vote in favor of this reorganization.
We know this proxy vote caused some difficulties and we apologize for the inconvenience. We do believe this reorganization is in the best interest of the shareholders.
There will be no changes to the Funds’ investment objectives, principal investment strategies, principal risks, investment adviser, or portfolio management teams. The benefits of reorganization allow the Funds greater access to legal, research, and operational resources with an expected decrease in expenses for each Fund.
The Funds will move to TPM effective at the close of business on April 29th, 2022.
The statements and opinions expressed are those of the speakers and are as of the date of this call. All information is historical and not indicative of future results and subject to change. Characteristics and other statistical measures refer to underlying stocks in the portfolio and do not represent or predict the performance of any fund.
Scott Howard is a registered representative of Foreside Fund Services, LLC.