Second Quarter 2014 Letter
July 8, 2014, By: Harris L. Kempner, Jr., President


Sometimes the most public numbers concerning the economy conceal what’s happening beneath.  This is one of those moments.  The first quarter U.S. GDP, primarily because of weather and mis-timing of health spending, was a shocking negative 2.9% (-2.9%).  We expect 2nd Qtr. GDP on the rebound to be up about 4%.  Putting the two together, it would appear the economy is growing at a rate of less than 1.5%/year.  However, beneath the surface the economy is re-accelerating at a very strong pace, and this time we are basing our projections on what is below the surface rather than the GDP numbers themselves.  We expect relatively strong economic growth for the rest of the year – averaging at least 4%/quarter for the second half.
Look at just some of the string of signs that indicate U.S. economic growth is accelerating sharply:

  • Aggregate hours increased at a 3.8% quarter over quarter annual rate in the second quarter (versus just 1.6% in the first quarter), which assuming productivity was unchanged, would imply real GDP increased at 3.8%
  • The composite PMI (Performance of Manufacturing Index) rose to 55.7% in the second quarter, versus 52.9% in the first quarter.


  • Vehicle sales increased at a 26.6% q/q annual rate in the second quarter, versus a decline of 0.1% in the first.  Vehicle sales are a direct input into consumer spending.
  • Heavy truck sales increased at a 41.7% q/q annual rate in the second quarter, versus -5.7% in the first quarter.  Heavy truck sales are a direct input into capital spending.


  • Unemployment claims declined 4.7% in the second quarter, and averaged 315,000.  In the first quarter they declined 3.9% and averaged 331,000.

There are of course still some drags.  Most importantly, consumer confidence is not high enough to indicate that consumer spending is going to be as strong as one would wish. However, we believe that unless there are significant black-tail events, the U.S. economy is finally launched – an expansion that will create over 200,000 jobs per month, substantially reduce the number of people who are perceived to be permanently unemployed, and return us to the economic strength that has been lacking since 2007-2008.

Interestingly enough, while there has been positive activity going on in the U.S. economy; there has been a disassociation between this country and the rest of the world.

  • China is in a slow-down.  They are growing, but certainly not at the rates they enjoyed in the previous five years.
  • Europe is stutter-stepping – sometimes forward, sometimes backward – growing very gradually.


  • Japan is also undergoing an economic shock.  In the second quarter consumer spending and housing declined sharply.  GDP is on track to drop substantially.  This is primarily due to the introduction of a new VAT tax increase (Value Added Tax).  Whether this is a one-time thing or not, it is not a pretty picture.

All in, the U.S. is now the economic engine of the world again – at just about the same time the chorus had been saying that could never happen.



We do not call stock markets, but we can observe how stock markets have acted under certain circumstances in the past.  One of the things the stock market dislikes is the potential of increased short-term interest rates.  We have noted that as this economy strengthens (see above), there are many people beginning to believe that short-term interest rates will increase sooner, i.e. the 3rd quarter of 2015, rather than the first quarter of 2016 as previously thought.  Under these circumstances, there have historically been downward pressures on the stock market until the extent of the interest rate rise is perceived by the market.  It is more likely than not that this will happen this time as well. If it does, we are prepared to take advantage of the buying opportunity with below market buy orders already in place.



This, of course, is the cue to say that bonds are going to be under pressure as interest rates begin to rise.  We still believe it, and we’ve been positioned accordingly for at least a year.  Observing the underlying strength of the economy that we have discussed, concerns are arising once more that inflation rates will increase.  For significant inflation to happen there must be wage price pressure increases because, after all, labor is over 70% of the cost factors in the economy.  Historically, this has happened when the unemployment rate reaches a level somewhat below 6%.  The unemployment rate is at 6.1% right now and it would appear that this area, where inflation can return and affect bond prices, is not far away.  We continue to be invested in Treasury Inflation Protected Securities (TIPS) to have some protection against that inflationary return.


What we think we are looking at is a  deceptive situation in which the growth of the U.S. GDP in the first two quarters is minimal, but underneath all that is an increasingly strong economy which finally will bring us back to the levels we have been straining for since the recession of 2008-2009.
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