Fourth Quarter 2015 Letter
January 19, 2016, By: Harris L. Kempner, Jr., President

The United States and Worldwide

We expect the U.S. economy to grow between 2.5% and 3% in real terms in 2016. The Fed will raise rates slowly enough not to be a drag on economic growth. The American consumer, whose spending makes up about 70% of the U.S. economy, is in extremely strong shape and will be carrying us through difficulties posed by some slowdowns in overseas areas which will primarily affect manufacturing. Strikingly, for the first time since 2010, we expect all-in government spending to be a net positive for the economy.

The consumer marches from strength to strength. Despite all the chatter regarding unemployment statistics not being reliable, more of us are working than has ever been the case in the U.S. economy, with an unemployment rate looking as if it is going below 5% in the next several months. As importantly perhaps, for the first time in the last 7 years, wage growth is now accelerating (from 2% to 2.5% during 2015). (BLS Statistics). This is a key factor which has been missing throughout much of the recovery since 2010 and underpins our optimism about consumer spending. We think, this is primarily because labor is finally getting a little tight. It looks to us as if this trend will increase even past 2016. The consumer balance sheet is relatively strong with far more saved as a percent of income and less borrowed than has been true for over the last 40 years in the U.S. (Evercore). Nothing like a severe recession to provide an incentive to save more. Adding to this are the consumer benefits of lower oil and gas prices, about which more later. All this has taken consumer confidence up to relatively high levels while improving buying intentions. The consumer is the foundation rock on which U.S. economic growth rests in 2016.

U.S. manufacturing, however, is projected to be somewhat stagnant, or even slightly down this next year. Happily, if you can say anything happy about this, manufacturing is estimated to represent only about 12% of the U.S. economy. In places like Texas, all the manufacturing activities related to oil and gas including drilling, steel fabrication, etc., are clearly in decline, but the whole energy piece only represents about 15% of total U.S. manufacturing. (Cornerstone Economics.) Manufacturing overall has also been affected by slowdowns in overseas economies, especially in China, and by the relatively high dollar which reduces U.S. manufacturing competitiveness.

China needs to be dealt with specifically. We believe that China will be stable for the first part of the year, but then there are signs that it could be turning more positive. Thus, a neutral to positive factor for 2016. All-in though, we are not counting on manufacturing to contribute positively to economic growth of the U.S. economy, and it could be a slight drag.
And, notably, an observation about government spending, by which we mean all federal, state and local spending, nationwide, and which represents about 18% of the U.S. economy. (Evercore). For the first time since fiscal 2008-09, this sector looks to us to be a net addition rather than a subtraction to the U.S. economy. Our estimates are for an increase of 2.5% in 2016, a tailwind to GDP.

There are some other specific economic factors which we think need to be discussed. We, in our shop, were taken by surprise by the depth of the oil and gas decline in 2015. The gloom, as we all know down here, is quite thick. However, we believe that worldwide demand will be perceived to be catching up with worldwide supply during 2016, despite the fact that Iran is likely to add an estimated 500,000 barrels a day to the world supply. (International Energy Association). Demand is growing fast enough, we think, to make up the present 1.5% to 2% difference between world supply and demand and to begin to eat into storage. We therefore believe that oil prices will be averaging somewhat higher than they are now in 2016. As a working hypothesis, we are using $40-$45 a barrel for the entire calendar year with improvement above that in the last half.
The same gradual improvement holds true for many other commodities, if we are correct in our U.S. growth projection and in our Chinese assessment.
So, the U.S. overall in 2016? Steady, moderate growth, based primarily on the U.S. consumer.


As of this writing on January 19, 2016, the stock market in our opinion, is going through a typical episode in which the dangers to economic growth are exaggerated and little attention is being paid to the positives. Of course, no one can predict whether the market might fall further than it has in the early part of this year, but we do think that the strengths in the economy that we have laid out in this piece will lead to somewhat stronger earnings of the S&P during 2016 and a re-valuation from present levels at some point during the year.

Fixed income investments presently revolve substantially around what the Federal Reserve will do with regard to rates in the coming months. We are forecasting U.S. economic growth at 2.5% – 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 several times 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.

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