Q3 2015 • September 30, 2015 | Saturna Capital

Following Principles of Islamic Finance

Q3 2015 Highlights:

Despite the lack of a "Grexit" and no Fed rate hike, markets across the globe fell in Q3 2015.

  • Slowdown in China
  • Emerging markets maelstrom
  • Japan halted and Europe battered
  • Carnage in US markets
  • Mixed earnings results

Environment

At the end of last quarter, we suggested global equity markets faced two potential risks: a Greek exit from the eurozone and the US Federal Reserve's first rate hike. Neither came to pass, yet stock markets around the world took a battering. Investors believed that a possible Fed rate hike would wreak havoc on countries engaged in excessive overseas borrowing, which hit emerging markets especially hard. The slowdown in China exacerbated fear in countries that depend on exporting commodities, such as Brazil, South Africa, and Indonesia. In Brazil, South Africa, Turkey, Thailand, Malaysia, Indonesia, and others, questionable governance and sinking currencies did nothing to help the situation. As a result of these headwinds, the Institute of International Finance (IIF) stated in its most recent report that net capital flows for global emerging markets will be negative in 2015 for the first time since 1988.¹ The IIF projects net outflows to reach $541 billion for the year. Making matters worse, residents of the various countries are shipping their money overseas at record rates. According to the IIF, domestic outflows from emerging markets may surpass $1,000 billion in 2015. Such conditions may entice the most adventurous investors, but we are inclined to wait for some stability in commodity prices and the opportunity to assess the effects of the first rate rise.

Emerging markets were not alone in receiving punishment. For some time, we have voiced our skepticism surrounding Japan's revitalization plan known as "Abenomics" in homage to Prime Minister Shinzo Abe. While the Japanese stock market took off on a tear in the first part of the year as a result of significant yen depreciation, that came to a screeching halt in the third quarter with the Nikkei Index dropping -11.79% in US dollars. A sharp drop in the inflation rate and a reported decline in second quarter GDP growth contributed to the reversal of fortune.

Despite escaping the immediate fallout of a "Grexit," European markets were also battered during the quarter with the Bloomberg Euro 500 Index dropping -7.96% in US dollars. Performance worsened further on revelations of diesel emissions fraud perpetrated by Volkswagen that sent its share price down roughly 35% over the back half of September.

Finally, we arrive at the US, which did not escape the carnage. The Russell Growth, Russell Value, S&P 500, and Nasdaq Indices fell between -5.29% and -8.39% during the quarter with growth at the low end of the decline and value at the high end. Higher benchmark exposure to Energy and Financials in the Value Index contributed to the discrepancy between the two styles.

Outlook

Last summer, conventional wisdom pointed to a September lift-off for the Fed. Economists and market strategists no longer agree that the Fed will take action by year-end. Dollar strength appears to be taking the wind out of manufacturing sails. Recent employment figures have been disappointing, including a resumption in the decline of the labor participation rate. At the same time, sinking commodity prices and stagnant wage growth are not the typical ingredients of higher inflation.

Civilian Labor Force Participation Rate

Trimmed Mean PCE Inflation Rate

Equity markets generally cheer a diminished risk of rate hikes, at least in the short term. They also cheer improving earnings, and here the picture has been positive — with an important caveat. Of the 499 companies in the S&P 500 that had reported second quarter earnings by the end of September, 69% exceeded consensus expectations versus a long-term average of 63%.² That sounds pretty good until we realize that aggregate second quarter earnings increased only 1.2% year-on-year. Expectations were clearly modest. Further muddying the picture, only 48% of the companies reported sales that exceeded analyst consensus, well below the long-term average of 60%, and below the previous four quarters' average of 56%. Companies have done a good job managing expenses, but cost-cutting in an environment of weakening sales is not a recipe for secular earnings expansion.

 

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S&P 500: Q2 2015 Earnings vs. Expectations
Sector Above % Match % Below % Surprise Factor % Reported Total # Index Total #
Consumer Discretionary 73% 10% 18% 6% 84 84
Consumer Staples 70% 11% 19% 3% 37 37
Energy 60% 10% 30% 4% 40 40
Financials 61% 11% 28% 4% 87 88
Health Care 93% 5% 2% 7% 55 55
Industrials 73% 9% 18% 4% 66 66
Materials 61% 14% 25% 5% 28 28
Technology 71% 10% 19% 3% 68 68
Telecom Services 60% 0% 40% 4% 5 5
Utilities 52% 7% 41% 4% 29 29
S&P 500 69% 10% 21% 4% 499 500

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Source: Thomson Reuters

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S&P 500: Q2 2015 Revenue vs. Expectations
Sector Above % Match % Below % Surprise Factor % Reported Total # Index Total #
Consumer Discretionary 52% 0% 48% 0% 84 84
Consumer Staples 39% 0% 61% -2% 36 37
Energy 49% 0% 51% 5% 39 40
Financials 60% 0% 40% 2% 85 88
Health Care 69% 0% 31% 1% 54 55
Industrials 29% 0% 71% 0% 66 66
Materials 29% 0% 71% -1% 28 28
Technology 57% 0% 43% 0% 67 68
Telecom Services 20% 0% 80% 0% 5 5
Utilities 24% 0% 76% -5% 29 29
S&P 500 48% 0% 52% 0% 493 500

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Source: Thomson Reuters

 

Amana Income Fund

The Amana Income Fund Investor Shares declined -7.87% in the third quarter, better than the -8.39% drop in the Russell Value Index but lagging the -6.44% fall in the S&P 500. Equally, the fund's year-to-date decline of -8.59% beats out the Russell Value's -8.96% contraction but lags the S&P 500, which has lost -5.29%.

There was really only one stand-out stock in the quarter, and that was Nike. Its strong fiscal first quarter results sent the shares soaring nearly 9% in a day. CEO Mark Parker received a new contract earlier in the year and declared that Nike remains a growth company — an aggressive comment for a global footwear and apparel maker with a market capitalization in excess of $100 billion. Early signs show he means business, with Nike doing well across almost every geography and category. Nike has undoubtedly benefited from Adidas' missteps of late, but the company also has been proactive in targeting new opportunities, such as among women athletes. Smuckers' first report after its acquisition of Big Heart Pet Food pleased investors, although its core business was lackluster.

With the exception of Industrials and Materials, stock selection during the quarter was solid with outperformance against the Russell Value Index in Consumer Staples, Consumer Discretionary, Health Care, Technology, and Energy, where we also benefited from low relative exposure.

There's an obvious theme uniting the majority of the underperforming stocks during the quarter: global industrial exposure. The strengthening of the US dollar has challenged industrial companies that derive a significant portion of their sales overseas. The environment will likely remain challenging, although the euro has moved off its lowest levels versus the dollar, and signs of economic recovery in Europe are spreading.

Rockwell Automation dropped out of the top ten holding list. As noted above, it's share price suffered along with most industrial companies. Microsoft, which held steady during the quarter despite some intra-period volatility, replaced it.

As of September 30, 2015

Ten Largest Contributors Return Contribution
Nike, Class B 14.13% 0.44
JM Smucker 5.88% 0.12
Kimberly-Clark 3.76% 0.07
United Parcel Service, Class B 2.57% 0.05
McCormick & Co 2.03% 0.04
General Mills Inc 1.51% 0.03
Eli Lilly 0.84% 0.02
Microsoft 0.91% 0.02
PepsiCo 2.00% 0.02
Intel 0.09% 0.02
Ten Largest Detractors Return Contribution
PPG Industries -23.30% -0.77
Rockwell Automation -18.13% -0.53
Methanex -40.44% -0.49
E.I. du Pont de Nemours -20.09% -0.44
United Technologies -19.26% -0.38
Parker Hannifin -15.85% -0.37
Carlisle -12.35% -0.34
Johnson Controls -16.00% -0.34
Emerson Electric -19.51% -0.34
AbbVie -18.43% -0.33
Top Ten Holdings Portfolio Weight
Eli Lilly 4.1%
Nike, Class B 3.7%
Novartis ADR 3.2%
Illinois Tool Works 3.2%
Microsoft 3.1%
Bristol-Myers Squibb 3.0%
Colgate-Palmolive 3.0%
Honeywell International 3.0%
3M 2.9%
Pfizer 2.8%

Asset Weighted Average Debt to Market Cap: 14.7%

 

Amana Growth Fund

In the third quarter the Amana Growth Fund Investor Shares slipped -5.12% against a -5.29% drop in the Russell 1000 Growth Index and a -6.44% fall in the S&P 500. Year-to-date the Fund has fallen -5.37%, while the S&P 500 is down -5.29%, and the Russell 1000 Growth Index is down -1.54%. Year-to-date performance among our selections in Technology and Industrials are the main source of the underperformance.
Several of our holdings performed well in the quarter, led by Google, which has benefited from the appointment as CFO of former Morgan Stanley CFO Ruth Porat. Google is known as a freewheeling, somewhat undisciplined company. Ms. Porat has already had a salutary effect as the shares reacted strongly to the quarterly results announced in mid-July.

Infosys has been one of our more volatile holdings over time, but the Indian information technology outsourcing firm benefits from the strengthening of the US dollar. The firm was also cleared in a case that had been brought to the US Labor Department claiming illegal use of H-1B visas.

TJX has made regular appearances among our top contributors, as have Adobe and Church & Dwight, companies to which we remain committed over the long term.
We also see some repeat performances among the largest detractors, with Trimble, Norfolk Southern, and Qualcomm appearing for the second consecutive quarter. Trimble leads its field of GPS solutions, but weakness in mining and agricultural commodities have damaged its business. Norfolk Southern has suffered from declining shipments of coal and fracking sand. Qualcomm has been losing market share to Samsung.

TJX and Eli Lilly are new entrants among the top ten holdings, supplanting PepsiCo and Estée Lauder.

As of September 30, 2015

Ten Largest Contributors Return Contribution
Google, Class A 18.30% 0.32
Infosys ADS 20.44% 0.27
TJX Companies 8.26% 0.21
Clorox 11.88% 0.19
Church & Dwight 3.80% 0.11
Lowe's 3.34% 0.08
Adobe Systems 1.49% 0.07
United Parcel Service, Class B 2.57% 0.06
PepsiCo 1.80% 0.05
Eli Lilly 0.84% 0.01
Ten Largest Detractors Return Contribution
Trimble Navigation -30.01% -0.61
Apple -11.66% -0.51
Intuit  -11.72% -0.48
Potash Corp. of Saskatchewan -33.01% -0.48
Amgen -9.48% -0.43
Qualcomm -13.48% -0.35
ASML Holding -15.51% -0.30
Express Scripts Holding -8.97% -0.27
Norfolk Southern -11.92% -0.25
Lincoln Electric Holdings -13.41% -0.22
Top Ten Holdings Portfolio Weight
Adobe Systems 5.4%
Apple 4.3%
Amgen 4.1%
Akamai Technologies 3.9%
Intuit 3.8%
Church & Dwight 3.8%
Novo Nordisk ADS 3.3%
TJX Companies 3.2%
Lowe's 3.0%
Eli Lilly 3.0%

Asset Weighted Average Debt to Market Cap: 10.6%

 

Amana Developing World Fund

As described in the introduction, it's been tough sledding in emerging markets. The Amana Developing World Fund Investor Shares fell -13.37% in the third quarter, which sounds bad, but was better than the -17.90% collapse in the MSCI Emerging Markets Index. Year-to-date the Fund has shed -18.34% versus a -15.47% fall in the Index. The primary reason for the difference in performance between the first half and the third quarter was the rise and fall in China. We did not see evidence of fundamental support for the rapid appreciation of Chinese stocks that began last year. We therefore did not participate and subsequently were far outpaced by the index. That bull market rapidly turned into a rout, accounting for the much improved relative performance in the third quarter. Looking ahead, we do not anticipate a meltdown of China's economy, but we are taking a cautious approach toward engagement. We do see continuing stress for emerging market currencies and are not enthusiastic about committing new funds to Latin America, Turkey, or much of Southeast Asia.

New portfolio holding Samsonite leads the list of top contributors. Although an American brand, Samsonite is headquartered in Hong Kong with significant production in China, India, Thailand, and Mexico. China is also the company's fastest growing market, and emerging markets clearly represent the strongest growth opportunity. Western Digital benefited from a 14.5% pop on the last day of the quarter when Unisplendour Corporation of China announced its $3.8 billion investment in new shares to take a 15% stake in the business. Unisplendour agreed to pay $92.50 per share compared to a market price of $69.37 the day prior to the announcement. The market price did not fully adjust to the $92.50 level because of dilution from the newly issued shares.

MercadoLibre, the eBay of Argentina and Brazil, appeared among the top contributors in the previous quarter but was punished during the most recent period, illustrating the volatility of e-commerce and Latin America. The shares had soared to an all-time high in June before being caught in the emerging markets maelstrom. With the exception of Baidu, CNOOC, and Lenovo, the weakness among the other detractors was compounded by currency depreciation versus the US dollar.

Baidu and Telekomunikasi Indonesia fell out of the top ten holdings list and were replaced by Unilever and Samsonite.

As of September 30, 2015

Ten Largest Contributors Return Contribution
Samsonite International 4.82% 0.14
Western Digital 1.83% 0.08
Kimberly-Clark de Mexico, Class A 5.42% 0.07
WuXi PharmaTech Cayman ADR 2.25% 0.04
Alamos Gold  3.36% 0.02
KPJ Healthcare -21.19% 0.00
Aurico Metals Inc -14.38% 0.00
SM Prime Holdings -0.23% -0.01
BIMB Holdings -17.09% -0.01
Tiger Brands -5.63% -0.03
Ten Largest Detractors Return Contribution
Mercadolibre Inc -35.66% -1.32
Aspen Pharmacare Holdings -28.32% -0.90
M. Dias Branco -44.31% -0.83
Baidu ADS -30.98% -0.80
Lenovo Group -37.86% -0.74
MTN Group -29.75% -0.57
Kalbe Farma -25.27% -0.55
Telekomunik Indonesia ADS -17.84% -0.45
Mead Johnson Nutrition -21.54% -0.44
CNOOC ADR -25.32% -0.43
Top Ten Holdings Portfolio Weight
VF  3.3%
AboitizPower 3.1%
SM Prime Holdings 2.9%
Bangkok Dusit Medical Services 2.6%
Clicks Group 2.6%
MercadoLibre 2.6%
Unilever ADS 2.4%
Aspen Pharmacare Holdings 2.4%
Samsonite International 2.4%
Western Digital 2.3%

Asset Weighted Average Debt to Market Cap: 14.3%

 

Footnotes:

¹ Chandran, Nyshka. Is this the mother of all warnings on EMs? CNBC, October 1, 2015. 
http://www.cnbc.com/2015/10/01/emerging-markets-to-post-first-negative-year-of-net-capital-flows-since-1988.html

² Harrison, G., Aurelio, D. This Week In Earnings, Aggregate Estimates and Revisions. Thomson Reuters, October 9, 2015. 
http://www.trpropresearch.com/pdf/This_Week_In_Earnings.pdf

 

Performance Summary

As of September 30, 2015

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Average Annual Total Returns (Before Taxes) 1 Year 3 Year 5 Year 10 Year Expense Ratio
 
Amana Income Investor Shares (AMANX) -4.46% 9.66% 9.53% 7.54% 1.13%
Amana Income Institutional Shares (AMINX)¹ -4.23% n/a   n/a   n/a   0.88%
S&P 500 Index -0.61% 12.38% 13.33% 6.80% n/a
Russell 1000 Value Index -4.43% 11.58% 12.28% 5.69% n/a
 
Amana Growth Investor Shares (AMAGX) 0.84% 9.86% 9.52% 7.77% 1.08%
Amana Growth Institutional Shares (AMIGX)¹ 1.03% n/a   n/a   n/a   0.83%
S&P 500 Index -0.61% 12.38% 13.33% 6.80% n/a
Russell 1000 Growth Index 3.17% 13.58% 14.46% 8.08% n/a
 
Amana Developing World Investor Shares (AMDWX)² -20.64% -5.94% -3.97% n/a   1.59%
Amana Developing World Institutional Shares (AMIDX)¹ -20.33% n/a   n/a   n/a   1.40%
MSCI Emerging Markets Index -19.28% -5.26% -3.57% 4.26% n/a

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Expense ratios shown are as stated in the Funds' most recent Prospectus dated September 28, 2015.

Performance data quoted represents past performance, is before any taxes payable by shareowners, and is no guarantee of future results. Current performance may be higher or lower than that stated herein. Performance current to the most recent month-end is available by calling toll-free 888-732-6262 or visiting Month-end Performance. Average annual total returns are historical and include change in share value as well as reinvestment of dividends and capital gains, if any. 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. Shares of a Fund may only be offered for sale through the Fund's prospectus or summary prospectus.

The S&P 500 is an index comprised of 500 widely held common stocks considered to be representative of the US stock market in general. The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the US equity universe. It includes those Russell 1000 Index companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000 Value Index measures the performance of the large-cap value segment of the US equity universe. It includes those Russell 1000 Index companies with lower price-to-book ratios and lower expected growth values. The MSCI Emerging Markets Index, produced by Morgan Stanley Capital International, measures equity market performance in over 20 emerging market countries. When available, Saturna uses total return components of indices mentioned. Investors cannot invest directly in the indices.

¹ Institutional Shares of the Amana Funds began operations September 25, 2013.

² The Amana Developing World Fund began operations September 28, 2009.

A Few Words About Risk

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 www.amanafunds.com, or call us toll-free at 888/73-AMANA (888-732-6262).

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-US companies and in foreign markets. Investing in foreign securities involves risks not typically associated directly with investing in US 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.

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Asset-weighted average debt to market capitalization: This ratio represents the average debt to market capitalization of the portfolio. It is calculated by taking the debt to market capitalization for each company (its debt divided by its market capitalization), then weighting these values (multiplying each by the company's percent share of total portfolio assets), then totaling the weighted values.

The Nasdaq Composite Index measures the performance of more than 5,000 U.S. and non-U.S. companies traded "over the counter."

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The Bloomberg European 500 Index is a free float capitalization-weighted index of the 500 most highly capitalized European companies.