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Q2 2023

In our 2022 year-end commentary we noted the remarkably consistent track record of stock market gains in every year that followed a midterm election dating back to World War II. We also noted the rare instances of the US stock market declining over two consecutive years. History was setting up 2023 to be a good year and, reviewing the first half of 2023 performance, the track record appears likely to remain intact. Year-to-date, the S&P 500 Index rose a healthy 16.89%, while the more Tech-heavy NASDAQ Composite Index soared 32.32%. Such figures, however, belie a darker picture just below the surface, as index performance was driven by a handful of mostly mega-cap stocks: Alphabet, Amazon, Apple, Meta (Facebook), Microsoft, Netflix, Tesla, and Nvidia. Together these stocks account for 30% of the S&P 500 Index’s market capitalization, up from 22% at the start of the year. As a market capitalization-weighted index, larger capitalization stocks have a greater effect on index performance. To see the result, we need only compare the performance of the S&P 500 Index to the performance of the S&P 500 Equal Weight ETF as a proxy for an equal-weighted S&P 500 Index, as shown in Heavyweights Rule.

Following the March collapse of Silicon Valley Bank, Signature Bank, and Credit Suisse, the S&P Equal Weight ETF moved into negative territory, remaining lackluster until June 2023. Over the same period, the large-cap Tech stocks continued appreciating, receiving a boost in mid-May from Nvidia due to demand for Artificial Intelligence (AI) chips.

While Nvidia’s year-to-date 189.54% appreciation helped pull the benchmark higher, a reversal could shave points off the S&P 500 Index while other stocks appreciate. The six-month performance gap of 9.44% between market capitalization and equal-weighted indices registered over the first half of 2023 ranks as the third-widest gap over the past 25 years. The widest gap was 10.71% in March 2000 during the height of the dot-com bubble, a period that bears more than a passing resemblance to the current AI frenzy. That March 2000 spread was wiped out and reversed over the following 15 months, as the collapse in online stocks dragged the Index down and obscured the solid performance of stocks that had been neglected during the dot-com bubble. Whether history will rhyme remains to be seen, but a longer-term view shows that the two versions of the S&P 500 rarely deviate more than a few percentage points from each other on an annualized basis.

Outlook

In early September of 1939, Germany invaded Poland, and Britain and France declared war on Germany. However, for eight months, there was minimal fighting; it wasn't until May 1940 when the German Panzerdivision rolled into the Low Countries and France that the war took off. The eight-month interregnum came to be known as “The Phoney War.”¹ Market observers could be forgiven for thinking the same of the yet-unrealized recession that was assumed to be an inevitable consequence of the Federal Reserve’s aggressive rate tightening in the wake of high post-pandemic inflation. Economists are generally a sunny lot, rarely forecasting downturns in advance of their arrival. For 2023, however, consensus strongly favored a global recession.² In the first half, European economies were certainly weak, while the removal of China’s COVID-19 restrictions released a burst of activity that subsequently cooled to the point of spurring officials to take stimulative measures. Meanwhile, Japan demonstrated surprising strength, while the US economy soldiered on with first-quarter gross domestic product (GDP) growth of 2.0%, 339,000 new jobs in May, and an unemployment rate of 3.7%.³ What now?

Just as May 1940 brought an end to the Phoney War, we cannot dismiss future economic contraction based on it not having arrived. Inflation remains elevated and earlier hopes of a Fed pivot have evaporated. Indeed, the Fed has indicated the possibility of two additional rate hikes by year-end, following the June pause. Higher-for-longer, in terms of inflation and interest rates, does not bode well for growth. And what of that genie of economic prognostication, the yield curve? While boasting an impressive record of predictive success, it provides little guidance regarding timing. A general rule of thumb looks for a recession to begin within a year of the curve inverting, although the lag has been as great as two years. Disconcertingly, the two-year and 10-year yield curves inverted for good almost exactly a year ago, while the Cleveland Fed currently estimates the probability of recession within one year at 79%.⁴

What this means for stock market returns remains anyone’s guess, but so far, activity in 2023 indicates that bad economic news may be interpreted as good stock market news if investors believe lower rates are just around the bend. Valuations may prove problematic for the architects of this year’s index gains, but most stocks performed meekly, as described above. It may be that investors have already discounted the risks of lower earnings for companies not involved in AI, creating an opportunity for the first-half wallflowers to move to the center of the dance floor.

Saturna Sustainable Equity Fund

Saturna Sustainable Bond Fund

Performance Summary

As of June 30, 2023

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^A By regulation, expense ratios shown are as stated in a fund’s most recent prospectus or summary prospectus, dated March 31, 2023 and incorporate results from the fiscal year ended November 30, 2022. Saturna Capital, the Funds’ investment adviser, has voluntarily capped actual expenses of the Sustainable Equity Fund at 0.75% and actual expenses of the Sustainable Bond Fund at 0.65% through March 31, 2024.

^B Saturna Sustainable Equity Fund and Saturna Sustainable Bond Fund began operations on March 27, 2015.

Performance data quoted herein represents past performance, which is no guarantee of 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 their original cost. Current performance may be higher or lower than the performance data quoted herein. Performance current to the most recent month-end can be obtained by visiting www.saturnasustainable.com or calling toll-free 1-800-728-8762.

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 S&P Global 1200 Index is a global stock market index covering nearly 70% of the world’s equity markets.  The FTSE WorldBIG Bond Index is a multi-asset, multi-currency benchmark, which provides a broad-based measure of the global fixed-income markets.  The MSCI ACWI covers approximately 85% of the global investable universe, with large- and mid-cap representation across 23 developed market and 23 emerging market countries.  Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.   When available, Saturna uses total return components of indices mentioned.  Investors cannot invest directly in the indices.

Performance Summary

As of June 30, 2023

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The Morningstar Sustainability Rating is not based on fund performance and is not equivalent to the Morningstar Rating (“Star Rating”). 

© 2022 Morningstar®.  All rights reserved.  Morningstar, Inc. is an independent fund performance monitor. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely.  Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.

^C Morningstar Ratings^™ (“Star Ratings”) are as of June 30, 2023. The Morningstar Rating™ for funds, or “star rating”, is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product’s monthly excess performance (not including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods.

^D Morningstar Sustainability Ratings are as of May 31, 2023. The Morningstar Sustainability Rating™ is intended to measure how well the issuing companies of the securities within a fund’s portfolio are managing their environmental, social, and governance (“ESG”) risks and opportunities relative to the fund’s Morningstar category peers. The Morningstar Sustainability Rating calculation is a two-step process. First, each fund with at least 67% of assets covered by a company-level ESG score from Sustainalytics receives a Morningstar Portfolio Sustainability Score™. The Morningstar Portfolio Sustainability Score is an asset-weighted average of normalized company-level ESG scores with deductions made for controversial incidents by the issuing companies, such as environmental accidents, fraud, or discriminatory behavior. The Morningstar Sustainability Rating is then assigned to all scored funds within Morningstar Categories in which at least ten (10) funds receive a Portfolio Sustainability Score and is determined by each fund’s rank within the following distribution: High (highest 10%), Above Average (next 22.5%), Average (next 35%), Below Average (next 22.5%), and Low (lowest 10%). The Morningstar Sustainability Rating is depicted by globe icons where High equals 5 globes and Low equals 1 globe. A Sustainability Rating is assigned to any fund that has more than half of its underlying assets rated by Sustainalytics and is within a Morningstar Category with at least 10 scored funds; therefore, the rating is not limited to funds with explicit sustainable or responsible investment mandates. Morningstar updates its Sustainability Ratings monthly. Portfolios receive a Morningstar Portfolio Sustainability Score and Sustainability Rating one month and six business days after their reported as-of date based on the most recent portfolio. As part of the evaluation process, Morningstar uses Sustainalytics’ ESG scores from the same month as the portfolio as-of date.

The Fund’s portfolios are actively managed and are subject to change, which may result in a different Morningstar Sustainability Score and Rating each month. 

The Saturna Sustainable Equity Fund was rated on 99% and the Saturna Sustainable Bond Fund was rated on 93% of Assets Under Management.

Percent Rank in Category is the fund’s percentile rank for the specified time period relative to all funds that have the same Morningstar category. The highest (or most favorable) percentile rank is 1 and the lowest (or least favorable) percentile rank is 100. The top-performing fund in a category will always receive a rank of 1.  Percentile ranks within categories are most useful in those categories that have a large number of funds.

Footnotes to commentary

¹ British spelling is generally used on both sides of the Atlantic, rather than the American “phony.”

² “Chief Economists Say Global Recession Likely In 2023, But Pressures On Food, Energy and Inflation May Be Peaking.” World Economic Forum. January 16, 2023. https://www.weforum.org/press/2023/01/ chief-economists-say-global-recession-likely-in-2023-but-costofliving- crisis-close-to-peaking/

³ “The Employment Situation – June 2023.” Bureau of Labor Statistics. July 7, 2023. https://www.bls.gov/news.release/pdf/empsit.pdf

⁴ “Yield Curve and Predicted GDP Growth.” Federal Reserve Bank of Cleveland. June 2023. https://www.clevelandfed.org/en/indicatorsand- data/yield-curve-and-predicted-gdp-growth

⁵ “A Rocky Recovery.” International Monetary Fund. April 2023. https:// www.imf.org/en/Publications/WEO/Issues/2023/04/11/ worldeconomic- outlook-april-2023

⁶ Bahceli, Yoruk and Milliken, David, “Analysis: Soaring UK bond yields don’t herald repeat of ‘mini-budget’ chaos.” Reuters, June 14, 2023. https://www.reuters.com/markets/rates-bonds/soaring-uk-bondyields- dont-herald-repeat-mini-budget-chaos-2023-06-15/

Important Disclaimers and Disclosure

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 Saturna Sustainable Funds limit the securities they purchase to those consistent with sustainable principles. This limits opportunities and may affect performance.

Investing involves risk, including possible loss of principal. Generally, an investment that offers a higher potential return will have a higher risk of loss. Stock prices fluctuate, sometimes quickly and significantly, for a broad range of reasons that may affect individual companies, industries, or sectors. When interest rates rise, bond prices fall. When interest rates fall, bond prices go up. A bond fund’s price will typically follow the same pattern. 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.” Investing in foreign securities involves risks not typically associated directly with investing in US securities. These risks include currency and market fluctuations, and political or social instability. The risks of foreign investing are generally magnified in the smaller and more volatile securities markets of the developing world.

A fund’s 30-Day Yield, sometimes referred to as “standardized yield” or “SEC yield,” is expressed as an annual percentage rate using a method of calculation adopted by the Securities and Exchange Commission (SEC). The 30-Day Yield provides an estimate of a fund’s investment income rate, but may not equal the actual income distribution rate. Without the voluntary expense cap, the 30-Day Yield for Saturna Sustainable Bond Fund would have been 4.58% and the 30-Day Yield for Saturna Sustainable Equity Fund would have been 0.83%. Unsubsidized yield does not adjust for any fee waivers and/or expense reimbursements in effect.

Effective maturity and modified duration are measures of a fund’s sensitivity to changes in interest rates and the markets. A fund’s effective maturity is a dollar-weighted average length of time until principal payments must be paid. Longer maturities typically indicate greater sensitivity to interest rate changes than shorter maturities. Modified duration differs from effective maturity in that it accounts for interest payments in addition to the length of time until principal payments must be paid. Longer durations tend to indicate greater sensitivity to interest rate changes than shorter durations. Call options and other security-specific covenants may be used when calculating effective maturity and modified duration.

Variable rate securities risk: Variable rate debt securities (which include floating rate debt securities) pay interest based on an interest rate benchmark. When the benchmark rate changes, the interest payments on those securities may be reset at a higher or lower rate and, as a result, such securities generally are less price sensitive to interest rate changes than fixed-rate debt securities. However, the market value of variable rate debt securities may decline, or not appreciate as quickly as expected, when prevailing interest rates rise, particularly if their interest rates do not rise as much, or as quickly, as interest rates in general. Conversely, variable rate securities will not generally increase in market value if interest rates decline. However, when interest rates fall, there may be a reduction in the payments of interest received by the Fund from its variable rate securities.