Q4 2015 • December 31, 2015 | Saturna Capital

 

 

Navigating Today's Volatile Markets

 

Q4 2015 Highlights:

We review the highs and lows of 2015 and our outlook for 2016.

  • Price of oil fell below $30 to a 12-year low.
  • China still a wild card after epic late-year market rout.
  • F.A.N.G. stocks (Facebook, Amazon, Netflix, Google) spelled relief.
  • The US dollar strengthened against many foreign currencies.
  • Consumer Discretionary topped sector returns.

Environment

After three years of largely uninterrupted appreciation, global stock markets, with a few exceptions, hit a wall in 2015 as the S&P 500 Index squeaked out a paltry 1.38% rise, and the Dow Jones Industrial Average Index added only 0.21%. The Nasdaq, led by the F.A.N.G. highflyers (Facebook, Amazon, Netflix, and Google), provided some relief and rose a respectable 7.11%. While the non-tech oriented broad indices failed to register significant gains, that's not to say there weren't opportunities to make money, as we can see in the chart below. In the United States the consumer buoyed a double-digit return from Consumer Discretionary stocks and mid single-digit returns from Health Care, Consumer Staples, and Information Technology. Meanwhile, index performance was dragged down by the woeful year for energy and other commodity stocks as the prices of numerous soft and hard commodities plummeted over the course of the year.

S&P 500 Sector Returns

Counterintuitively, the answer to the question everyone debated over the course of the year was initially treated as a non-event on December 16 when the Federal Reserve raised the target range for the federal funds rate by 25 basis points to between .25% and .50%. The S&P 500 dropped the following day but quickly recovered until the meltdown in China sparked a renewed sell-off.

Conditions were hardly better elsewhere with the developed market MSCI EAFE Index (Europe, Australasia, Far East) slipping -0.39%, as a US dollar-denominated 10.99% total return from the Japanese TOPIX Index was pulled down by the larger weight of Europe, where the FTSE Eurotop 100 Index fell -3.14% in dollar terms. For real carnage, however, one had to turn to the emerging markets, which were beset by falling commodity prices, capital flight, poor governance, and plummeting currencies. The MSCI Emerging Markets Index sank -14.92% during the year. Brazil, Malaysia, Thailand, Indonesia, Turkey, South Africa, and Mexico all suffered from declining markets and depreciating currencies versus the US dollar. Of course, the story of the year in emerging markets was the incredible run in Chinese stock prices over the first half of the year, which devolved into an epic rout in the second half — a rout that has accelerated as we enter 2016.

Outlook

Crystal ball gazing always presents opportunities to look foolish in hindsight, but prognostication in the current environment seems unusually likely to embarrass. As we write, oil prices have dipped below $30 for the first time since 2003. Saudi Arabia appears committed to making life difficult for US shale oil producers and has continued to pump aggressively while US ingenuity has maintained production at higher-than-expected levels. At the same time, Iraqi production is rising and Iranian sanctions may soon be lifted, leading to increased production there. Continued weakness seems inevitable, but low prices have resulted in slashed exploration budgets and the shuttering of uneconomic wells. Meanwhile, consumers living in the moment have responded to cheap oil prices by driving more and buying SUVs and other trucks while shunning the more efficient passenger cars on the lot.

Our Funds are generally underweight energy relative to their respective benchmarks and, at the risk of suffering one of the aforementioned embarrassments, we find it unlikely prices will remain at these depressed levels throughout the year. Could energy prices decline further? Absolutely, in the short term, but ultimately supply and demand will determine prices as shown in the chart below. As countries recovered from the global financial crisis, inadequate supply pushed oil prices higher, while transitioning to surplus production led to our current situation. The supply/demand gap has begun narrowing, and we expect it will continue to do so. We seek opportunities to increase energy exposure given the longer-term expectation of higher prices.

OPEC Demand/Supply Balance until 4th Quarter 2016

China presents another wild card for 2016. The meltdown in Chinese equities has dragged down indices around the world, while China's rate of economic growth, potential for currency devaluation, and future appetite for commodity imports worry developing economies. Unlike oil, we have no confidence in predicting the likely outcome for China's economic development over the course of the next 12 months. It's abundantly clear that China's government is concerned given its posturing in the South China Sea as a means to distract the public. It's equally clear the government has no coherent policy strategy given stopgap measures such as reduced taxes on automobiles, market circuit breakers that are suddenly eliminated, and bans on the sale of stock. Good governance is important and, in China, lacking.

While the US looks at first blush to be in better economic health than most of the world, we have already seen the negative impact of a stronger dollar on industrial production and export industries. The US also faces the prospect of future Fed rate increases or, more ominously, a reversal of policy on recognition that the December hike was premature.

Of course, we are also in a presidential election year, one unlike anything most of us have ever seen. Populism on both the right and left has been a defining characteristic of the campaigns to date. Establishment candidates former Secretary of State Hillary Clinton and former governor of Florida Jeb Bush find themselves challenged in the case of Clinton, and swept away in the case of Bush, by competitors who reside much further away from the center. What this may mean for financial markets is impossible to know, but we expect large percentages of the American public to find the idea of "President Trump" or "President Sanders" distressing to say the least.

 

Sextant Growth

On December 31, 2015, Scott Klimo, CFA was appointed portfolio manager of the Sextant Growth Fund. Tyler Howard has been named deputy portfolio manager.

In the fourth quarter of 2015 the Russell 1000 Growth Index gained 7.32%, while the Sextant Growth Fund rose 4.82%. For the full year the Fund slipped -2.15%, against a 5.67% increase in the Russell 1000 Growth Fund.

During 2015 the Fund suffered from errors of allocation and selection. On the allocation front we were underweight the strongly performing Consumer Discretionary, Consumer Staples, and Health Care sectors, while we were overweight the relatively weak Financials sector. Selection issues exacerbated these allocation missteps. This was especially true in the Information Technology sector, which provided the single largest contribution to benchmark returns. The Fund's contribution from Information Technology was negative due to significant declines among several tech holdings. 

2015 has been described as the year of the F.A.N.G., an acronym for Facebook, Amazon, Netflix and Google, companies that appreciated dramatically. The Sextant Growth Fund held positions in all but Netflix. A substantial overweight allocation to Facebook led to its dominance among Fund contributors, while the Fund was underweight Amazon and Alphabet (Google).

Micron detracted from returns, but we believe it's valuation to be too compelling to sell despite its near-term headwinds. Similarly, despite being a detractor from the Fund's full-year performance, we believe Ashland to be a well-managed company hit largely by short-term currency effects.

Since the last quarter, CVS Health and Under Armour dropped out of the top ten holdings list to be replaced by Nike and Signature Bank.

As of December 31, 2015

Ten Largest Contributors Return Contribution
Facebook, Class A 16.42% 0.80
Microsoft 26.20% 0.41
Delta Air Lines 13.27% 0.39
BlackRock 15.16% 0.38
Tableau Software, Class A 18.10% 0.35
Medivation 13.74% 0.31
Amazon.com 32.72% 0.30
Alphabet, Class A 22.17% 0.29
Adobe Systems 14.34% 0.25
Signature Bank 11.49% 0.24
Ten Largest Detractors Return Contribution
Akamai Technologies -23.79% -0.51
Under Armour, Class A -16.71% -0.49
Hain Celestial Group -23.26% -0.27
Apple -4.16% -0.26
F5 Networks -12.74% -0.24
Welltower -9.34% -0.15
Micron Technology -5.47% -0.14
Church & Dwight -0.15% -0.07
TJX Companies -0.42% -0.03
Hudson Technologies 2.72% 0.00
Top Ten Holdings Portfolio Weight
Facebook, Class A 7.4%
FLEETCOR Technologies 4.7%
Apple 4.3%
Delta Air Lines 4.0%
BlackRock 3.8%
TJX Companies 3.2%
Starbucks 3.2%
Ashland 3.1%
Nike, Class B 2.9%
Signature Bank 2.9%
 

Sextant International

Following a brutal third quarter, developed international markets rebounded in the fourth quarter with the MSCI EAFE Index posting a gain of 4.75%. Regardless, it was insufficient to pull the index into positive territory, and it finished down -0.39% for the full year. The Sextant International Fund failed to keep pace with the rebound, rising 0.55% in the quarter to end the year with a return of -6.05%. The biggest hindrance to fund performance was our underweight position in Asia-Pacific in general, and Japan in particular. The Asia-Pacific region provided the strongest contribution to the benchmark by a wide margin. Japan's economy was buoyed in the first part of the year by yen depreciation. It generally flattened for the remainder of the year, but the damage was done from our perspective since other markets provided little opportunity to play catch-up.

Europe is the largest region in the benchmark, and here we are also underweight, although to a much lesser extent than in Asia-Pacific. Our exposure to out-of-benchmark regions such as Canada and Latin America inflicted the most damage to Fund allocation, contributing nearly all of the Fund's negative return for the year.

Four of our top performers during the quarter were Western European companies, although some of our Japanese holdings did well over the full year. Novo Nordisk has been in the Fund as long as any other holding and continues to execute its diabetes portfolio exceptionally well. Dassault has had good success introducing computer aided design into new markets, and, after several years of trying, Wolters Kluwer seems to have made the transition from print to digital dissemination of information.

Despite doing well in the final quarter, Panamanian airline Copa Holdings remains our most challenged investment due to the disarray among its key Latin American markets. While ASML had a tough year, it continues to dominate the global market for lithography machines used in the production of semiconductors. It's future success will depend on the successful introduction of extreme ultraviolet lithography. Belmond, Potash, Telus, Toronto-Dominion, and Turkcell are other examples of out-of-benchmark positions that were costly in 2015.

As of December 31, 2015

Ten Largest Contributors Return Contribution
Wolters Kluwer 9.59% 0.64
Dassault Systemes ADR 8.66% 0.48
MercadoLibre 25.68% 0.29
Copa Holdings, Class A 16.93% 0.27
Unilever ADS 6.55% 0.25
Novo Nordisk ADS 7.08% 0.25
Toyota Motor ADS 4.91% 0.23
Australia & New Zealand Banking ADS 10.11% 0.19
Sinopharm Group 14.75% 0.15
Toronto-Dominion Bank 3.55% 0.13
Ten Largest Detractors Return Contribution
Pearson ADR -37.15% -0.57
Novartis ADR -6.40% -0.43
Belmond, Class A -6.04% -0.23
Telus -11.36% -0.23
SK Telecom ADR -17.42% -0.16
Potash Corp of Saskatchewan -15.25% -0.15
BCE -4.58% -0.13
Telenor -5.08% -0.12
Telefonica ADR -5.37% -0.11
Sanofi ADR -9.02% -0.11
Top Ten Holdings Portfolio Weight
Wolters Kluwer 8.3%
Novartis ADR 7.1%
ASML Holding 7.0%
Dassault Systemes ADR 6.6%
Nice Systems ADS 6.3%
Toyota Motor ADS 5.4%
Unilever ADS 4.4%
Toronto-Dominion Bank 4.3%
BASF ADS 4.2%
Novo Nordisk ADS 4.0%
 

Sextant Core

The Sextant Core Fund reports a total fourth quarter return of 2.25% as compared with a total return of 2.42% for the Dow Jones Moderate Portfolio Index.

The Fund's underperformance can be tied to allocation issues as well as risk retraction. More broadly, the Fund has been hurt by a strengthening US dollar. Stocks with significant exposure to commodity currencies, such as Toronto-Dominion Bank, Canadian National Railway, and Brazilian companies Ambev and CCR, faced pressure as local currencies depreciated against the US dollar. The Fund holds a position in a local currency-denominated New Zealand bond that also saw declines in US dollar terms.

Equities

The Sextant Core Fund's mandate requires a 60% weight in equity securities, with two-thirds of that being exposure to US-domiciled companies and one-third exposure to foreign-domiciled companies. While we view this diversification as benefiting investors over the long term, non-US equities have underperformed in the current risk-off environment. The S&P 500 Index (US stocks) outperformed the MSCI EAFE Index (foreign stocks) by 2.29% for the three months ending December 31. The Fund remains underweight Technology and Consumer Staples and overweight Energy. Unfortunately, these allocations were not supportive of active returns as the Consumer Discretionary sector saw the strongest performance of any sector during the quarter. The Fund's overweight position in the poorly performing Energy sector also negatively impacted returns.

Fixed Income

In anticipation of the Federal Reserve's tightening monetary policy stance, the yield curve flattened, and yield spreads between two-year and 10-year Treasurys declined by -0.21% during the quarter. However, the change in policy has not significantly impacted long-term yields. This results in part from heightened volatility that leads investors toward "safer" investments, but may also reflect a benign outlook for economic growth.

The Fund remains overweight corporate debt relative to the benchmark. The Fund also reduced its credit risk exposure by gradually improving its overall credit profile. The strategy appears to be paying off with the fixed income portion of the portfolio outperforming the related fixed income portion of the benchmark by 84 basis points.

As of December 31, 2015

Ten Largest Contributors Return Contribution
Akorn 27.64% 0.42
Medivation 13.74% 0.21
Proctor & Gamble 11.38% 0.20
Lowe's 10.60% 0.18
Biogen 4.98% 0.17
Valmont Industries 19.16% 0.16
Express Scripts Holding 7.97% 0.16
Xilinx 11.50% 0.15
Honeywell International 10.01% 0.14
Novo Nordisk ADS 7.08% 0.13
Ten Largest Detractors Return Contribution
Williams Companies -28.58% -0.36
SK Telecom ADR -17.42% -0.30
NRG Energy -19.85% -0.17
Devon Energy -13.11% -0.13
Ambev ADR -8.20% -0.07
Qualcomm -6.05% -0.07
Telenor -8.02% -0.06
BHP Billiton ADR -18.53% -0.04
Skandinaviska Enskilda -3.02% -0.04
Oracle  1.26% -0.02
Top Ten Holdings Portfolio Weight
Republic of Chile Bond 2.6%
Fannie Mae Bond 2.4%
Lowe's Equity 2.3%
Nestle ADS Equity 2.2%
Biogen Equity 2.2%
Bellsouth Capital Funding Bond 2.1%
PepsiCo Equity 2.1%
Express Scripts Holding Equity 2.1%
Novo Nordisk ADS Equity 1.9%
Procter & Gamble Equity 1.9%
 

Sextant Global High Income

The Sextant Global High Income Fund declined by -1.13% in the fourth quarter of 2015 and completed the calendar year with a loss of -13.02%. Total Fund assets amounted to $6.6 million at year end, which included 4.6% in cash and income receivable.

Fund/Benchmark/Category Q4 2015 Return Calendar 2015 Return
Sextant Global High Income Fund -1.13% -13.02%
S&P Global 1200 Stock Index* 5.55% -0.84%
Bloomberg Global High Yield Corporate Bond Index -1.52% -4.65%
Morningstar World Allocation** 1.53% -4.15%

* Fund's prospectus benchmark
**Fund's Morningstar peer category

The Fund's performance in the fourth quarter, as well as the full calendar year, was again weighed down by plunging prices of raw materials producers. The declines in Anglo American, Potash, and South 32 each subtracted more than 1% from the performance of the Fund during the year. The continued weakness in the price of oil played its part as Goodrich Petroleum struggles to remain solvent and the market's assigning little recovery value to the company's 2019 bonds held in the Fund.

Our raw materials investments did not lose universally as Brazilian chemicals producer Braskem was the Fund's best performer both in the quarter and the full year. The company benefited from lower feedstock prices and the weak Brazilian currency that lowers its labor costs. The stock rallied sharply in the fourth quarter as the market began to differentiate between companies in Brazil's stock market, which was the worst performing of any country's stock market in 2015.

The undifferentiated price declines of many different raw materials strikes us as unusual given the assortment of seemingly unrelated culprits. Oversupply along with a strategy change at OPEC could be blamed for declining energy prices. Weakening demand from China could be blamed for declining iron ore and copper prices. Falling crop and fertilizer prices might be blamed on better harvests after tougher growing conditions of previous years.

Although these price declines could point to a systemic force at play, we do not see a coherent narrative for what such a force could be. If we were in the throes of a severe recession, the obvious culprit would be a shortfall of demand. But the world has not plunged into recession during the past year, and China's slowdown should impact only a subset of raw materials. The prospect of higher US interest rates along with the stronger US dollar may have increased the opportunity cost of investments in raw materials, but if so, why have valuations elsewhere remained elevated?

As of December 31, 2015

Ten Largest Contributors Return Contribution
Brakskem ADR 60.50% 1.62
Brazil (8.5% 01/05/2024) 14.31% 0.28
Engie ADR 12.95% 0.24
Orange ADR 11.43% 0.22
Microchip Technology 8.83% 0.21
Whistler Blackcomb Holdings 13.20% 0.21
Mbono (6.5% 06/10/2021) -1.39% 0.14
Groupe Bruzelles Lambert 6.90% 0.13
Hopewell Highway Infrastructure 5.50% 0.12
E.ON ADR 12.53% 0.12
Ten Largest Detractors Return Contribution
Anglo American ADR -44.12% -0.58
Goodrich Petroleum (8.875% 03/15/2019) -51.66% -0.56
ATI (5.875% 08/15/2023) -29.02% -0.54
SK Telecom ADR -17.42% -0.38
South 32 -19.85% -0.37
BHP Billiton ADR -18.62% -0.31
RCII (5.625% 11/15/2020) -10.86% -0.30
Potash Corp of Saskatchewan -15.25% -0.28
New York Community Bancorp -10.38% -0.25
Apollo Global Management -8.39% -0.18
Top Ten Holdings Portfolio Weight
Jefferies Group Bond 3.7%
Outerwall Bond 3.3%
Burlington Northern Santa Fe Bond 3.1%
Microchip Technology Equity 2.8%
San Miguel  Bond 2.8%
Grupo Bimbo Bond 2.6%
Total ADS Equity 2.5%
Rent A Center Bond 2.5%
Orange ADS Equity 2.5%
Novartis ADR Equity 2.4%
 

Performance Summary

As of December 31, 2015

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Average Annual Total Returns (Before Taxes) 1 Year 3 Year 5 Year 10 Year Expense Ratio
  GrossA Net
Sextant Growth (SSGFX) -2.15% 13.05% 10.11% 6.01% 0.96%B 0.95%
S&P 500 Index 1.38% 15.13% 12.56% 7.30% n/a
 
Sextant International (SSIFX) -6.05% -0.75% -0.72% 3.29% 0.78%B 0.77%
MSCI EAFE Index  -0.39% 5.46% 4.07% 3.50% n/a
 
Sextant Core (SCORX)C -4.25% 4.02% 4.04% n/a   1.10%B 1.10%
Dow Jones Moderate Portfolio Index -1.21% 6.01% 5.87% 5.48% n/a
 
Sextant Global High Income (SGHIX)D -13.02% -0.84% n/a   n/a   1.31%B 0.90%
S&P 500 Global 1200 Index -0.84% 9.66% 7.95% 5.69% n/a
Bloomberg Global High Yield Corporate Bond Index -4.65% 0.76% 4.49% n/a   n/a
 
Sextant Short-Term Bond (STBFX) 1.07% 0.74% 1.01% 2.62% 1.19%B 0.75%
Citi USBIG Govt/Corp 1-3 Year Index 0.62% 0.66% 0.95% 2.72% n/a
 
Sextant Bond Income (SBIFX) -1.46% 0.86% 3.67% 4.11% 1.17%B 0.90%
Citi US Broad Investment-Grade Bond Index 0.53% 1.41% 3.23% 4.59% n/a

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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 1-800-728-8762 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.

A By regulation, gross expense ratios shown are as of a Fund's most recent prospectus or summary prospectus, dated March 27, 2015, and incorporate results from the fiscal year ended November 30, 2014. Higher expense ratios may indicate higher returns relative to a Fund's benchmark. The Adviser has voluntarily capped actual expenses of Sextant Short-Term Bond at 0.75% and actual expenses of Sextant Bond Income and Sextant Global High Income at 0.90% through March 31, 2016.

Restated to reflect a reduction in the Advisory and Administrative Services base fee and a reduction in the maximum rate of the performance adjustment, as approved by the Board of Trustees on March 17, 2015. Please see the Statement of Additional Information for the actual dollar amount of fees paid to the adviser for the most recent fiscal year.

C Sextant Core Fund began operations March 30, 2007.

D Sextant Global High Income Fund began operations March 30, 2012.

The S&P 500 Index is an index comprised of 500 widely held common stocks considered to be representative of the US stock market in general. The MSCI EAFE Index is an international index focused on Europe, Australasia, and the Far East. The S&P Global 1200 Index is a global stock market index covering nearly 70% of the world's equity markets. The Bloomberg Global High Yield Corporate Bond Index is a rules-based, market-value weighted index engineered to measure the non-investment grade, fixed-rate, taxable, global corporate bond market. The Dow Jones Moderate Portfolio Index is a broad-based index of stock and bond prices. The Citi USBIG Govt/Corp 1-3 Year Index is a broad-based index of shorter-term investment grade US government and corporate bond prices. The Citi US Broad Investment-Grade Bond Index is a broad-based index of medium and long-term investment grade bond prices. Investors cannot invest directly in the indices.

 

A Few Words About Risk

The Growth Fund may invest in smaller companies, which involve higher investment risks in that they often have limited product lines, markets, and resources, or their securities may trade less frequently and have greater price fluctuation than those of larger companies.

The International Fund involves risks not typically associated with investing in US securities. These include fluctuations in currency exchange rates, less public information about securities, less governmental market supervision, and lack of uniform financial, social, and political standards.

The Core Fund involves the risks of both equity and debt investing, although it seeks to mitigate these risks by maintaining a widely diversified portfolio that includes domestic stocks, foreign stocks, short and long-term bonds, and money market instruments.

Investment in the Global High Income Fund entails the risks of both equity and debt securities, although it seeks to mitigate these risks through a widely diversified portfolio that includes foreign and domestic stocks and bonds. Issuers of high-yield securities are generally not as strong financially as those issuing higher quality securities. Investments in high-yield securities can be speculative in nature. High-yield bonds may have low or no ratings, and may be considered "junk bonds."

The risks inherent in the Short-Term Bond and Bond Income Funds depend primarily on the terms and quality of the obligations in their portfolios, as well as on bond market conditions. When interest rates rise, bond prices fall. When interest rates fall, bond prices go up. Bonds with longer maturities (such as those held by the Bond Income Fund) usually are more sensitive to interest rate changes than bonds with shorter maturities (such as those held by the Short-Term Bond Fund). The Funds entail credit risk, which is the possibility that a bond will not be able to pay interest or principal when due. If the credit quality of a bond is perceived to decline, investors will demand a higher yield, which means a lower price on that bond to compensate for the higher level of risk.

Important Disclaimers and Disclosure

Performance data quoted represents past performance which is no guarantee of future results.

This publication should not be considered 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. This material does not form an adequate basis for any investment decision by any reader and Saturna may not have taken any steps to ensure that the securities referred to in this publication are suitable for any particular investor. Saturna will not treat recipients as its customers by virtue of their reading or receiving the publication.

The information in this publication was obtained from sources Saturna believes to be reliable and accurate at the time of publication.

All material presented in this publication, unless specifically indicated otherwise, is under copyright to Saturna. No part of this publication may be altered in any way, copied, or distributed without the prior express written permission of Saturna.

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

The Nikkei 225 Stock Average Index is a price-weighted average of the 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange.

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

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 FTSE All-World Index is a market-capitalization weighted index representing the performance of the large and mid cap stocks from the FTSE Global Equity Index Series and covers 90-95% of the investable market capitalization.