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Just glancing at economic headlines, it would be easy to conclude that not much has changed over the last 12 months. A year ago, slowing economic and profit growth, a looming Brexit deadline and the trade war topped a long list of worries. These issues remain among the biggest concerns hanging over global markets today. But, it’s not Groundhog Day. We’re seeing encouraging differences in the investment landscape heading into 2020.
We entered 2019 coming off a brutal fourth-quarter selloff that dragged the S&P 500® Index into negative territory and made 2018 the decade’s only year with a negative total return.* From that low point, investors quickly found reasons to buy stocks again. The turnaround began with the U.S. Federal Reserve (Fed) adopting a more dovish stance early in the year before cutting rates three times beginning in July. It’s too early to judge the impact, but lower rates, along with progress on trade negotiations support increased business spending and sustained consumer confidence.
On the trade front, negotiators haven’t closed a comprehensive deal, but they were making progress as the year wound down. Adopting a new approach, the U.S. and China appear on track to keep the most punitive measures as part of a limited "phase one" agreement. This phased strategy is unlikely to produce a sweeping bargain that addresses all points of contention at once, but it may deliver incremental gains that help reduce uncertainty. The worst possible outcome also seems to be off the table in Europe. Negotiations, parliamentary maneuvers and the recent election make it less likely the U.K. will leave the European Union (EU) without a deal.
Though we believe these monetary and geopolitical shifts give the global economy room to improve, 2020 remains uncertain. With muted expectations for economic and profit growth, our investment teams continue to think defensively. We are paying greater attention to being able to withstand unexpected downturns.
We recommend our clients remain balanced with a keen eye toward downside risk. Without deviating from their long-term asset allocation policy, we believe investors will benefit from having exposure to proven equity and fixed-income strategies designed to help cushion short-term volatility. We believe this more cautious stance offers the potential to participate in the market’s upside with less exposure to volatility that could accompany swings in investor sentiment or unexpected economic or geopolitical events.
We wish you all the best in the new year. Thank you for investing with us.
*Based on total return of the S&P 500® Index.
The risk of a recession in the next year is fading, but growth may decelerate in the near term. Weaker capital spending and trade policy uncertainties may keep U.S. gross domestic product (GDP) at or slightly below its trend range of 2.0% to 2.5% annualized growth. The U.S. economy likely will remain stronger than the economies of other developed markets.
Despite still-weak manufacturing data in Germany, Europe’s economic slowdown has stabilized. However, we don’t foresee a growth pick-up in 2020, largely due to weak global demand. In the U.K., we expect lingering Brexit and trade negotiations to dampen growth.
Overall, growth in emerging markets (EM) remains stable and positive. Growth in China, which recently slowed to a nearly 30-year low, should improve due to fiscal stimulus. Although a dovish Fed remains supportive of EM growth, ongoing trade tensions and slow growth in developed markets remain headwinds to developing markets.
Headline and core inflation recently stabilized near 1.8% and 2.3%, respectively. But with core inflation’s rent component recently posting its smallest monthly gain in more than eight years, lower inflation is a growing risk. Meanwhile, longer-term, market-based inflation expectations remain below historical averages.
Lower energy prices and a slowdown in industrial production have fueled the recent deceleration in European inflation. Headline inflation fell to 0.7% in October, compared with 2.3% a year earlier. Core inflation has remained near 1.0%. U.K. inflation hovers near the central bank target, supported by a tight labor market and wage growth.
Inflation remains low and below central bank targets in most EM countries. Notable exceptions include Turkey and Argentina, where significant currency devaluation has caused inflation to spike.
After delivering three rate cuts during the second half of 2019, the Fed remains on hold to assess the effects of its recent easing moves. Given our expectations for moderating economic growth and muted inflation in the near term, we believe the Fed has room for one more rate cut in 2020.
The European Central Bank (ECB) recently kicked off a new round of quantitative easing (QE), which, combined with the central bank’s new tiered deposit rate, should provide a floor for European rates. We expect QE to continue through most of 2020. We believe the Bank of England, which has appeared more dovish recently, may cut rates in early 2020.
The People’s Bank of China continues to step up its monetary policy support amid lingering trade tensions with the U.S. The central bank’s November policy rate cut was the first since 2016, and policymakers could ease further depending on the status of trade negotiations.
Despite modest upward moves in longer-maturity Treasury yields, the ongoing risks to global growth and inflation have kept Treasury yields relatively low. As we expected, the Fed’s easing pushed shorter-maturity yields lower and helped restore an upward slope to the previously inverted Treasury yield curve. Although the Fed insists its monetary policy is “in a good place,” the Treasury futures market expects up to two rate cuts in 2020.
Yield curves across Europe have started steepening due to central bank accommodation and improved global sentiment. Most longer-maturity yields have climbed out of negative territory, but short- and intermediate-maturity yields remain below 0%. U.K. rates remain modestly higher and positive, and the curve has steepened slightly. Rates in Japan remain negative amid ongoing, but reduced, central bank stimulus.
Given the relatively benign interest rate environments in developed markets, we generally favor sovereign securities in select emerging markets. Specifically, we continue to focus on markets where rates are higher and more likely to fall or remain stable, including Mexico, Peru and Indonesia.
*Outlook as of 11/30/2019.
Our Disciplined Equity team’s measure of recession risk remains stable and modest, suggesting talk of an impending recession is overblown. Just a few months ago, the market was in an uproar over inversion of the yield curve and uncertainty around economic growth. And while it’s true that manufacturing activity slumped earlier in the year, conditions appear to have stabilized. Given the steady job market, consumer spending and central banks’ stimulus measures worldwide, we don’t foresee a recession anytime soon. Our measure of recession risk shows only about a one-in-four chance of recession over the next 12 months.
Compare our analysis with other widely regarded recession models. The New York Fed’s widely followed recession risk model shows about a 30% chance of recession in the next year. But that’s below what it predicted throughout this past summer. Similarly, American Century Investments’ Fixed Income team, which uses both qualitative and quantitative inputs in its analysis, sees the likelihood of recession as having receded in recent months. Similarly, bottom-up indicators of economic activity also appear to have stabilized or are on the upswing. For example, the outlook for U.S. corporate earnings appears to be improving. The ratio of publicly traded companies providing positive earnings guidance versus those providing negative guidance is now back above the average level since the financial crisis of 2008.
Though immediate worries of a global economic recession have receded, it’s possible for narrower slices of the economy to experience recession-like symptoms that could last months or years. For example, a plunge in crude oil prices began in mid-2014 and continued into early 2016, causing ripples through several sectors. Under those conditions, industrial companies saw revenues and new orders decline while inventory levels rose, and companies paused capital spending. We view such short-term, mini-recessions as opportunities to find what we believe to be higher-quality industrial companies at attractive prices.
More recently, industrial companies have been sensitive to swings in U.S./China trade relations and worries about the potential for a broader economic slowdown. As a result, even high-quality companies have experienced periods of stock price volatility despite having underlying earning power that appears sustainable through a downturn.
We believe a good example is Schneider Electric, a global leader in electrical distribution and automation and control products. The European company has evolved from a medium-sized business making electrical products for discrete automation and commercial buildings into a large global company serving a much broader market. The stock compares favorably to others in the industrial sector, with a strong balance sheet and a history of paying dividends to shareholders. These are key characteristics we seek as value investors.*
Energy was one of the worst-performing sectors in 2019. Increased U.S. shale production, a slowing global economy and new supply from countries such as Norway, Brazil and Guyana caused fears of crude oil oversupply.
Investors who were underweight the sector most likely benefited from that positioning. No one knows for sure how energy stocks will fare in 2020, but some positive signs indicate the fundamental pressures in the oil patch appear to be moderating. In December, the Organization of the Petroleum Exporting Countries (OPEC), Russia and other oil-producing countries within OPEC’s circle of collaborators elected to maintain their policy of managing supply to keep markets balanced. In 2021 and beyond, shale growth could slow, giving OPEC more leeway in setting oil prices. The demand side of the equation is a bit more uncertain because continued economic growth is necessary for this highly cyclical sector to find its footing.
Barring conditions such as a U.S./global recession, geopolitical conflicts or the return of supply from Iran and/or Venezuela, energy stocks might not suffer from the fundamental pressure they’ve felt recently. We tend to favor higher-quality companies in the energy sector, particularly integrated and oilfield service companies.
Companies are increasingly aware of sustainability, and many are offering customers more sustainable choices while managing environmental and financial risks. Over the last three years, we’ve seen publicly traded companies make material progress in reporting their advances in environmental, social and governance (ESG) sustainability. Many have established sustainability desks dedicated to engaging with investors on ESG issues. Even companies in carbon-intensive industries are proactively discussing their efforts to use water more efficiently or reduce workplace injuries.
The market is responding positively as evidenced by the amount of investor money flowing into strategies that use sustainable criteria either as a risk factor or as an investing objective. We can argue the merits of each approach, but we believe the increased corporate attention to sustainability is indisputable.
We use the sustainability prism to understand financial risk from an identified ESG issue. We’re just as interested in where the company is going as where it is today. We care about these issues because we’re always interested in what might affect a stream of cash flows or what could make them more variable. We also identify and invest in companies that we believe demonstrate sustainability leadership in their sectors.
*References to specific securities are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
A strategy or emphasis on environmental, social and governance factors (ESG) may limit the investment opportunities available to a portfolio. Therefore, the portfolio may underperform or perform differently than other portfolios that do not have an ESG investment focus. A portfolio’s ESG investment focus may also result in the portfolio investing in securities or industry sectors that perform differently or maintain a different risk profile than the market generally or compared to underlying holdings that are not screened for ESG standards.
"Given the steady job market, consumer spending and central banks’ stimulus measures worldwide, we don’t see a recession anytime soon."
Corporate earnings growth weakened in the final quarter of 2019, the third consecutive quarter of decline. Some pockets of strength remain—health care, consumer staples and information technology companies were among those reporting earnings gains. Conversely, materials, energy and most retail companies reported declines. While select companies have surpassed earnings expectations, many have dampened investor enthusiasm by simultaneously lowering forward guidance.
Uncertainty about global trade, already accommodative policies from central banks and concerns about the sustainability of the long-running bull market dampen the outlook for 2020.
We expect central banks to remain accommodative, which would benefit local economies and, in turn, corporate earnings. However, we note the Fed chose to “pause” its interest rate-cutting regime. We also wonder how effective further stimulus programs will be in Europe or Japan. Even though rates in many markets are below zero, growth remains sluggish.
As earnings growth becomes scarcer, we believe equity markets will reward companies that deliver above-consensus results and guide analysts and investors toward further growth.
Investors are suffering from trade war fatigue. After initial optimism for a "first phase” agreement, each side accused the other of failing to make enough concessions. Negotiators announced a limited phase one deal in December, but we expect the back and forth between optimism and fear to continue.
It’s difficult to predict when and how the dispute will resolve. However, the current U.S. administration may prefer to definitively deliver a deal before the presidential election next November. Analyzing individual stocks, we consider how trade pressures may affect the company. For example, we have identified companies with less exposure to global trade and believe opportunities exist for companies that are more locally and regionally focused.
After more than three years of market uncertainty following the referendum to leave the EU, resolution of the Brexit saga may be in sight. Prime Minister Boris Johnson’s Conservative Party is hailing its recent victory in the general election as a mandate to deliver Brexit on or before Jan. 31, 2020, and markets appear to have priced in such a scenario. The British pound and U.K. stocks have rebounded amid optimism for an orderly resolution to this seemingly endless situation.
We agree that the outlook for the U.K. has improved with removal of some of the uncertainty. We further expect U.K. equities would benefit from an orderly Brexit. However, many questions remain about how and when Brexit will occur because the U.K. and EU must still approve a formal trade agreement. We aren’t so sure they can execute an agreement before the end of 2020, as the Conservative party promises. If negotiations for new trade agreements with the EU and other trading partners prove to be as contentious as Brexit negotiations, there remains a danger that the U.K. could leave the EU without a deal. That outcome could undo most of the goodwill U.K. assets have gained since the general election.
"As earnings growth becomes scarcer, we believe equity markets will reward stocks of companies that deliver above-consensus results."
We believe conditions for emerging markets remain attractive because the global outlook is showing signs of improvement and trade dispute activity may be bottoming. Macroeconomic factors have weighed on EM stocks in the short term, but fundamentals for the asset class remain compelling.
It’s important to remember that emerging markets are a diverse group of countries. Correlations between markets are low because each has its own set of economic, fiscal and political characteristics. This allows us to identify opportunities in individual EM markets despite larger macroeconomic trends. We believe certain companies are well positioned to benefit from improving economic conditions in markets such as Brazil and Thailand. We are also finding examples of companies that are growing earnings despite less favorable economic conditions in their home countries.
China remains a focus. We continue to see opportunities despite slower growth and the effects of the trade war, e.g., in real estate and information technology. Some consumer-related companies, including private education providers and sportswear makers, are benefiting from strong consumer activity and aspirational spending.
Emerging markets have been under pressure from several macroeconomic trends emanating from developed markets. Trade conflicts, a strong U.S. dollar and Brexit have all weighed on investor sentiment and acted as headwinds for EM equities. We now see changes that may improve the outlook for EM economies.
U.S. dollar strength has weighed on EM stocks for several years. However, after three interest rate cuts in 2019 to support the U.S. economy, the U.S. Fed has held steady. If, as many investors believe, the Fed plans to maintain its “pause” in rate changes, we may see a levelling in the U.S. dollar rally. That would relieve some of the pressure on EM economies and stocks.
Global trade continues to concern investors worldwide. EM economies may have been affected more than some regions because their ties to both the U.S. and China are strong. However, intra-regional trade has improved as a result, lessening some of the effects of the global trade disputes. Some EM companies have benefited from the tariff escalation that has led some U.S. and China companies to seek new suppliers and buyers.
We are finding opportunities in more domestically and regionally focused companies and those less exposed to global trade. Consumer-facing companies and those tied to information technology and 5G infrastructure are attractive. Consumers are demanding increased access to education and financial goods and services, as well as status items.
"Macroeconomic factors have weighed on EM stocks in the short term, but fundamentals for the asset class remain compelling."
Our outlook for Treasuries remains positive. Heightened trade tensions, slowing global growth, muted inflation and dovish central banks are supporting the sector. Treasuries continue to offer higher relative yields than government securities elsewhere, driving global demand for Treasuries higher and yields lower. We expect the 10-year Treasury note* to trade in a range of approximately 1.5% to 2.0% over the next few months. After inverting earlier in the year, the Treasury yield curve has steepened recently, reflecting the effects of the Fed’s three rate cuts in 2019.
*A treasury note is a debt security issued by the U.S. government with a fixed interest rate and maturity ranging from one to 10 years.
We expect year-over-year headline and core inflation to stabilize near the Fed’s 2% target. We don’t foresee a near-term catalyst for higher inflation. Longer-term inflation expectations have modestly increased but remain well below historical averages. At these levels, we believe TIPS remain attractive.
We continue to find value in the U.S. securitized market, which remains less susceptible to the idiosyncratic elements of the corporate bond market. Additionally, we believe securitized bonds provide important downside protection to investors. We generally favor mortgage credit securities, including non-agency commercial mortgage-backed securities (CMBS), over agency MBS. We also believe asset-backed securities (ABS) offer attractive value.
Given the strong year-to-date rally, we believe investment-grade corporate bonds generally appear expensive. We also believe the credit cycle is in its late stages, which means spreads may widen as the cycle matures. Macroeconomic influences, including slowing global growth and trade conflicts, remain concerns, but the Fed cutting interest rates by 75 basis points in 2019 has mitigated those concerns somewhat. We still believe the banking and utilities sectors offer some of the best opportunities. We will closely watch the U.S. presidential campaign because several candidates have far-reaching policy agendas that could lead to significant long-term changes, particularly in the health care sector.
U.S. high-yield fundamentals remain stable. Companies continue to adjust their outlooks downward to reflect a more challenging macroeconomic backdrop. Valuations and spreads remain tight, particularly in the higher-quality tiers of the high-yield market, as investors position more defensively. Against this backdrop, we remain selective and favor higher-quality high-yield bonds with solid fundamentals and spread-tightening catalysts. We are finding the best opportunities in consumer-related sectors, including homebuilding and health care. We remain cautious toward the energy and retail sectors.
Municipal finances nationwide remain stable, and demand for munis, which remains at record levels, continues to outpace supply. Given our outlook for moderating growth, low interest rates and solid credit fundamentals, we have a modest bias toward lower-quality securities (investment-grade securities with BBB credit ratings). We continue to favor revenue bonds over general obligation and special tax bonds.
Most government bond yields in Germany and France remain in negative territory. However, with open-ended QE and a tiered deposit rate, we believe the ECB has effectively stabilized and put a floor on European rates. The market has retraced its expectations for more rate cuts. We are maintaining our underweight in core European rates. In the U.K., economic data remain weak, so we recently exited our short position in government bonds. Increased government spending may drive longer-maturity yields higher, so we have a slight curve-steepening bias. Elsewhere, we are maintaining an overweight in Norway.
We continue to underweight European credit, largely due to valuation concerns. Credit fundamentals remain benign but subject to ongoing economic concerns. Our underweight is focused on industrial sectors, which are more exposed to economic risks. We believe subordinated financial sector bonds still offer the most value. These securities have strongly outperformed year to date, and we have reduced our exposure to a more neutral position.
We believe benign central bank policy in developed markets, particularly the U.S., will provide a tailwind for EM assets. Given our expectations for a weaker U.S. dollar, we continue to favor local currency debt over external bonds. Our local positioning favors holdings in Russia, Israel and South Africa. Within our external sovereign exposure, we are overweighting holdings in Egypt, the Dominican Republic and Turkey. Among corporate bonds, we favor high yield over investment grade. We believe the oil and gas and technology, media and telecommunications sectors are the most attractive, and we are underweighting the metals and mining and real estate sectors.
Positive economic data and progress on trade talks between the U.S. and China have been a tailwind for risk assets. Equity markets are trading at all-time highs and credit spreads have tightened significantly. While the markets still have room for upside, we advise remaining cautious because valuations are stretched, and risks persist.
Trade discussions continue and many more difficult structural issues remain unresolved. Future negotiations will tackle more complex core items, such as technology transfer, intellectual property, industry subsidies and currency. Reaching agreement on all these issues won’t be easy and the back-and-forth negotiations are likely to result in greater volatility for markets.
Another key area of uncertainty is the 2020 U.S. presidential election. So far, equity markets have not been overly concerned about the risk of policy changes. However, as the election nears and front runners emerge, political agendas will likely have more of an impact on the market and specific sectors. For example, we could see additional pressure on the U.S. energy, financials, technology and health care sectors. On the flip side, proposals to break up big tech, could benefit brick-and-mortar retailers. Eliminating student debt and raising wages would help increase consumer spending.
Credit markets experienced a dramatic shift in 2019. Loans have been particularly stressed. Company-specific events and a pick-up in credit downgrades among lower-quality loans caused investors to be risk averse and spurred a flight to higher quality among loans and collateralized loan obligations (CLOs). Outflows from retail funds also created headwinds.
Despite these stressors, we believe the U.S. economy remains in good shape. Thus, the selloff created relative value opportunities for loans and CLOs that may now offer more attractive yields compared with other asset classes.
From a technical perspective, we may continue to experience periodic stretches of retail outflows that create price volatility. However, we expect the effect to be diminished because retail funds now account for a smaller portion of the loan market. At the same time, CLO investors have become a larger share of the investor base. They tend to buy and hold and haven’t been selling into the recent weakness.
Looking ahead, we think it’s prudent to be wary of the ability of corporate borrowers to service their debt as the credit cycle ages. Technical factors, idiosyncratic credit issues and downgrades may continue to trigger price volatility and inefficiencies. While we expect defaults to rise among weaker credits, we believe the stress is largely contained. CLOs, with their unique structural characteristics, have proven resilient through periods of stress in the past.
"Though a cautious, high-quality orientation is warranted, we believe leveraged loans and CLOs offer attractive yields compared to other asset classes."
Academics debate whether the bull market in stocks officially ended in December 2018. We prefer to think of stocks as being on one long—sometimes rocky—road higher since the end of the financial crisis and Great Recession in 2009. Regardless of how you do the math, it’s fair to ask if the bull is on its last legs or if further gains are yet to come.
We see warning signs that indicate caution. First, the market appears to be fairly valued, with some measures suggesting it’s overvalued. Second, economic growth has been slowing for roughly two years in the U.S. and in essentially every major industrialized economy overseas. A factor in the slowdown is the uncertain environment for trade and government policy worldwide, which magnifies the risk of a downturn in growth and complicates any potential policy response. The manufacturing sector in the U.S. has also been up and down—the latest measures of industrial production, factory and durable goods orders declined, while a key manufacturing index recently turned up from a low base. Corporate earnings growth has also been lackluster.
That said, however, one economic driver has remained remarkably resilient—the U.S. consumer. Representing over 70% of U.S. economic activity, consumer spending is arguably the main reason this recovery and bull market have persisted well past historical norms. Most of the retail-related data we see suggest the recovery can carry on a bit longer. The healthy job market is one big support for consumer spending, so we’ll be watching for any slowdown in hiring. Another key factor we’re monitoring is the level and direction of interest rates. The Fed is on hold for now, apparently confident that it has done enough to support growth going forward.
So, we’re not ready to declare the bull dead just yet. But we’re cautious and emphasizing a balanced approach. We remain neutrally positioned in our own multi-asset portfolios. And because these economic and policy tensions won’t likely resolve quickly or cleanly, we encourage individual investors to think carefully about how much volatility they are prepared to tolerate in pursuit of their financial goals.
We explained our qualitative judgements above, arguing for a balanced approach to investor portfolios. Our quantitative models also point toward a neutral allocation to stocks and bonds. The leading argument for stocks at present comes from attractive earnings yields, though our other fundamental measures point toward bonds.
We have moved to an overweight to the U.S. versus non-U.S. developed equities as a result of recent shifts in both ourfundamentals and technical models. In particular, stronger relative economic conditions and market momentum favor the U.S.
Our model is shifting toward EM equities, reflecting stronger relative returns and economic fundamentals, though these vary widely by country. Nevertheless, enough components of our model—including important measures of interest rates—continue to favor the U.S. though we remain neutral overall.
The sentiment and fundamental portions of our model point toward large company stocks over small company equities. However, relative valuations favor small caps after having lagged large caps by a wide margin in 2019. Add it all up, and we remain neutral by size.
We remain overweight growth relative to value, but by the slimmest of margins. Our measure of investor sentiment showed a much smaller preference for growth than it has in many months at the time of this writing. Relative valuations favor value stocks, but not by enough to push us off our growth bias.
We are neutral to slightly long duration in the U.S. and slightly short in many European government bonds. Duration is a measure of bond price sensitivity to interest rate changes. Having a long duration is beneficial when rates fall but hurts when rates rise. We also look to take profits on mortgage-backed and corporate credit trades, looking for more attractive valuations or opportunities to deploy capital.
Real estate investment trusts (REITs) have benefited from the Fed’s rate cuts and low bond yields in 2019, as their relatively high yields make them attractive to income investors. We remain neutral on the asset class, which we believe offers significant portfolio diversification benefits.
Q1 | 2020
Q1 | 2020 Presentation
Quarterly insights videos from our portfolio managers
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.
International investing involves special risks, such as political instability and currency fluctuations.
Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.
References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
American Century Investments uses a multifactor stock-ranking model incorporating a variety of stock attributes, which fall into four categories or factor families: valuation, growth, quality, and sentiment.
Diversification does not assure a profit nor does it protect against loss of principal.
Alternative mutual funds that hold a variety of non-traditional investments also often employ more complex trading strategies than traditional mutual funds. Each of these different alternative asset classes and investment strategies have unique risks making them more suitable for investors with an above average tolerance for risk.
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