Q4 2023

The S&P 500 Index finished 2023 at 4,769.83, recouping nearly all of 2022's losses and finishing within 1% of the record high set on January 3, 2022. For the fourth quarter of 2023, the Index returned 11.69%, a solid performance that was more evenly distributed across sectors and stocks than earlier in the year. The Investor Shares of the Sextant Growth Fund appreciated slightly more, with a return of 11.82% for the quarter. For the full year the Investor Shares returned an attractive 28.25%, well ahead of the S&P 500's full year return of 26.29%. While Technology stocks had an average weight of roughly 40.5% of Fund assets over the year, they contributed about 59% of Fund returns, followed by Consumer Discretionary and Communications.

2023 Performance

Technology dominated equity markets in 2023 and accounted for the largest contributors to Fund returns. Apple and Microsoft are the two largest positions in the Sextant Growth Fund, followed by Alphabet and Amazon, making for the fortuitous combination of large positions and strong stock appreciation. The top performing stock for the year was Nvidia, followed by Advanced Micro Devices. While the positions in these AI chip leaders are not as large, we are fortunate to have invested in Nvidia, one of the year's strongest performers. At year-end 2023, Adobe's acquisition plans were dashed when they and Figma abandoned their $20 billion deal because of opposition from European regulatory authorities. We believe the effect on Adobe's outlook to be minimal. Lululemon and Costco both enjoyed appreciation to rival the Tech stocks. Lululemon has done well growing its core North American business by rates in the mid-teens, while boosting growth further through its entry into China. Costco has shown it's not just a pandemic play and has continued to do well in an inflationary environment as consumers seek the best possible prices. Mastercard suffered with the sharp decline in travel during pandemic lockdowns, so we felt that "revenge travel" would bode well for the stock, especially if international trips rebounded, as they did.

Several of the weakest performers from 2023 are no longer in the portfolio. Albemarle, Enphase, Trimble, and PayPal were sold, while Horizon was acquired by Amgen. We were early to the Horizon story but had confidence in the thesis and added to the position after the stock dropped considerably. That confidence was rewarded when Amgen subsequently bid for the company, taking us close to breakeven for the year. We believe that both Enphase and Albemarle have important roles to play as the world transitions away from fossil fuels but were early in taking on exposure. We lost confidence in the ability of Trimble's management to capitalize on what appear to be clear opportunities. Corteva remains in the portfolio, although we are closely monitoring management execution. We retain confidence in the long-term outlooks for Johnson Controls, Elevance, and Nike.

Year End

Abbott Labs and Oracle dropped out of the Top 10 Holdings, while Motorola Solutions and Monster Beverage entered. Abbott barely changed price in 2023 as it suffered from a post-COVID drop in diagnostic revenue. We still like its longer-term thesis. Oracle performed reasonably well during the year but was weak in the fourth quarter, while Motorola Solutions and Monster both leapt higher.

In the fourth quarter of 2023, the Z Shares of the Sextant International Fund returned 17.63% compared to gains of 10.47% for the MSCI EAFE Index and 9.82% for the MSCI ACWI ex US Index. For the full year ended December 31, 2023, the Z Shares returned 25.12%, outperforming the respective benchmark returns of 18.85% and 16.21% over the same period. The Technology, Consumer Discretionary, and Health Care sectors were the primary drivers of outperformance, and there were no notable underperformers. The top individual contributors during the quarter came from Technology (Dassault Systemes, ASML, NICE), Consumer Discretionary (MercadoLibre, Lululemon) and Health Care (Novo Nordisk). Marginal detractors came from Materials (Nutrien), and Staples (Unicharm).

The trifecta of pain in the third quarter (sticky inflation, a hawkish Federal Reserve, and unrelenting labor strength) all reversed in the fourth quarter, which propelled a surge higher in global equities and other risk assets. Often, a sharp contraction of money supply alongside other indicators of deterioration can lead to disinflation. However, due to the abnormalities of the pandemic-induced economic cycle, disinflation took longer than expected, and now is picking up steam. US core personal consumption expenditures (PCE) in October was a pivotal data point, remaining flat month-on-month and then dropping to 3% year-over-year from 3.4% in September. Even non-farm payrolls subsided in October and November to 150,000, and 199,000, respectively.

Fed Chairman Jerome Powell, the once reliable friend to the hawks, made a surprise move during the December Fed meeting. He stated that the risk of under or overtightening was "balanced" and that current rates were "well into restrictive territory." This nail in the coffin sent pessimists into hibernation, and the markets went on a joyride through the rest of 2023. It is likely that many investors were caught offsides and had to chase performance into year-end (generally not a healthy fundamental driver of returns), leaving equities in an overbought scenario to begin the new year.

Market Outlook

Looking ahead into 2024, the stars are aligning for global equities. Even the Fed's favorite lagging indicators, such as core PCE and non-farm payrolls, noticeably softened. The broader economy and consumer activity held up reasonably well, to the surprise of many. Certain parts of the economy have most likely experienced independent rolling recessions to the extent that some sectors and industries are already on their way back into stabilization/recovery mode (such as Real Estate, Industrials, semiconductors, and consumer electronics).

One of the remaining bear arguments relates to the the difference between the Fed's dot plot relative to market expectations. The dot plot is a map of what each member of the Federal Open Market Committee (FOMC) predicts interest rates will be in future periods. The rationale is that because the futures market is pricing in five to six theoretical rate cuts compared to the dot plot's three cuts, markets will end up being disappointed and sell off when this becomes apparent.

At the expense of getting too philosophical, investing is not always about accurately predicting the endpoint, but rather how one participates in the pathway that ends up having a bigger impact on investment returns. The Fed may cut rates by only 75 basis points (bps) this year, perhaps because the current economy is generally stable and does not require more. An investor using this endpoint prediction as the basis of their initial investment decision (the market is too optimistic about rate cuts) may be cautious and stay on the sidelines. But with inflation coming down and the economy relatively stable, there is a good chance that equities will grind higher, even though this endpoint prediction was technically wrong about the absolute level of interest rates at year end. Pessimists that dig in too long waiting for disappointment might find themselves being left behind, as the band Kansas would say, like dust in the wind.

Portfolio Positioning

Chairman Powell clearly wants to go down in history as the Fed chair that engineered a soft landing in the post-pandemic economic cycle. Fortunately for him, it seems that a significant portion of the inflation equation was indeed "transitory" in nature, and just took longer than anyone expected. This, in conjunction with the tightening monetary cycle, supports the idea that the global economy might get back home in one piece. Powell is likely to continue flip-flopping between dovish and hawkish jawboning going forward until inflation finally approaches 2%, even if it takes him years to do it.

Global economic growth is likely to be sluggish to neutral, especially when considering that structural changes to the economy, such as deglobalization and onshoring, are here to stay. Although interest rates should decline, the cost of capital is going to be higher over the next decade than the last. Lackluster topline growth coupled with margin pressure suggest that productivity will be the most important metric to success in the new economy. Companies with business models that provide solutions that boost enterprise productivity will likely generate secular, above-market growth, even amid most recessionary macro scenarios – we define this as "detached growth."

The Sextant International Fund continues to prioritize companies with these characteristics. Within the broader detached growth opportunity set, areas of particular focus include: 1) digital economic transformation (ASML, Accenture, Taiwan Semiconductor, STMicroelectrics), 2) artificial intelligence (NICE, SAP, Wolters Kluwer), and 3) idiosyncratic compounders (Novo Nordisk, Ferguson).

International stocks as a whole offer compelling valuations relative to US equities. As of writing, the forward price-to-earnings ratio of the S&P 500, the STOXX Europe 600, and the Tokyo Stock Price Index stood at 19.5x, 12.5x, and 13.5x, respectively. The 10-year historical median forward P/E of these indices were 17.8x, 15x, and 14x, respectively. This shows that US equities are trading at a premium to their historical valuation, while international stocks are trading at a discount. This is because international companies are further under the radar and still in the earlier innings of growth compared to their US peers.

The Sextant Global High Income Fund returned 6.84% in the fourth quarter of 2023, ending the period with $9.9 million in net assets. The Fund's equity benchmark, the S&P Global 1200 Index, returned 11.29%, while its fixed income benchmark, the Bloomberg Global High Yield Corporate Index, returned 7.67%. The Fund's Morningstar Global Allocation peer group had a category average of 8.07%.

Factors Influencing Performance

The S&P 500 closed out 2023 with a bang by racking up nine straight weeks of gains — the first time a streak of that length had been reached since January 1994, according to S&P Dow Jones Indices.¹ With the Federal Reserve likely to lower interest rates once inflation cools, and optimism about advances in artificial intelligence (AI) driving productivity gains, investors seemed to have an easy view over the "wall of worry" and were willing to bid stocks higher.

Nintendo was the Sextant Global High Income Fund's top equity performer for the quarter, returning 24.96% amid holiday sales buzz. Basic Materials stocks BHP and Southern Copper also buoyed quarterly performance with gains of 20.09% and 15.92%, respectively. On the bond side, falling long-term interest rates helped the Fund's most interest rate-sensitive issues to reach double-digit gains for the quarter.

Oil company Woodside Energy (-9.45%) was the Fund's worst stock performer of the quarter, as the outlook for oil and gas prices diminished with falling inflation.

Looking Ahead

The outlook for the 2024 economy is positive: inflation appears contained, the Fed is set to lower rates, and falling borrowing costs may help to further stimulate economic growth in the US. Companies are eager to employ AI tools to boost worker productivity and increase profit margins. The strong performance of stocks in the fourth quarter of 2023 suggests investor optimism about this outlook, and the market's results in 2024 are likely to depend on the extent to which these optimistic expectations come to fruition. As 2024 is also an election year in the US, there may be cresting political uncertainty after the typically benign "third-year effect," where political uncertainty is at an ebb.

The Sextant Core Fund returned 9.83% for the 2023 calendar year. The Fund's benchmark, the Dow Jones Moderate Portfolio Index, returned 12.70% for the same period. In the fourth quarter the Fund returned 7.36% compared to 9.18% for the benchmark. As of December 31, 2023, the Fund recorded an SEC yield of 2.21%. For the fiscal year ended November 30, 2023, the Fund reported a portfolio turnover of 13%.

Factors Affecting Past Performance
 
Equities

The Sextant Core Fund's mandate allocates a 60% weight in equity securities, with two-thirds being US-domiciled companies and one-third foreign-domiciled companies. The Fund generally holds equity positions in larger companies with strong balance sheets; the average market capitalization of positions held by the Fund was $219.5 billion with 17% total debt to market capitalization at year-end. The Fund's 56.04% equity allocation at year-end was comprised of 57 positions across 12 countries. At year-end 2022, the Industrial sector was the largest weighting of the equity portion of the portfolio, followed by Health Care and Technology. At the end of 2023, the largest sector of the equity portion of the portfolio was Technology at 21.88%, followed by Industrials (18.79%), and Health Care (12.36%).

For the fourth quarter, positive contributors from the Technology and Consumer Discretionary sectors were offset by positions in Energy and Materials. Health Care and Consumer Staples were more idiosyncratic, with positions in each among the top contributors and detractors. Similarly, for the full year, positive contributors from the Technology and Consumer Discretionary sectors were offset by Materials, Consumer Staples, and Utilities, while Industrials and Health Care were among both top contributors and detractors.

Fixed Income

The Sextant Core Fund targets an allocation of 40% cash and investment-grade fixed-income securities. The Federal Reserve, with its aggressive interest rate raises, was the dominant driver of fixed income markets in 2023. Over the course of the year, the Fed hiked rates to 5.375% at the midpoint to try to slow inflation. While higher interest rates caused existing bond prices to fall, they also restored bond yields and the asset class's ability to cushion portfolio volatility. With expectations solidifying that the Fed was likely done hiking rates, long-dated corporate bonds were among the Fund's top contributors in the fourth quarter.

Looking Forward

The US equity and bond markets ended 2023 with a buoyant November and December, driven by expectations that interest rate hikes were in the rearview mirror and cuts were coming down the pike. While interest rate cuts may be in store for 2024, the reason for those cuts is just as important as the number of cuts. While measured cuts following cooling inflation should support asset prices, rapid cuts due to deteriorating real economic growth would be especially concerning. As markets stare down such a dichotomic outlook, we see the value of a 60/40 portfolio: bonds provide shelter from the storm and equities provide exposure to prevailing winds.

The Sextant Short-Term Bond Fund returned 2.06% for the fourth quarter of 2023. The Bloomberg US Aggregate 1-3 Year Bond Index returned 2.71% for the same period. For the year ended December 31, 2023, the Fund returned 3.96% and the benchmark returned 4.65%. The primary reason the benchmark outperformed the Fund was the Fund's relative shorter duration.

The Sextant Bond Income Fund returned 7.50% for the fourth quarter of 2023. The Bloomberg US Aggregate Index returned 6.82% for the same period. For the year ended December 31, 2023, the Fund returned 5.55% and the Index returned 5.53%. The primary reason the Fund outperformed the benchmark was the Fund's relative longer duration.

In 2023, financial assets largely demonstrated favorable performance and inflation metrics declined. Some central banks signaled an early victory against rampant inflation. Considering the extraordinary measures that central banks took over the past two years in response to the pandemic, such celebrations may have some merit. Out of the 97 central banks that the International Monetary Fund (IMF) tracks, 88 had raised their policy rates by an average of 212 basis points (bps) since the start of 2023.² This represents the most widespread and synchronized tightening of monetary policy in decades.

Global inflation metrics declined in 2023, in line with generally anticipated consensus views. This provided some global central banks with sufficient cover to take a wait-and-see approach to the fourth quarter of 2023. The Federal Reserve, in response to lower inflation prints in the US, took a similar wait-and-see stance. When the Fed held their meeting in December 2023, Chairman Jerome Powell surprised investors with the enticing possibility that the committee may reduce benchmark interest rates sometime in 2024. Market participants estimated three rate cuts in the first half of 2024, which would reduce interest rates by 75 basis points (bps).³ While market expectations shifted during the last few weeks of 2023, the fixed income markets experienced a significant rally. The 30-year Treasury yield declined more than 67 bps and the 10-year Treasury yield fell 69 bps.

Many investors have largely embraced the belief that the inflation "dragon" has been slain, but this may not be the reality. Over the last few years, inflation rates have reached levels not seen since the 1980s.⁴ It is entirely possible that these inflationary pressures cooled temporarily and are hibernating in the face of recent monetary tightening policies.

The Fed's indication of easing benchmark rates could potentially undermine policy measures employed over the past two years and reinvigorate aggregate demand and inflation. A working paper published by the IMF in September 2023 found that in the more than 100 inflation shock episodes that have occurred since the 1970s, inflation was resolved in under five years for only 60%. Even in those "successful" cases, resolving inflation took an average of more than three years. "Most unresolved [inflationary] episodes involved 'premature celebrations' where inflation declined initially, only to plateau at an elevated level or re-accelerate," said the IMF. "Countries that resolved inflation had tighter monetary policy that was marinated more consistently over time, lower nominal wage growth, and less currency depreciation, compared to unresolved cases."⁵

The working paper from the IMF is an important cautionary warning for investors. Taming inflation generally takes time—potentially, more time than what policymakers and market participants estimate.

Sextant Bond Income Fund

The primary reason that the Sextant Bond Income Fund outperformed the Bloomberg US Aggregate Index over the fourth quarter was the Fund's longer effective duration relative to the Index. At quarter-end, the Fund had an effective duration of 7.06 years while the Index had an effective duration of 6.20 years. Following this pattern, the longer corporate bonds in the Fund also had the highest total returns. These bonds benefited from both the falling long end yields and the tightening corporate credit spreads. Chubb Holdings of 2045 returned 16.6% for the quarter, and Alabama Power of 2044 returned 13.56%. The security with the lowest total return, the 2047 State Street floating rate bond, had a very short duration and high sensitivity to market volatility and liquidity. The bond returned -17.13% for the quarter. While the floating rate security has a long final maturity, its effective duration is only 0.171 years.

Sextant Short Term Bond Fund

The primary reason that the Sextant Short-Term Bond Fund trailed the Bloomberg US Aggregate 1-3 Year Index during the fourth quarter was the Fund's shorter duration relative to the Index. At quarter-end, the Fund's effective duration was 1.18 years while the Index had an effective duration of 1.77 years. Additionally, 47.2% of the Fund's portfolio was represented by bonds with maturities between one and three years. Meanwhile, the Index held 96.6% of its portfolio in one to three-year bonds. The Fund's best performing bond was also one of the longest in the portfolio. Take-Two Interactive bonds of 2027 returned 4.49% for the fourth quarter. There were no negative performers in the Fund during the quarter, but the lowest performers tended to be recently purchased bonds, such as the 2026 Federal Home Loan Bank 5.65% bond, which returned 0.4%.