The Federal Reserve (Fed) continues to make progress in its effort to balance economic growth with inflation. However, the stock market has been anything but balanced, with a handful of stocks generating nearly all the market returns so far this year. Though the S&P 500 ended the quarter on another up note, the index's overall positive performance was again driven by a narrow group of stocks. So far in 2024, 64% of the market's return can be attributed to seven names (Alphabet, Amazon, Apple, Eli Lilly, Meta, Microsoft, and Nvidia). At the same time, 75% of S&P 500 stocks are underperforming the index, 38% have had negative returns, and only two sectors out of 11 outperformed the index (Technology and Communication Services).
Looking at the indices for the second quarter, the S&P 500 Total Return (TR) was 4.28% and is 15.29% year- to-date. The Dow Jones Industrial Average Total Return (TR) was -1.27% in the quarter and 4.79% year-to-date, and the Bloomberg U.S. Government/Credit Bond Index return was 0.05% in the second quarter and -0.68% year-to-date.
Several key economic indicators pointed to a slowdown in the second quarter. Job growth softened with the unemployment rate rising to 4.1% in June, up from 3.6% a year ago at this time. Additionally, job growth slowed, averaging 177,000 new jobs per month in Q2, down from an average of 267,000 in Q1. In late June, the U.S. Labor Department reported that the total number of Americans collecting jobless benefits reached the highest level in more than two years. Wage inflation, which had been stubbornly high, is also slowing. In June, wages were up 3.9% from a year ago, and that compares with a 4.7% rate of increase at this time last year.
As job growth has slowed, consumer confidence has also declined, leading to weakened retail sales growth. In June, retail sales increased to an annual rate of only 2.3%, down from a 5.5% growth rate in December. Existing home sales also declined again in the second quarter after improving a bit earlier in the year. The National Association of Realtors reported that on an annualized basis, sales of existing homes fell to 4.1 million in May. That compares to a rate of 5.1 million two years ago and a peak of 6.7 million back in 2021 when mortgage rates were low.
Future Outlook
Despite economic growth slowing in the second quarter, there are reasons to feel cautiously optimistic. The Fed's preferred measure of inflation, the personal consumption expenditures price index (PCE), was up 2.6% in May from a year earlier compared to a year-over-year increase of 3.2% at this time last year. That's the direction the central bank would like to see sustained and increases the likelihood of the central bank cutting rates in the coming months.
The Fed's mandate is to balance employment and inflation. An economy in equilibrium creates enough new jobs that keep incomes, spending, and investment growing without causing inflation to accelerate. This can lead to a broad economic expansion into the future.
Rate reductions also could bring greater balance to the overall market. This year, the biggest companies have posted the largest earnings growth, a key driver of market performance. Estimates for the S&P 500 continue to be revised upward for 2025 and 2026, boosted by the megacap stocks mentioned earlier. However, earnings for small and midsize companies have been less robust. Earnings estimates for the S&P Small Cap 600 Index in 2025 and 2026 have seen consistent downward revisions. That's because most smaller companies need to borrow to fund their growth. Unlike the bigger businesses, they do not have large cash reserves or enjoy high levels of cash flow. Current high interest rates have elevated borrowing costs, cutting into smaller companies' earnings. This helps explain the weaker market performance of small cap stocks. Interest rate cuts could boost earnings growth for smaller companies, leading to better performance for all stocks and sectors.
A key aspect of our job as investment managers is balancing potential return against potential risk. We do this in several ways, but it is critical to exhibit valuation discipline that trims positions when they become expensive and adds to those positions when valuations become attractive. At first glance the stock market appears to be overvalued compared to the 10 -year average. However, a closer look shows that much of this overvaluation is due to the AI-fueled technology boom surrounding the largest 10 companies. The remaining 490 companies trade at a much more reasonable valuation, right in line with the historical average. While we remain positive on the long-term prospects for AI, our valuation discipline is helping us find good opportunities in other parts of the market. We will continue to examine opportunities to invest in well-run companies exhibiting durable competitive advantages that we believe are attractively priced.
Performance Review
In the second quarter, the Mairs & Power Growth Fund built upon its positive start to the year and is now up 14.32% year-to-date. However, it gave up some of its relative performance and is slightly trailing the S&P 500 Total Return (TR) which is up 15.29%. For comparison, the Fund's peer group, as measured by the Morningstar Large Blend Category, was up 12.4% over the same period.
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 the most recent month-end performance figures, please call Shareholder Services at (800) 304-7404. Expense Ratio 0.64%.
The Fund's underperformance relative to its benchmark was split fairly evenly between sector allocation and stock selection. Like the start of the year, the market's positive returns are being driven by just a handful of stocks. The so-called “Fab 4” of Nvidia (NVDA, Financial), Amazon (AMZN, Financial), Meta (META, Financial), and Microsoft (MSFT, Financial) have all significantly outperformed the broader market. Additionally, after a slow start to the year, Alphabet (GOOG, Financial) rebounded sharply in the second quarter thanks to significantly beating revenue projections and a large sequential improvement in margins. Together, these five stocks drove more than 60% of the market's returns. Thankfully, the Fund has significant positions in all but Meta.
Nvidia extended its meteoric rise into the second quarter and is now up an astounding 150% year-to-date, accounting for almost a third of the market's returns alone. The company continues to see immense demand for its graphic processing unit (GPU) chips that power generative artificial intelligence (AI). The speed of its GPU chips remains cutting edge. However, Nvidia is not resting on its laurels and will be launching its newest GPU architecture, Blackwell, later this year. Blackwell promises to be magnitudes faster than its prior line of GPU chips.
Given the interest in AI, it is unsurprising that “Old Economy” industries have lagged. In particular, Industrial and Healthcare stocks have languished, which has hurt relative performance due to the Fund's overweight position in both sectors. Fortunately, we are seeing signs of a bottom in both sectors and have been adding to our positions accordingly.
Outside of the Industrial and Healthcare sectors, stock picking remains quite successful. As previously mentioned, Nvidia, Alphabet, Microsoft, and Amazon have been positive contributors to relative performance. The Fund has also benefited from our investments in companies that are not necessarily tied directly to AI but we believe will likely benefit from the adoption of this emerging technology.
One great example of this is Qualcomm (QCOM, Financial), which is a long-term holding of the Fund. While it may not be a household name, chances are high that you use their technology multiple times a day, since the company's modems and chipsets are vital to cellular communications. In fact, Qualcomm has a near monopoly on cellular modems. The company's competitive position has been built through more than $60 billion in research and development (R&D) over the last 10 years, leading to a portfolio of more than 164,000 active patents. Qualcomm is up nicely this year as its technology will likely play a big role in the AI market, as devices such as smartphones become key to delivering AI inferencing.
nVent (NVT, Financial) is another example of a company that is benefiting from the market's enthusiasm around AI adoption. Based primarily in Minneapolis, nVent was spun off from Pentair in 2018. The company is a large supplier of system protection, fastener, and thermal wiring solutions with a dominant position in electronic protection equipment. Management has done a remarkable job revitalizing innovation and reinvigorating organic growth and has invested heavily in liquid cooling. The process involves servers being cooled via water rather than air like with more traditional datacenter systems. Given the extreme heat generated by AI datacenters, future datacenters will need this new technology to cool their servers, providing a promising growth opportunity for nVent.
Overall, we are delighted in the performance of our technology investments and believe that the Fund is well positioned to take advantage of the emergence of AI. Stocks outside the “Fab 4” have not fared well this year, and we are finding opportunities in the Healthcare, Industrial, and Utility sectors. We remain committed to our disciplined investment approach and these companies fit our investment doctrine. They possess positive durable competitive advantages, attractive long-term growth opportunities, and excellent management teams. As a result, each company should do well in their own right. However, these investments also have the potential to harness AI to boost revenue or drive cost efficiencies, which would be icing on the cake.
Andrew R. Adams, CFA
Lead Manager
Pete J. Johnson, CFA
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 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.
