1st Quarter 2016 Letter
April 19, 2016, By: Harris L. Kempner, Jr., President
The United States and Worldwide
Despite the fact that it now appears that the U.S. GDP in the 1st Quarter was 1% or less, we still believe, as we did at the start of the year, that the U.S. GDP will grow at the rate of 2 ½% – 3% for calendar 2016. There are several reasons for this.The first is a statistical anomaly that has appeared in the last 2 years, and looks to be repeating itself. As this layout shows, both 2014 and 2015 1st quarter GDP was extremely low followed by a resounding make-up in the 2nd quarter. (Evercore ISI)
Real GDP Q/Q A.R.1Q 2Q
We believe that there are signs that the same thing will be occurring in the 2nd quarter 2016. The first of these is employment, which is extremely strong. The latest unemployment applications at 253,000 tied a record low since 1973. In the past 6 months, according to national employment statistics (WSJ), the economy has overcome any slowdowns and created over 1.5 million jobs, which is a very substantial number. According to all reports, many people who have been out of work for a long time are now coming back into the labor market. This labor strength sets up an excellent consumer potential, going forward even though the American consumer is no longer spending more than they make and saving a healthy 5% of income. These overall statistics indicate the consumer will be adding substantially to the economy as the quarter and the year roll on.

The latter is particularly true if you take a look at consumer spending. At first blush, the March consumer retail spending figure of -.3% seems low. Although retail sales were apparently flat in the full 1st quarter, in fact they were strong when price drops were taken into account. Real retail sales were up a healthy 4% quarter-to-quarter. (Cornerstone Macro) This means that while inflation is substantially in check, the consumer is spending a lot on specific items. This is a much healthier underpinning for consumer activity than would appear from the headline numbers.

Other factors are that oil prices have improved since January, which is likely to benefit areas that have been quite weak in the U.S. economy for the last year. Housing, responding to lower mortgage rates, is likely to become a noted addition to U.S. strength in this quarter.
China, as the world’s second largest economy, again deserves some special mention. At the beginning of this year, we indicated we thought that China’s economy would be stable despite omnipresent fears of a deep drop in their economic activity. We now believe that it could actually be growing some due to the most recently announced growth in Chinese exports, which was reported to have risen 11.5%. Consonant with this, the Chinese nominal GDP was announced at +7.29% for the first quarter, up from 6.0% in the fourth quarter. This is much better than the fears of a hard landing held at the beginning of the year.
All in, we think the U.S. economy continues to be quite solid, growing at a reasonable pace and no significant slowdown is in the picture for this year. Much of the rest of the world is also doing better than the fear-laden predictions at the start of the year.

The stock market went through a very difficult period during the 1st quarter based, as we observed at the start of the year, on very negative assumptions about world growth, U.S. economic growth, and the potential of recessions in many places. As these fears have lessened, the U.S. stock market has come up from very depressed levels in February to slight gains for the year as a whole. We think that progress from here will be a function primarily of earnings and earnings expectations, as it is traditionally. We see no chance of a recession in this country during 2016 and that alone is enough to provide general support of the stock market going forward.

Fixed income investments presently revolve substantially around what the Federal Reserve will do with regard to rates in the coming months. Despite many analysts’ contrary opinions, we are still forecasting U.S. economic growth at 2 ½% – 3%. If our economic scenario holds, with continuing growth in the U.S. economy and continuing improvement of both employment and real wages, we expect the Feds will raise rates twice by the end of calendar 2016. If they do so, bonds will be somewhat weaker because of higher interest rates. Our fixed income portfolios continue to be invested in U.S. Treasury Inflation Protected Securities (TIPS) because we expect inflation to eventually be a factor in the U.S.