First Quarter 2014 Letter
April 10, 2014, By: Harris L. Kempner, Jr., President

At the beginning of the year, we projected that U.S. economic growth would be better than the average of the past five years and would come in at 3¼-3¾% real GDP.  The first quarter of 2014 presented a national growth picture that was massively handicapped by one of the most severe winters the Midwest and Northeast United States has seen in generations.  Nevertheless, we maintain our view of overall growth in the U.S. of 3¼-3¾% in real terms for calendar 2014.  Note that this means that if growth in the first quarter was approximately 2%, as we believe, we must be projecting that growth will be picking up to better than 3½% per quarter on average for the next three quarters.

Part of the reason for this continued optimism is that in the last quarter as things warmed up in later March, there were many signs of strength in the U.S. economy:

  • Vehicle sales in March rose to a rate of 16.3 million vehicles a year. This was a seven year high.
  • U.S. manufacturing PMI in March rose to 53.7%, despite all weather-related headwinds.
  • The U.S. Service PMI, which is the largest piece of the economy, increased substantially to 53.1%, again despite all weather-related difficulties.
  • Bank Loans, for the first time since the recession, began to grow considerably, particularly loans to consumers.

In addition, there are other positive signs for the second quarter of 2014.

  • Based on Ward’s estimates, vehicle production in the second quarter is projected to increase at a 25% quarter-by-quarter annual rate, which is an encouraging sign for jobs, income, and the overall economy.
  • Easter is late this year, which probably pushed some demand into April that typically has been in March.
  • Budget deficits are at a seven-year low.
  • Household wealth is near record levels.

Most importantly for us, however, in the midst of all this is the gradual, but solid, growth in overall employment, which will benefit the U.S. economy for many quarters to come.  According to a Bloomberg report, the U.S. economy lost 8.7 million jobs in the recession of 2008-2009.  All but 437,000 of them have been regained since the recovery began.  With employment growing at approximately 180,000 jobs a month, we should be at or above the total jobs level at the height of 2007 within several months.

Within the various employment sources, private enterprise is actually above the high in 2007.  U.S. Government statistics indicate all job losses have been in various federal, state, and local government areas.  That looks to be turning as well, particularly at the state and local levels.  We find this progression promising, while recognizing the statistical picture indicates an increase in total unemployment over the time frame.

While employment is moving back solidly toward previous highs, inflation is still in check.  It is our contention that inflation is most affected by the cost of labor (wages are approximately 70% of the cost of U.S. Service economy).  There are no signs yet of labor inflation due to shortages, though we are keeping a wary eye out for such problems.  As long as jobs are increasing and inflation stays under control, we believe the basic stage is set for the kind of growth we are talking about.

One negative, of course, is the relative slow-down in China.  This will be a headwind for all the world economies, but primarily for those economies that export commodities to China.  We think it is much less of a factor in the United States and a Chinese slow-down is built in to our calculations of anticipated economic growth.

Europe and the rest of the developed world are growing very slowly, and a legitimate question that could be raised is whether the U.S. economy can continue growing, while the rest of the world is not. The answer to that question is yes, it can. We call your attention to 1992-1994, in which Europe was actually in recession, Japan was not growing, and China was a negligible factor.  However, the U.S. economy grew 3.4% annualized in those years.

Of course there are always potential Black Swan events.  The recent one that nobody saw coming was Russia/Crimea/Ukraine.  If that escalates into a serious economic and even military conflict with the West, our economic growth projections become highly questionable.  However, our best analysis at this moment is that this will not be a major economic factor.

We are still maintaining our overall perception of the U.S. economy – growth in real GDP of 3¼-3¾% in calendar 2014.  If this is true, earnings will be solid, bonds will be cheaper, and rates higher at the end of this year than they are at present.

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