Q1 2012 • March 31, 2012
While the economic news from foreign shores continues to invite concern, domestic economic releases have been mostly positive. Most notably, after consistently disappointing expectations since the onset of the financial crisis in 2008, employment data from the Bureau of Labor Statistics has beaten expectations over the last several months. Indeed, even the revisions have been strongly positive:
|Non-Farm Payroll Jobs Created|
This was enough to drive the unemployment rate down to 8.3%.
Buttressing the positive employment news has been data from the Institute for Supply Management, which continue to suggest that the U.S. economy will continue to expand. In contrast to past quarters, news of Greek bailouts and European sovereign debt problems were not able to dampen investor sentiment. Improving economic numbers combined with the European Central Bank's ("ECB") LTRO program gave investors the courage to take risk. Not surprisingly, higher beta sectors such as Financials, Information Technology, and Consumer Discretionary led the S&P 500 higher. The Index rallied 12.00% in the quarter and a huge 24.49% from the end of September 2011. Treasurys sold off, though not as much as might be expected given that the official rate of inflation remains at 2.9% and the ten-year U.S. Treasury bond only yielded 2.21% at the quarter end. Nevertheless, the sell-off resulted in stocks outperforming bonds by a walloping 12.29% in the quarter.
Given the "risk on" sentiment it was no surprise to see stocks in the most vulnerable sector performing the best. The S&P 500 Financials Index produced a 22.05% total return and with a weight of nearly 15% in the S&P 500 Index, it was a key factor driving returns in the quarter. Indeed, despite all the talk about dividend investing, growth stocks outperformed value stocks as the attraction of dividend paying stocks remained a crowded play.
Markets outside the U.S. also experienced strong advances. Japan, whose central bank also recently engaged in easy monetary policy in an effort to devalue the yen, saw their markets advance 12.08% (20.29% in yen terms). Brazil, also engaged in policies designed to manage the value of its currency, saw its equity markets advance 16.34%.
Despite the efforts of central bankers and the spate of good economic news, there are a number of fundamental and technical factors that keep Saturna Capital somewhat guarded about the current investment environment. First, several countries in the European Union, our largest trading partner, continue to struggle with significant structural problems that plague their economies. The unemployment rate in Spain is a whopping 24%. Youth unemployment in that country is a disastrous 50% — so high that it threatens the long-term future prospects for a whole generation of young people. Greece's prime minister recently conceded that they would likely need a third bailout. Portugal is likely to default and serious questions have arisen about Spain's and Italy's abilities to manage their debt. While the ECB's LTRO program helped to dampen sovereign bond yields, its end has seen some evidence of rates rising in the Euro zone. As for the revived U.S. economy — the outlook there remains uncertain as the Bush Tax Cuts, Employment Insurance Extension and the accelerated depreciation of fixed assets ends. While the median forecasts of GDP suggest 2.2% growth in 2012 rising to 2.85% growth in 2014, the dispersion of opinion is large — a spread of 1.9% between high and low estimates for 2012 and 2.8% for 2013.
At the company level, sales and earnings growth have continued to advance, though at a slower pace than in past quarters. Increases in earnings multiples helped push the market higher. The S&P 500 Index traded at 12.7x earnings at the beginning of the quarter and 13.5x earnings at the end of it. Indeed, multiple expansion, rather than growth in earnings and book value, is largely responsible for the entire advance in the market in the first quarter. As a value-oriented investor focused on company fundamentals, we would prefer to see company earnings contribute more to the increase in equity prices than we experienced in Q1. Also, as stock multiples rise, it creates a more difficult environment for us as we seek opportunities to invest capital.
AMANA INCOME FUND
The Amana Income Fund continues to perform well, but as has often been the case, tends to lag in "risk-on" environments. The value-focused Income Fund returned 6.24% in the quarter, trailing the S&P 500 Index by 6.35%. The market rally that started last November has been led by Financials and was biased toward growth-oriented stocks such as those in the information technology space. As avoidance of the Financial sector is part of the Fund's mandate, this sector's rally and its 14.91% weight in the benchmark resulted in a performance handicap the Fund was not able to overcome on a relative basis. For the three years and five years respectively to March 31, 2012, the Fund returned 61.97% and 26.31% as compared with 87.99% and 10.48% for the S&P 500 Index.
The Fund received a 2012 Lipper Best Fund Award for superior ten year performance among 40 funds in Lipper's Equity Income category. This year's award is Amana Income Fund's fourth Lipper Best Fund Award since 2007, and recognizes the Fund's consistently strong, risk-adjusted returns over the ten year period ended December 31, 2011.
The portfolio continued to see its exposure to the Utility sector decline as its position in Sempra Energy was liquidated to both take profits and avoid a stock that was seeing further increases in balance sheet gearing. Profits were also taken in Canadian Pacific Rail as a proxy battle saw the stock price rise more than 12%. SK Telecom was also sold as the stock has suffered from persistent price weakness for more than a year. Additions were diverse with the Fund adding to existing positions in Kellogg, PPG Industries, National Fuel Gas, GlaxoSmithKline, Chungwa Telecom and Freeport-McMoRan.
|Illinois Tool Works||Industrials||23.06|
|Taiwan Semiconductor||Information Technology||18.36|
While the Fund's overweight position in Industrial and Materials names continues to support performance, its underweight position in Information Technology held back relative performance. The portfolio is roughly 11% underweight relative to the S&P 500 Index as of March 2012, in part due to a lack of dividend paying stocks in this sector. The few that do pay decent dividends are largely already held in the Fund. Stocks that performed poorly in the quarter were dominated by defensive names. This is not much of a surprise given the current increase in risk appetite in the market. Health care names such as Bristol-Myers Squibb, Eli Lilly, GlaxoSmithKline, and AstraZeneca saw modest declines or poor returns. Many Health Care firms continue to see flat or declining returns on capital sometimes despite growth in sales and earnings. This has weighed against these names for a number of years and continues to impact investor sentiment toward them. Yet, they contribute value due to their diversification benefits.
|National Fuel Gas||Utilities||-12.78|
|Chunghwa Telecom||Telecommunication Services||-7.57|
|Bristol-Myers Squibb||Health Care||-3.28|
|Eli Lilly||Health Care||-1.89|
|General Mills||Consumer Staples||-1.63|
|Vodafone Group||Telecommunication Services||-1.28|
AMANA GROWTH FUND
Despite the stellar returns in the quarter, Amana Growth Fund has slightly lagged the S&P 500 Index (11.84% vs. 12.59%). As with the Amana Income Fund, the lack of exposure to Financials was a significant drag on performance. Thankfully, much of this beta risk was made up in the Information Technology sector where the Fund is significantly overweight. For the 3- and 5-year periods to March 2012, Amana Growth Fund's total return of 71.87% and 31.77% compare to the S&P 500 Index's total returns of 87.99% and 10.48%, respectively.
As mentioned above, the risk-on environment we find ourselves in has led to rallies in the Financials and Information Technology sectors. Accordingly, Information Technology shares dominated the top performing stocks list. Industrials like Regal-Beloit and LAN Airlines (which passed regulatory hurdles in its merger with TAM Airlines) also provided support. Though not represented in the table below, consumer discretionary names such as TJX Companies and Petsmart also performed well. With valuations expanding, managers have become increasingly selective in investing capital. The Fund added to positions in Adobe, Gartner, and Google. In the Industrials sector, the Fund added to positions in Union Pacific, Gentex, and Regal-Beloit. The Fund also added to a number of Consumer Staples and Health Care names.
|Monster Beverage||Consumer Staples||34.77|
|Agilent Technologies||Health Care||27.71|
|Trimble Navigation||Information Technology||25.39|
While IT stocks had a general rise in the markets, not all names in this sector participated in the rally. Hewlett-Packard sold off 7.03% as investors remain concerned about the now-diversified company's future earnings growth. SanDisk and Google were also weak. Related to the Technology sector, the poor performance of retailer Best Buy showed a continued struggle to grow its top line as consumers increasingly turn to lower priced products online.
|Eli Lilly||Health Care||-1.89|
|Best Buy||Consumer Discretionary||1.33|
As for dispositions, the Fund sold its position in Cree following a steep recovery in the stock early in the New Year. As with the Amana Income Fund, the Amana Growth Fund also took profits from its position in Canadian Pacific Rail as Pershing Square's take-over battle was effective at moving the stock higher.
AMANA DEVELOPING WORLD FUND
As emerging market economies changed from monetary tightening to easing, markets were increasingly willing to bid up equities. Most emerging equity markets saw decent double-digit gains. For the three months ended March 31, 2012, the Amana Developing World Fund produced a total return of 5.99%. In comparison, the MSCI Emerging Markets Index had a 13.99% total return. However, for the twelve month period, the Amana Developing World Fund outperformed its benchmark by 6.88% as the Fund returned -1.77% as compared to -8.65% for the MSCI Emerging Markets Index. The twelve-month return benefitted from the Fund's large cash position.
In contrast to U.S. equity markets, sector gains in emerging markets were more diverse, perhaps in part due to differing growth environments for defensive sectors such as Health Care. Chinese medical equipment manufacturers Mindray Medical and Aspen Pharmacare Holdings were both rewarded with strong gains by improving visibility on future earnings growth. The Fund initiated positions in Aspen Pharmacare Holdings and FX Energy. We believe the latter has good prospects at growing its reported natural gas reserves beyond what is currently priced into the stock. Pacific Rubiales Energy gained nearly 60% as earnings increased more than 100%. The company also increased its dividend 18%.
|Pacific Rubiales Energy||Energy||58.96|
|Mindray Medical||Health Care||30.25|
|Aspen Pharmacare Holdings||Health Care||29.48|
|MRV Engenharia||Consumer Discretionary||23.87|
|Richter Gedeon||Health Care||21.79|
Laggards include Ctrip.com International, which was sold in the quarter as the company was not able to grow its earnings enough to justify their valuation. Other dispositions included Total Access Communications, which experienced slowing growth and higher capital requirements; and Sterlite Industries, which reported poor results.
|Ctrip.com International||Consumer Discretionary||-7.52|
|Telekomunikasi Indonesia||Telecommunication Services||-0.93|
|MTN Group||Telecommunication Services||2.66|
|Kalbe Farma||Health Care||4.18|
Top Ten Holdings
|Amana Income Fund|
|Illinois Tool Works||2.0%|
|Canadian National Railway||2.0%|
|Other Portfolio Securities Mentioned|
|Canadian Pacific Railway||0.3%|
|DuPont (E.I.) De Nemours||1.5%|
|Freeport-Mcmoran Copper & Gold||1.5%|
|National Fuel Gas||0.6%|
|Amana Growth Fund|
|International Business Machines||2.2%|
|Other Portfolio Securities Mentioned|
|Canadian Pacific Railway||0.2%|
¹ TAM Airlines is currently merging with LAN Airlines.
|Amana Developing World Fund|
|LAN Airlines ADS||2.2%|
|Mead Johnson Nutrition - A||2.0%|
|Quimica y Minera Chile ADS||1.9%|
|Dr. Reddy's Laboratories ADR||1.8%|
|Other Portfolio Securities Mentioned|
|Aspen Pharmacare Holdings||0.8%|
|China Petroleum & Chemical||0.5%|
|Freeport-Mcmoran Copper & Gold||0.8%|
|Pacific Rubiales Energy||1.2%|
|Total Access Communications||0.0%|
Q3 2012 Performance
|Average Annual Total Returns (Before Taxes)||10 Year||5 Year||3 Year||1 Year|
|As of March 31, 2012|
|S&P 500 Index||4.11%||2.01%||23.42%||8.54%|
|Russell 1000 Value Index||4.58%||-0.81%||22.82%||4.79%|
|Russell 2000 Index||6.47%||2.13%||26.91%||-0.18%|
|Russell 1000 Growth Index||4.24%||5.09%||25.28%||11.02%|
|Amana Developing World Fund¹||N/A||N/A||N/A||-1.77%|
|MSCI Emerging Markets Index||14.07%||4.84%||25.22%||-8.65%|
As of the Funds' most recent Prospectus dated September 9, 2011, the expense ratios were 1.21% for Amana Income, 1.14% for Amana Growth, and 1.61% for Amana Developing World.
Please consider an investment's objectives, risks, charges and expenses carefully before investing. For this and other important information about the Amana Funds, please obtain and carefully read a free prospectus or summary prospectus from www.amanafunds.com or by calling toll-free 888/73-AMANA.
Performance data quoted herein represents past performance and does not guarantee future results. 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 the original cost. Current performance may be higher or lower than performance data quoted herein. Returns do not reflect the potential deduction of a 2% redemption fee on shares held less than 90 calendar days which if applied would have lowered quoted returns. The Funds cannot guarantee that their investment objectives will be met. Securities of the Fund may only be sold by offering the Fund's prospectus. The Russell, S&P 500, and Morgan Stanley ("MSCI") indices are widely recognized indices of common stock prices which reflect no deductions for fees, expenses or taxes. Investors cannot invest directly in the indices.
¹ The Amana Developing World Fund began operations September 28, 2009.
A Fund's performance depends primarily on what happens in the stock market. The market's behavior is often volatile, particularly in the short-term and in periods of unusual market occurrences. Because of this, the value of your investment will rise and fall, and you could lose money. For performance current to the most recent month-end, please ask your representative, visit our Average Annual Returns Page or call us toll-free at 888/73-AMANA (888-732-6262).
A Few Words About Risk
By diversifying its investments, each Fund seeks to reduce the risk of owning only a few securities. Diversification does not assure a profit or protect against a loss in a declining market. The Growth Fund typically invests in smaller and less seasoned companies than the Income Fund, which may lead to greater variability in the Growth Fund's returns. Growth stocks, which can be priced on future expectations rather than current results, may decline substantially when expectations are not met or general market conditions weaken.
The Funds may invest in non-U.S. companies and in foreign markets. Investing in foreign securities involves risks not typically associated directly with investing in U.S. securities. These risks include fluctuations in exchange rates of foreign currencies; less public information with respect to issuers of securities; less governmental supervision of exchanges, issuers, and brokers; and lack of uniform accounting, auditing, and financial reporting standards. There is also a risk of adverse political, social or diplomatic developments that affect investment in foreign countries.
Islamic principles restrict the Funds' ability to invest in certain stocks and market sectors, such as financial companies and fixed-income securities. This limits opportunities and may increase risk.
Important Disclaimers and Disclosure
This report is intended only for the information of the reader, and is not to be used for or considered as an offer or the solicitation of an offer to sell or buy any securities or other financial instruments of any kind, including without limitation, any mutual fund or other product offered, sponsored, created, or managed by Saturna Capital Corporation or its subsidiaries or affiliates ("Saturna"). This report is not intended for distribution to, or use by, any person or entity who is a citizen or resident of, or located in, any locality, state, country, or other jurisdiction in which such distribution, publication, availability, or use would be contrary to law or regulation or which would subject Saturna to any registration or licensing requirement within such jurisdiction.
This document should not be considered as providing investment advice or services, or any service offered by Saturna. Saturna may not have taken any steps to ensure that the securities referred to in this report are suitable for any particular investor. Saturna will not treat recipients as its customers by virtue of their reading or receiving the report.
Nothing in this report constitutes investment, legal, accounting or tax advice or a representation that any investment or strategy is suitable or appropriate to a particular investor's circumstances or otherwise constitutes a personal recommendation to any investor. Saturna does not offer advice on the tax consequences of any investment.
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The information in this report was obtained from sources Saturna believes to be reliable and Saturna believes the information and opinions in the material are accurate and complete as of the date of this material. However, information and opinions contained herein will change over time and without notice. Saturna has no obligation to update or amend any information or opinions at any time. Saturna makes no representations as to the accuracy or completeness of this material, nor does it have any responsibility to ensure that any other materials, including any containing materially different information, are brought to the attention of any recipient of this report.
Under no circumstances shall Saturna, its employees, or any affiliate, be responsible for any investment decision by any recipient. This material is distributed on condition that it will not form the sole basis for any investment decision by any recipient. Any recipient who is not a market professional or institutional investor should seek the advice of an independent financial advisor prior to making any investment based on this report or for any necessary explanation of its contents.
Saturna does not provide tax, legal or accounting advice. Investors should consult their own tax, legal and accounting advisers before engaging in any transaction. In compliance with IRS requirements, recipients are notified that any discussion of U.S. federal tax issues contained or referred to herein is not intended or written to be used for the purpose of (A) avoiding penalties that may be imposed under the Internal Revenue Code; nor (B) promoting, marketing or recommending to another party any transaction or matter discussed herein.
Past performance does not imply or guarantee future performance, and no representation or warranty, express or implied is made regarding future performance. The price, and value of, and income from, any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of foreign securities and financial instruments is subject to exchange rate fluctuation that may have a positive or adverse effect on the price or income of such securities or financial instruments. Investors in securities such as ADRs — the values of which are influenced by currency volatility — effectively assume this risk.