Market Review
The Russell Midcap Growth Index finished a volatile quarter with a 6.54% return. Two sharp selloffs in the quarter, during the first weeks of August and September, were met with rallies. Investors bought the dips on
reassuring economic data, including a positive revision to second quarter GDP and better-than-expected second quarter earnings.
Inflation continued to ease, allowing the Federal Reserve to refocus on the labor market, where some weakness in employment tempered optimism of a soft landing. In anticipation of a rate cut, interest-rate-sensitive stocks rose through the quarter. The market rally spread from the Magnificent 7 and broadened across sectors and market caps, as midcap stocks outperformed large caps. The Fed's aggressive rate cut
of 50 basis points in September indicated that employment uncertainties and cyclical pressures could weight on growth.
Performance Review: Stock selection broadly aided results
The Fund (Investor Shares) returned 8.55% (net of fees) for the quarter, outperforming the Russell
Midcap Growth Index's 6.54% return. While stock selection was mostly positive across sectors, selection in the Health Care sector was the largest contributor, buoyed by a strong quarter from life sciences leader Agilent
Technologies. Selection within Real Estate weighed on relative results.
For the year-to-date, the Fund returned 13.32%, outperforming the benchmark return of 12.91%. Selection within Information Technology led outperformance, while selection within Real Estate hampered relative returns.
Top Contributors
Guidewire Software (GWRE, Financial), the leading software provider for property and casualty insurers, is reaping the benefits of its cloud migration efforts as it continues to penetrate the market with its comprehensive platform
of claims, billing and policy management solutions.
Equifax (EFX, Financial), a consumer credit reporting agency, is poised to benefit from a rebound in the mortgage market thanks to its unique employment and consumer credit datasets.
Sherwin-Williams Company (SHW, Financial), the largest U.S. residential paint provider, has managed to maintain strong growth in less-than-ideal macro conditions by offering compelling value and further stands to benefit from an
improving real estate market.
MercadoLibre (MELI, Financial), Latin America's leading e-commerce marketplace, continues to fortify its leadership position with an impressive ecosystem of products, from shipping to financial services, resulting in
improved earnings per share.
Trane Technologies (TT, Financial), a leading global climate solutions company, provides sustainable HVAC systems for commercial and residential applications. The company benefits from several long-term secular trends, such
as global warming and sustainability mandates.
Bottom Contributors
Teradyne (TER), a supplier of automated test equipment for semiconductors, was affected by a broad sell-off in semiconductor-related stocks. We see some “green shoots” in demand and believe Teradyne is well
positioned as artificial intelligence moves to smartphones and PCs.
KLA Corporation (KLAC, Financial), a provider of process control and yield management semiconductor equipment, also fell along with declines in semiconductor stocks. It is also well positioned to benefit from a rebound in
the semiconductor segment.
Atlassian Corporation (TEAM, Financial), a workflow software provider, has faced short-term volatility due to the migration of their on-premises software offering to the cloud. The company's growth potential remains strong,
and its profit picture should improve as the cloud transition is completed.
Cadence Design Systems (CDNS, Financial), an electronic design automation (EDA) software and hardware company, was impacted as the semiconductor rally stalled. Its high market share puts it in a favorable
position as market sentiment improves.
Western Digital Corporation (WDC, Financial), a leading supplier of data storage devices, is another holding impacted by the broad sell-off in semiconductor stocks as demand for its hard drives are impacted by similar
cyclical factors.
Portfolio Positioning: A long runway for our thematic overweights
We maintained our key thematic overweights in the Semiconductor, Software, Life Sciences Tools and Services industries, as well as housing-related companies. We also added a new overweight in the
Transportation industry.
Semiconductors, a market darling during the first half of the year due to demand spurred by artificial intelligence (AI), trailed during the third quarter. We maintained our overweight position as we expect our
Semiconductor holdings to benefit as AI moves from data centers to smartphones and laptops. Increasing semiconductor complexity is requiring more design, capital equipment and testing.
In Software, we added Autodesk (ADSK, Financial) and Cloudflare (NET, Financial) while exiting Bill.com (BILL, Financial). We believe Autodesk's dominant position in architecture, engineering and construction software allows it to increase
margins and offer attractive revenue growth. Cloudflare has built its own internet network, providing its customers with lower latency and better security. We exited Bill.com as we had concerns around its competitive moat.
We also maintained the overweight in the Life Sciences Tools and Services industry. During the quarter, we sold IQVIA (IQV, Financial) and added to our West Pharmaceutical (WST, Financial) position. We believe there is more upside in West's industry-leading injectables packaging business than in IQVIA's clinical research outsourcing business.
We continued a significant overweight in housing-related stocks compared to the benchmark. We were pleased to see our housing stocks rally as investors anticipated that the Fed's rate cuts could spur a housing
rebound.
We welcomed J.B. Hunt (JBHT, Financial) to the portfolio during the quarter. The largest intermodal transportation provider in the country, J.B. Hunt is well positioned to benefit when freight volumes improve. We continue to
own Old Dominion Freight Lines (ODFL), which is, in our view, the best managed and most profitable less-than-truckload transportation provider in the country.
Outlook: A supportive fiscal and monetary backdrop for mid-cap stocks
Our near-term outlook for equities is positive although we are watching geopolitical and economic risks. During the third quarter, the Federal Reserve reduced its short-term interest rate by 50 basis points to stimulate the economy. The Fed has pivoted to an accommodative monetary policy as employment growth has slowed and inflation is decelerating. The U.S. government, meanwhile, continues to run a large deficit, which is also
supporting the economy.
China, the world's second-largest economy, introduced a large package of monetary and fiscal stimulus to accelerate growth. The European Central Bank is cutting interest rates to stimulate the economy as
well.
We believe that if the fiscal and monetary stimulus policies are successful, then our thematic overweights in the Life Sciences Tools and Services industry, and housing and freight transportation companies should
provide tailwinds to the portfolio. We expect these companies to recover sharply from their rolling recessions.
If, however, an unexpected shock such as a geopolitical event causes the market to sell off, we believe that our
strategy of investing in competitively advantaged businesses that gain market shares with strong balance sheets and seasoned management teams should provide some downside protection.
Thank you for your investment in the Parnassus Mid Cap Growth Fund.
Yours truly,
Ian E. Sexsmith, Lead Portfolio Manager
Robert J. Klaber, Portfolio Manager
Performance data quoted represent past performance and are no guarantee of future returns. Current performance may be lower or higher than the performance data quoted. Current performance information to the most recent month end is available on the Parnassus website (www.parnassus.com).
Investment return and principal value will fluctuate, so an investor's shares, when redeemed, may be worth more or less than their original principal cost.
