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Judging Fed Policy Path Requires Keeping One Eye on Domestic Economic Fault Lines and Another on Those Abroad

The policy statement released on Wednesday by the Federal Reserve’s Federal Open Market Committee (FOMC) represents a continuation of the “wait-and-see” trend anticipated by the market. The Fed continues to keep the door open to interest rate policy normalization, which it began in December, with the pace of change dictated by economic data and financial conditions. Overall, economic data in the U.S. have marginally deteriorated since the central bank embarked on rate normalization away from emergency conditions, but the Fed’s mandated objectives of full employment and price stability are still largely on track for continued tightening this year, even if at a slower pace than anticipated. Indeed, the language of today’s statement highlighted some of those concerns, for example mentioning that “business fixed investment and net exports have been soft.” Also, vitally, the FOMC stated that “…global economic and financial developments continued to pose risks,” underscoring the extent to which external economic and financial market stresses can influence Fed policy today.

Further, the FOMC’s changes to its Statement of Economic Projections (SEP) also highlight the likely slower path of interest rate change this year, and some continued uncertainty over U.S. growth prospects in a world of slowing economic growth overall. For example, the Fed downgraded real GDP growth projections in 2016, from the 2.4% it had assumed in December to 2.2% today, with 2017 growth also witnessing a modest reduction. We agree that the data will continue to marginally deteriorate from here, which justifies the Fed’s lowered anticipated “dot-plot” path of one or two more hikes by year-end, versus the four implied by the December SEP. We believe the door was open to beginning this normalization process a couple years ago, and to some extent the Fed missed its optimal window of opportunity to normalize rates in an easier manner. Today, the central bank must contend with payrolls growth that is likely peaking, challenging financial market conditions from abroad, and an inflation rate that appears to be firming.

Unlike some others, we don’t believe the U.S. economy will enter a recession anytime soon, but labor market growth will slow in the quarters ahead, as companies are scaling back expenditures of all kinds (capital expenditures, hiring, and inventory-builds, for example), as their top-line revenues and earnings decelerate. Moreover, changes to headline payrolls tend to lag corporate earnings/profits changes by a six-month time frame, so the rolling over of the growth rate of corporate profits in recent quarters should feed through to a worsening jobs picture by the back half of 2016. Further, temporary hiring has started to slow, which historically has been a signal of future weakness in payrolls growth, as it hints at changes in the supply/demand of labor. All these dynamics put the Fed in a difficult position regarding normalizing rates, since the economic cycle may be moderating as the central bank seeks to raise rates.

We are not arguing that these dynamics represent a tangible economic weakness that threatens the recovery, but rather that slowing payrolls growth is likely to keep the Fed’s rate normalization path more contained than outlined at the December meeting, and perhaps even than the path implied by today’s SEP. We also think there is a tangible wage and inflation lag, and believe that this will also play out going forward, as we have recently witnessed with current inflation data, such as Average Hourly Earnings, the CPI and Core PCE readings.

Generally speaking, it is not the U.S. consumer that concerns us, as consumer spending is likely to support the economy on the back of very strong employment growth over the past few years and potentially improved wage growth in the year ahead. What does concern us, though, is another potential economic fault line, the fact that a variety of corporate sector metrics have been disappointing of late. Years of extraordinarily easy monetary policy stoked corporate borrowing and financial engineering, and some companies are now struggling with the increased debt load as revenues and profits begin to roll over (see graph).

Additionally, what is ironic is that while everyone (understandably) focuses on the domestic economic situation, the factor that has opened the door again for the Fed to keep moving rates this year, which seemed impossible only a few weeks ago, is the improvement in financial conditions. That has largely come on the heels of China policy makers making a decision to not aggressively devalue their currency to protect against capital flight, an aggressive ECB, and a stabilization in oil’s persistent price descent. Thus, while we think that the U.S. data is marginally deteriorating, and may continue to do so, we think that financial conditions, including the potential strength of the USD (and its related influence on global growth and corporate earnings), will be one of the primary determinants of whether that door for further Fed moves stays open or gets slammed shut due to global economic/market duress.

Hence, keeping an eye on the Fed for market price-action going forward may also mean keeping the other eye focused outside the U.S., and somewhat outside the Fed’s core dual mandates of employment and price stability. Indeed, the path of monetary policy change in the year ahead may be determined as much by what occurs outside the country’s borders than within them; more so than any time in recent history.

Growth is not a Valid Reason for Investment, not Even for Emerging Markets

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For many years, a constant within the capital markets was that emerging markets equalled growth. This also served as the universal argument for investing in emerging markets. For Marc Erpelding, fund manager of the BL-Emerging Markets fund, emerging markets will experience a slower rate of growth in the future.

“The days of “simple” growth, backed by state investment programmes and exports based on low wage levels are pretty much gone. Going forward, the service sector and the domestic consumption will play an ever greater role. However, studies have shown that there is no link between economic growth and stock market performance. So “growth” is not a valid reason for investment, not even for emerging markets.” Therefore, according to Erpelding, the slowdown in growth should not necessarily be considered a negative development.

His investment process includes focusing on firms “which are in a position to create added value in the long term for their customers and shareholders; ideally, they can do this independently of macroeconomic trends. Firms that have high barriers to entry, present robust balance sheets and generate strong positive cash flows generally have the advantage of seeing less correction in bear markets and often emerge on top after crises. In addition, we only invest in easy-to- understand business models. It does not matter to us whether or not these companies are included in the index or what their weighting is.” This consistent investment approach can result in them being very underweight in financials or commodities. “We often find that banks lack transparency and, in the case of commodities firms, the investment decision tends to depend more on the commodity cycle than on the company itself.”

In the years 2010 to 2014, the MSCI Emerging Markets index mainly moved sideways. “However, we are less interested in the direction of the index than in the price performance of the high-quality companies we are tracking. Since May 2015, we have seen sharp corrections in this segment too, which we have used to raise the equity ratio from around 68% to approximately 84% at present. This is the highest equity ratio in the fund since the financial crisis. The corrections have led to more attractive valuations for many high-quality firms and allowed us to add to existing positions or initiate on new companies. These are purely bottom-up decisions. We will increase the equity ratio further, should high- quality companies increasingly undergo correction.. In an asset class that is (unfortunately) still regarded as satellite and therefore heavily depends on investors’ appetite for risk, we think this countercyclical approach makes great sense” he concludes.

Buy and Sell Side Join Forces in Support of STS Securitisation

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The Association for Financial Markets in Europe (AFME), the European Fund and Asset Management Association (EFAMA), the International Capital Market Association (ICMA) and Insurance Europe have issued a joint paper backing efforts by EU policymakers to develop a robust and successful framework for simple, transparent and standardised (STS) securitisation.

In line with the Commission’s flagship Capital Markets Union initiative, the associations believe that a new framework for securitisation could play a pivotal role between banks’ financing and capital markets, enabling much-needed non-bank funding alternatives and providing investors with high-quality fixed income securities and attractive yields.

In the joint paper, the organisations affirm that securitisation is an important element of well-functioning financial markets and call for securitisation to be treated on a level playing field with other forms of investment. They highlight their shared views on the key points for EU policymakers to consider in their development of the new framework.

Simon Lewis, Chief Executive of AFME, said: “The development of a high-quality securitisation market in Europe is an integral part of the Capital Markets Union and contributes to the Commission’s objectives to revive the real economy through increased financing and prudent risk transfer. For the European securitisation market to be safely and successfully rebuilt, the new framework must be attractive for both issuers and investors whilst operating under a strong but fair and rational regulatory regime. We are delighted to unite with investors and other market participants on this important policy initiative.”

Peter De Proft, Director General of EFAMA, commented: “EFAMA is acutely aware of the generational opportunity offered by the Capital Markets Union in restoring economic growth in Europe. The Commission’s securitisation package, as an essential component of a successful CMU, could potentially generate billions in additional funding for the economy and could act as a key driver in encouraging investor participation in European capital markets. This joint initiative of the buy-side and sell-side is testament to the sheer emphasis we believe should be placed on achieving a balanced securitisation framework which will work for our markets, our investors and Europe as a whole.”

Martin Scheck, Chief Executive of ICMA, said: “Securitisation represents a crucial asset class for investors and borrowers in Europe. As an association with both buy- and sell-side members we have strongly welcomed efforts to revive securitisation as a key element in financing the drive to restore jobs and growth in Europe. This joint paper underlines our commitment to supporting an appropriately designed framework to achieve this.”

Michaela Koller, Director General of Insurance Europe, said: “Insurers must have access to a wide range of assets in order to diversify their portfolios, and this includes a need for high quality securitisations. Steps to identify good securitisations have already been made under Solvency II and the Commission’s proposal is a continuation of this, with some important improvements. However, further improvements are needed, some of which this paper outlines. From an insurer’s perspective, we are calling for a much needed revision of the capital treatment of securitisations under Solvency II.”

What Wealthy Families in Latin America Need to Know About Compliance Rules

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“Compliance rules have dramatically changed in the last few years, and the next two ones will be even more complicated or challenging for most wealthy families,” says Martin Litwak, from law firm Litwak & Partners who discusses how the new compliance rules are impacting private wealth management in Latin America.

According to the Lawyer, “there is a lot of information online about FATCA and CRS coming from banks and financial providers, but some families are not getting the best advice, from independent lawyers, on what to do or not do, how to manage the risks and the practical impact of these changes. It is not about filling out a new questionnaire. Families must make sure that the set of structures in place are in compliant with the new scenario. It is not just one piece of law that has changed; the whole system is now different.”

Nowadays countries are cooperating for tax purposes, and the information on a family’s assets is available to authorities as well as to third parties. “Which is a bigger issue in a region like Latin America, where kidnappings take place and many governments are corrupt. The fact that information could exchange hands for very little money is very dangerous” he says.

In his opinion, families must have the right structures in place before all these new rules take effect. They also should report whatever they have or own. “If they do not like the consequences this reporting may have, they can move to a different country with a better tax system. If they are not prepared to do this, they may be able to save or differ some taxes and/or to reach some level of confidentiality at least vis a vis third parties other than governments by setting up trusts and/or private family funds.”

Jurisdictions traditionally considered as offshore international financial centers have stronger protections of secrecy and privacy. “With offshore assets, it is better to structure them offshore too. Our clients usually pursue three objectives: privacy, tax optimization and succession planning. If they value secrecy the most, regulated investment funds (perhaps with their shares being publicly traded) are better than trusts. If succession planning is more important, a trust structure might be the best solution. We try to identify what matters to them the most, but they must also understand what can and cannot be achieved in this new transparent world.”

Litwak will be present at the marcus evans Latin Private Wealth Management Summit 2016 in Panama.

MiFID II and Lessons from The UK

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Europe has been given some breathing space with the MiFID implementation being put back a year, but this is not an excuse to sit still and doing nothing. As RDR was the precursor for MiFID II, distributors in Continental Europe have turned to the UK to understand how it might affect the distribution landscape and what lessons if any can be learned.

First of all, it’s important to understand one of the fundamental differences between RDR and MiFID. In the UK, advice has to be paid for whether it is provided by an independent financial adviser, a tied adviser or a bank adviser. All advice must be paid for. This had the unwanted effect of creating an advice gap because modest investors were no longer able to afford advice. In addition, banks pulled out of advice provision because they could not offer a cost-effective service and because they were concerned of future poor advice scandals.

In Europe the situation is different. Under MiFID II, only independent advice has to be paid for, meaning that tied advisers can continue to benefit from retrocessions as long as these are declared to the investor. This will not create an advice gap as it has done in the UK, but it is likely to drive investors towards solutions where they do not have to pay for advice (although in reality they will pay much more over the years in rebates). For countries with nascent advice industries, such a move could spell trouble but there are plenty of ways that independent advisers and wealth managers can fight back and ensure they have a long-term future in financial services.

Lesson one: It is important to remember that this is a supply-side reform. Investors will always need advice, but how they access it will change. People will still need advice on their savings and investments and long-term plans. The industry is not going to end just because of this new legislation.

Lesson two: work closely with the regulator to ensure that you get the best out of this legislation in Spain. Don’t protest and be difficult, make sure your voice and opinions are heard and taken into account.

Lesson three: Don’t wait until it’s too late. The most successful advice and wealth businesses in the UK started working on their post RDR model straightaway. You can gain a competitive advantage by working out your proposition now. Review your costs, your client base and understand how you add value. Promote that message consistently.

Lesson four: Don’t try to do things the old way. You need to adapt and change to the new environment. Make the use of technology and the internet to deliver a streamlined and cost-effective service. Make your proposition as attractive as possible to your clients.

Lesson five: Do not wait for the regulator or the press to promote your business. Do it yourself and do it now. Push your trade associations to work with you to promote the value of independent advice and superior investment skills. Be proactive. Advertise. Place articles in the press. Do everything you can to persuade consumers that tied advice is not the best advice.

And if all else fails, there is one last thing you can do… define yourself as non-independent!

Opinion column by Bella Caridade-Ferreira, CEO at Fundscape

The presentations can be found here.

Jérémie Fastnacht Joins Banque de Luxembourg as a Portfolio Manager

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Jérémie Fastnacht has joined BLI – Banque de Luxembourg Investments as a portfolio manager. His main responsibility in this role will be to support Guy Wagner in managing the BL-Equities Dividend fund.

The 30-year-old Frenchman comes from Banque de Luxembourg, where he served for one and a half years as an analyst and equity portfolio manager in the Private Banking Investments department.

“Quality research is even more important in today’s market environment. We are therefore staying on our chosen path and – as we have done successfully with our BL-Equities Europe and BL-Equities America funds – have provided our fund manager with a co-manager,” said Guy Wagner. “With Jérémie we have selected an in-house candidate, especially as he knows the Bank, our investment philosophy, and shares our values.”

Jérémie Fastnacht added: “I am pleased to take on this new role on the equity fund team of BLI – Banque de Luxembourg Investments. Alongside Guy I will share responsibility for the Bank’s flagship funds, which is highly motivating.” Jérémie holds a master’s degree in Finance from Université Paris-Dauphine and completed a post-graduate program in Financial markets from SKEMA Business School / North Carolina State University. Jérémie began his career as an equity fund manager at BCEE Asset Management in Luxembourg in August 2012.

Why We Think Mexico Is a Standout in Latin America

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I recently traveled to Latin America and had the opportunity to visit and collaborate with a number of our team members based in the region, including Rodolfo Ramos Cevallos, who works out of our office in Mexico City. Oil prices have certainly had an impact on Latin American economies—for better or for worse—but it was clear to us that Mexico has many potential growth drivers, with reform efforts playing a key part. I’ve invited Rodolfo to talk more about the economic prospects in his home country.

Over the last two decades, Mexico has taken decisive steps to integrate with the global economy through trade agreements, so it can be affected by external factors such as slowing global growth. While 2015 was a challenging environment for investors—including those in Mexico—we think Mexico stands out from many other countries in Latin America, and as well as other emerging markets, for a number of reasons. Mexico has developed into a high-value-added exporting powerhouse to the United States. It has passed structural reforms geared to encourage competition and attract investments at a time when most countries are shying away from private investment and liberalization, and it has stable fiscal and macroeconomic management. Because of this differentiation, Mexico’s equity market has been able to outperform broader Latin America as well as emerging markets overall (as measured by MSCI indexes) in the last one-, three- and five-year periods.

Currently, we are seeing opportunities in the export sector, which has benefited from a weakening in the Mexican peso versus the US dollar over the past couple of years. The automotive industry is a good example; Mexico is the seventh-largest automobile manufacturer in the world and largest supplier of automobile parts to the United States. Production of light vehicles has been on the rise, expected to grow from 3.2 million units annually in 2014 to more than 5 million units by 2020. We are also seeing bargains in the mining sector. While the mining sector has been out of favor in recent years, we have been able to find cost-competitive companies in Mexico with solid balance sheets that appear well-positioned to potentially benefit when the cycle turns.

Within Mexico, we are also finding opportunities in the banking and financial services sectors and believe banks are likely to continue to grow as younger generations get more comfortable using credit than perhaps their parents or grandparents were. Overall loan penetration in Mexico currently stands among the lowest in all of Latin America, and we believe financial services companies should do well as new industries (namely energy and oil) get listed and monetized in the equity market.

Monetary Policy and the Peso

The Mexican peso is one of the most liquid currencies in the world and the most liquid in emerging markets, which is why it is widely used by market participants to hedge emerging market risk. A large derivatives market also drives currency prices. The peso has historically been correlated with oil prices due to Mexico’s oil assets and the government’s dependence on them for tax revenues. These dynamics pushed the peso to an all-time low versus the US dollar at the beginning of the year. The peso’s dismal performance has been a major area of frustration and concern for global investors, especially considering Mexico’s stable macroeconomic outlook. Mexico’s central bank, Bank of Mexico (or Banxico), has historically taken a hands-off approach to foreign exchange markets. However, this extreme volatility prompted Banxico to announce a surprise interest rate hike in February and to directly sell US dollars to banks (instead of its routine US dollar auctions) to bolster the currency. The Mexican peso reacted positively to these actions, but it currently remains undervalued, according to our calculations.

Monetary policy is very much coordinated between the US Federal Reserve and its Mexican counterpart, which should limit any adverse impacts from a tightening cycle in US monetary conditions. However, we believe any US tightening will be a slow and gradual process due to stubbornly low inflation in the United States, expected at a mere 1.3% for 2016, based on the current Bloomberg consensus forecast. We do not foresee a material impact on Mexico’s economy from a gradual increase in interest rates in the United States.

The Impact of Oil, and Reforms

While oil is meaningful to the Mexican government in terms of revenues, Mexico’s reliance on oil is considerably less than is commonly believed, as oil represents only about 10% of its exports. With the decline in oil prices and an increase in economic activity, oil’s importance in Mexico has been significantly reduced in the last couple of years, with income tax and value-added tax (VAT) picking up the slack. Oil’s contribution to the federal budget has dropped by half in the last couple of years from about 40% in 2008 to about 20% in 2015. Unfortunately, consumers have generally not seen lower prices at the pump yet, but with the liberalization of the oil sector that could change in the coming years.

Throughout Latin America, governments can no longer rely on high commodity prices to help them finance key programs and projects, particularly related to infrastructure. So I think reforms are going to be very important. Energy reform in Mexico has opened up the oil sector to private investment through different participation schemes. Previously, the state-owned enterprise Pemex was the only firm that was allowed to capitalize on oil resources. Now, the newly established National Hydrocarbons Commission has the authority to auction fields to private parties. The commission has conducted three auctions so far, and each was more successful than the previous one, with the most recent auction securing a 100% assignment rate. The onshore fields already auctioned have low costs and have been profitable even at currently low oil prices. In addition to these auctions, Pemex will be able to partner with specialized oil players to develop its existing resources. The government is currently working on the rules governing the Mexican equivalent of a US master limited partnership (MLP) that will be used to list energy assets from Pemex and private parties. We believe all of these developments will likely lead to an increase in foreign direct investment.

Telecommunications has been another key area of reform, which has encouraged competition with the creation of an independent regulator, among other things. Telecommunications prices have dramatically declined since the reform’s implementation, translating into a direct saving to consumers. Last year, tumbling telecommunications prices played a major role in inflation falling to a record low of 2.13% in 2015.

In sum, the Mexican economy has been improving in a number of areas. Consumption has been very strong, and the government has been very proactive in announcing cuts as well as relying much more on private investment to finance a number of planned projects. Short-term market jitters aside, the US economy still looks strong, which should help Mexico going forward and make it an attractive place to invest.

Column by Mark Mobius and Rodolfo Ramos Cevallos

Family Investment Principals Will Gather at the 2016 FOX Spring Global Investment Forum

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Family Office Exchange (FOX) will hold the 2016 FOX Spring Global Investment Forum, April 6 at the Harvard Club in New York City and it is the first of two family investment-focused Forums for the year.

By and for owners of investment capital and their CIOs, the Forum is designed from the FOX member’s perspective to meet the interests and needs of the family investment decision-makers and asset allocators who will be in attendance.

At the conference, a panel of families and top advisorswill talk about the challenge of finding alpha in the market today and share insights on how they are addressing the challenge

Acclaimed architect, designer, thought leader, and author William McDonough will shed light on business models that allow business professionals to do more with less—and note the impact this philosophy has on bottom line profits and the investment implications of the next industrial revolution.

And Bloomberg Television anchor and editor-at-large Erik Schatzker will share his unprecedented insight into the companies and stories moving the markets, and identify key macro-themes that are actionable and relevant for multi-generational ultra-wealthy families.

For additional info or registration, please use this link.

Is the U.S. Growth Slowdown Trending into a Recession?

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While the US Federal Reserve starts its two-day meeting, in which no rate hike is expected, Monica Defend, Head of Global Asset Allocation Research at Pioneer Investments writes that her outlook for the US economy for 2016 is for decent growth, driven by Personal Consumption, Government Consumption (finally back to contributing positively to growth after years of retrenchment) and Investments (particularly strong performance of Residential Investments, while Non-Residential Investments will face a difficult first part of the year).

She believes that “the probability of a U.S. recession this year is still limited and the resilience of our base case is confirmed against further stress on selected financial indicators. In particular, we expect the US consumer to be resilient and sustain growth on the back of a healthy labor market, improvements on the compensation profile, and still moderate inflation, which should support real income growth.”

Amongst the key insights that can be found on her latest publication titled “A US Recession is not on the Horizon” are:

Leading indicators seem to point to a tentative stabilization and improvement in growth of the US and sectors hit by the strong dollar and weak oil price.
They currently expect inflation to move gradually towards the Fed Target of 2%. Should the oil and commodity prices trend higher than they currently assume in our scenario, we may witness a higher than expected increase in inflation, still not priced in by the market.
On monetary policy, they believe that Fed will be on hold in March, and will manage market expectations carefully. “A move in March would been an unwelcome surprise for financial markets, but we see this risk very limited.”

To read Monica’s entire Update, follow this link.

We Are All in This Together

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FIBA welcomed more than 1,300 people to its 16^th Annual Anti Money Laundering (AML) Compliance Conference held March 7^th to 9^th in Miami. Regulators, policy makers and financial leaders from 42 countries representing 330 financial institutions and corporations shared expertise on the evolving trends in the AML landscape with the intention of enhancing overall transparency across banking and non-banking institutions.

Among the highlights from this year’s program the recent corruption scandals involving FIFA, IAAF and ITF that have not only made news headlines, but have also called into question the level of risk assessment partnering financial institutions should be applying to sports or entertainment federations. These cases have highlighted the obvious intersection between sports and finance because without proper financing, sport federations would cease to exist, placing both parties at risk and in need of a practical solution. Increased scandals warrant an increased “know your customer’s customer” approach by banks to ensure they are proactively aware of any potential fraudulent behavior occurring among clients.

In a different session, an in depth conversation with FinCEN Director, Jennifer Shasky Calvery, shed light on how the organization works and what their goals include. Ultimately, they’re not looking to “jail anyone,” least of all compliance officers, but rather find mechanisms to collect information. The obligation of protecting the financial system from criminals and terrorists lies not just with the financial services industry, but also the regulators and law enforcement. “We all are in this together,” was the message.

Finally, a subject directly related to Miami was the theme of one of the key sessions of this edition of the conference. On March 1, 2016, FinCEN’s third and most recent GTO on Miami took effect. Issued by FinCEN, the GTO is not meant to be a regulatory solution for issues, but rather a tool to understand the source of fraud, which is particularly high in this region. Currently, 22% of US real estate purchases are via all-cash transactions. The GTO requires that title insurance companies identify the true owners of shell companies, in an effort to prevent the laundering of illicit proceeds.

“The opportunity to facilitate an open dialogue between regulators and banks in one room is incredibly fulfilling and truly moves the needle on our industry,” said FIBA CEO, David Schwartz. “Compliance responsibilities and regulations may differ from region-to-region in terms of what’s expected by regulators and what’s realistic for banks, however, the common goal is to find practical solutions that protect customers, institutions and the overall system. This was our most successful event yet, and we thank our sponsors, partners and speakers who helped make it possible.”