Slip slidin` away Slip slidin` away You know the nearer your

Quarterly Commentary
June 2016
Slip slidin' away
Slip slidin' away
You know the nearer your destination
The more you're slip slidin' away
Paul Simon’s 1975 Lyrics to “Slip Slidin’ Away” may be relevant and prescient in
2016. The worldwide destination has been and continues to be decent economic growth
(2.0%-4.0% GDP) with mild inflation (~2%), that in turn will allow central banks to
“normalize” interest rates and exit their various forms of quantitative easing. Coming
out of the Great Recession most economic indicators for most countries showed a strong
recovery, “nearer their destination,” but over the last three or four years that global
economic recovery has been “Slip Slidin’ Away.” One consequence of this “Slip Slidin”
is that the odds of the U.S. Federal Reserve increasing interest rates in 2016 recently
“Slipped” lower than the odds for them cutting rates!
KCM chart/ Bloomberg data
KCM INVESTMENT ADVISORS LLC
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KCM chart/ Bloomberg data
A Gross Domestic Product weighted indicator of global PMIs has been drifting lower
since 2013, still expanding (above 50), but the trend is lower.
KCM chart/ Bloomberg data
J.P. Morgan’s Global Manufacturing index is slipping; still the S&P is near a high.
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KCM INVESTMENT ADVISORS LLC
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KCM chart/ Bloomberg data
KCM chart/ Bloomberg data
Global PPIs (wholesale selling price of goods) and Eurozone inflation expectations are
trending lower making it unlikely that the European Central Bank exits its Quantitative
Easing anytime soon, keeping downward pressure on interest rates.
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KCM INVESTMENT ADVISORS LLC
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KCM chart/ Bloomberg data
KCM chart/ Bloomberg data
S&P 500 Company sales and earnings growth are slipping, a headwind for the market.
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KCM INVESTMENT ADVISORS LLC
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KCM chart/ Bloomberg data
KCM chart/ Bloomberg data
More slidin’…
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KCM INVESTMENT ADVISORS LLC
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KCM chart/ Bloomberg data
KCM chart/ Bloomberg data
If “Leading Indicators” decline below “0”, history tells us we are likely entering a
recession. We are not there yet, but we will be monitoring the declining trend.
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KCM INVESTMENT ADVISORS LLC
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KCM chart/ Bloomberg data
Federal Reserve quantitative easing (top chart) has clearly driven stock and other risk
asset prices higher. Any pause or reversal is a head wind for those same risk assets.
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KCM INVESTMENT ADVISORS LLC
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Over the last 20 years, the use of borrowed money by non-financial firms has changed
(chart-bottom of page 7). The portion used for productive expansion of business has
steadily declined while the portion used for less productive financial engineering
(buybacks and acquisitions) has progressively increased.
So, how do we invest in a Slip Slidin’ world? Central banks have signaled their
willingness to take all necessary steps to shore up weak economies; they are not going
to raise interest rates anytime soon. Investors’ insatiable demand for income will be an
ongoing theme. On the equity side, stick with KCM’s dividend BlueBlood stock
portfolio, comprised of companies that pay a fat dividend and have demonstrated the
ability and willingness to raise those dividends over time.
The fixed income markets rallied during the second quarter bringing yields down about
35 basis points on the ten year Treasury bond, 40 basis points on the thirty year
Treasury bond. Long-term Government securities, denominated in most any currency,
are high risk investments because of their sensitivity to changing interest rates, not
credit quality. For example, the U.S. thirty year Treasury bond has a risk duration of
about 23. If the yield on the bond goes up 1%, the price will decline about 23%, not a
good risk/reward.
The most attractive fixed income investment remains twenty year municipal bonds
with a ~5% coupon, ten years of call protection and a 2.3% yield to call. For tax
free portfolios, corporate bonds may make sense, but we suggest sticking to investment
grade, short-term, U.S. dollar denominated credits.
Carefully selected preferred stocks are still attractive. Preferred stocks performed
well year to date and still make sense for a portion of a balanced portfolio. They do not
offer the appreciation potential of common stocks and they come in a bewildering array
of structures, nonetheless, the appeal is their relatively higher yield. Because they come
in so many combinations of credit quality, maturity, call protection, coupon structure
and tax treatment, we emphasize careful selection and diversification when constructing
the Preferred stock portion of a portfolio. We continue to like selected credits with high
coupons and yields to their 2-5 year call dates of 4%-6%.
June 30, 2016, marks KCM’s 20th anniversary. We thank you, our loyal clients and
friends, for allowing us to celebrate this milestone…
Jay Kellett & your KCM Team
This material has been prepared by KCM Investment Advisors LLC on the basis of publicly available information, internally developed
data and other third party sources believed to be reliable. KCM Investment Advisors LLC has not sought to independently verify
information taken from public and third-party sources and does not make any representation as to the accuracy, completeness or
reliability of the information contained herein. This material is presented solely for informational purposes and nothing herein
constitutes investment, legal, accounting or tax advice, or a recommendation or solicitation to buy, sell or hold a security. No
recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be
assumed that any investment in securities, companies, sectors or markets identified and described were or will be profitable. Actual
investments or investment decisions made by KCM, whether for its own account or on behalf of clients, will not necessarily reflect the
views expressed in this document. Since economic and market conditions change frequently, there can be no assurance that the trends
described here will continue or that any forecasts are accurate.
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