The market's performance for most of 2023 was driven by the “Magnificent 7” Technology stocks. However, in the fourth quarter, we saw signs that the market is broadening. The market rallied from its third- quarter plunge, with much of recovered ground due to stabilizing interest rates and moderating inflation. The S&P 500 Total Return (TR) rose 11.69% for the quarter and 26.29% for the year, the Dow Jones Industrial (TR) gained 13.09% in the quarter and 16.18% in 2023, and the Bloomberg U.S. Government/Credit Bond Index returned 6.63% in the fourth quarter and 5.72% for the year.
Economic indicators were generally mixed throughout 2023. The labor market has remained resilient to lulls in the market, with unemployment remaining close to record lows. Jobless claims have gone up-and-down from week-to-week, but they've stayed at very low levels. However, the housing market is struggling, with sales of existing homes down substantially. On the other hand, new construction is increasing, and prices are holding up. Finally, despite consumer confidence being soft throughout much of the year, household spending still grew at a moderate pace.
Looking back at 2023, inflation was the central theme throughout and continued its gradual slow down. There were some nervous moments, particularly in the third quarter when oil prices spiked higher and economic growth temporarily accelerated. Market worries that inflation was rising once again led to a sell-off. But as the fourth quarter progressed, those trends reversed, and the inflation news continued to improve. In November, the Federal Reserve (Fed) delivered an early Christmas present, declaring that interest rate cuts are likely in 2024.
More glad tidings about inflation arrived just before Christmas. In December, the federal government reported that the personal-consumption expenditures (PCE) price index, an index closely monitored by the Fed, fell 0.1% in November. That's the first time that the PCE index had declined since April 2020. The government also reported that core inflation dropped to an annualized rate of 1.9%.
Other economic data provided additional comfort and joy during the holiday season. Overall personal income rose 0.4% in November, compared to a 0.3% gain in October. What's more, consumer spending rose 0.2% in November, higher than 0.1% in October, though lower than September's 0.7% increase. All this may be why the Conference Board's Consumer Confidence Index rose significantly in December, with early signs suggesting that shoppers boosted their holiday spending. All this upbeat news led the economy and the market to end the year mostly merry and bright.
Future Outlook
Early in 2023, the outlook for earnings deteriorated. In January, the consensus was that earnings would grow 8% for the year. By April, the expectation was no growth at all. But from there, earnings growth expectations began to climb. Now, the consensus for 2023 is that earnings grew 7% and are expected to grow 6% in 2024. The positive trends in earnings, interest rates, and of course inflation all provide support to the market outlook for 2024.
With earnings growth expectations improving, many stocks that lagged the market last year have brighter prospects in 2024. Value stocks could become in vogue again. In 2022, value stocks outperformed growth by about 23%, but that more than reversed last year, with growth outperforming value by 37%. We anticipated that growth stocks would perform better due to a dampening earnings picture. Now, the trends suggest that sectors dominated by value holdings could come back powerfully in the coming year.
The future also looks sunnier for mid- cap stocks. While the gap between large-cap and mid-cap valuations has widened in the past few years, it's worth noting that mid- cap earnings growth has kept pace with the S&P 500. We believe many mid-caps are trading at a discount, and we expect the valuation gap to close at least a little bit.
However, there is one dark cloud on the horizon in consumer spending. While consumers seemed more upbeat at the end of 2023, the gloom they felt through most of last year hasn't completely lifted. Despite a resilient economy, many people still feel that their finances are tight. One reason: While inflation is slowing and wages have been rising, the prices of goods remain well above their pre-pandemic levels. In other words, while the cost of dinner at a favorite restaurant may not have increased since September, it could still be 20 percent higher than in 2021. Those kinds of elevated prices can cause a lasting gloom that takes a while to dissipate. To be sure, some items did drop in price during the fourth quarter, but many families are still finding it difficult to make ends meet.
As we look forward to 2024, we remain committed to investing in companies with durable competitive advantages for the long-term. Whether we experience a soft landing or a recession, we invest for entire economic cycles and not the short-term. We will continue with the same investment process and philosophy that has served our clients well for more than 90 years.
Performance Review
The Mairs & Power Growth Fund posted solid 2024 results and outperformed the S&P 500 TR Index. The Fund returned 27.70% for the year while the S&P 500 TR Index increased 26.29%. The Growth Fund also outperformed its peer group as measured by the Morningstar Core Index, which was up 22.13%.
The S&P 500's returns were dominated by just a handful of stocks, the so-called “Magnificent 7” that consists of Alphabet (GOOGL, Financial), Amazon (AMZN, Financial), Apple (AAPL, Financial), Meta (META, Financial), Microsoft (MSFT, Financial), Nvidia (NVDA, Financial), and Tesla (TSLA, Financial). These stocks were buoyed by investors' enthusiasm for AI and increased prospects of lower interest rates as inflation subsides. Thanks to our concerted effort to diversify into technology stocks over the past few years, we benefited from this upswell. The Fund's largest holding—Microsoft—was up more than 58%. Alphabet, another large holding for the Growth Fund, was up 58%. Amazon increased more than 80% and Nvidia was up a stunning 239%. Unsurprisingly, these stocks were the main contributors to the Fund's outperformance.
All of our Materials holdings—Ecolab (ECL, Financial), HB Fuller (FUL, Financial), and Sherwin Williams (SHW, Financial)—also posted strong results in 2023, a stark reversal from the prior year. After oil prices spiked above $100 in 2022 due to the Ukraine-Russia Conflict, oil has since pulled back to the low $70s. Oil and its by-products are major inputs for all of our Materials holdings; as such, lower oil prices have led to a rebound in profits. For example, our largest Materials holding—Ecolab—is expected to increase earnings more than 15% this year after declining 5% last year.
Lower oil prices also hurt Energy stocks, which was a significant boon to relative performance, since the Fund has zero exposure to this sector. Elsewhere, sector selection was a major headwind; notably, the Fund's overweight positions in Healthcare and Industrials hurt relative performance, as these Sector's lagged the market.
The Fund's relative performance was negatively impacted by what we didn't own as well. In particular, not holding Apple for most of the year cost the Fund more than 300bps (basis points) of performance. Apple may be the best-known company in the world and its seemingly ubiquitous iPhone holds a dominant share of the global cell phone market. Apple is even more dominant among Millennials and Gen Zers, which should lead to even greater market share as these cohorts age. This loyal user base should pay huge dividends for shareholders as Apple continues to monetize this ecosystem, especially as the company delves deeper into services, payments, and AI. We initiated a position in Apple during the fourth quarter and await a more attractive entry point to add to our position.
We added two smaller positions to the portfolio in the fourth quarter as well—Piper Sandler (PIPR, Financial) and Best Buy (BBY, Financial)--both of which are Minnesota-based. Piper Sandler, founded in 1895, is a leading investment bank based right in our backyard in Minneapolis. Piper's management has done an excellent job of expanding its merger and acquisitions (M&A) expertise and growing its share of M&A deals. Due to higher interest rates, the M&A environment has slowed considerably but should re-accelerate as companies adjust to the new interest rate regime. We also initiated a position in Best Buy, a leading electronics retailer with more than 1,000 stores nationwide. We've been impressed with management's ability to navigate a difficult retail landscape, gaining share amongst its offline competitors. The consumer electronics market is suffering from a spending hangover after the Pandemic, but we are starting to see green shoots of a recovery; in the meantime, Best Buy offers a 5% dividend.
Our technology investments have paid off handsomely and we are well positioned to take advantage of the growing interest in artificial intelligence. Outside of the “Magnificent 7,” most other stocks experienced muted returns in 2023, especially in mid-caps and so-called old economy industries. Consequently, we are finding compelling opportunities and are particularly interested in companies that can utilize AI to improve sales and profitability. When JP Morgan was once asked what the market will do, he famously responded “It will fluctuate.” However, as 2024 unfolds, we will remain true to our valuation discipline as well as our long-term focus and take advantage of any short-term fluctuations that may occur.
Andrew R. Adams, CFA Pete J. Johnson, CFA
Lead Manager Co-Manager
The Mairs & Power Growth Fund posted solid 2024 results and outperformed the S&P 500 TR Index. The Fund returned 27.70% for the year while the S&P 500 TR Index increased 26.29%. The Growth Fund also outperformed its peer group as measured by the Morningstar Core Index, which was up 22.13%.
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 by visiting www.mairsandpower.com. Read the summary prospectus or full prospectus carefully before investing.
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.
