Second Quarter 2015 Letter

July 6, 2015, By: Harris L. Kempner, Jr., President


We are lowering our 2015 economic growth outlook for the U.S. economy from 3 ½-4% down to 3-3 ½%.  This is despite the fact that the internals of the U.S. economy are very strong indeed, and appears to be getting stronger still.  Rather, it is because of increased uncertainties in international economies and foreign affairs, which we believe will impact worldwide economic growth to a greater extent going forward than we thought at the beginning of the year.  Of concern to us are Europe, China, and the Iran nuclear negotiations, so we will begin with some discussions of those areas.


Greece & Europe

The Greek people have just voted to refuse an offer of the European Union for a bail-out.  It is not at all clear what the next steps will be, but it is important to note that Greece, itself, is not a major part of the European economy.  However, the uncertainty factor is negatively affecting Germany, and thus the rest of Europe.  Germany is almost 30% of the Eurozone in terms of its economy, and its business confidence and consumer expectations had already declined somewhat this year, even before the Greek crisis.  This has been primarily due, in our opinion, to the Russian sanctions, one of their major customers.  However, with the Greek situation we expect further declines in German optimism and therefore German economic activity, no matter how the crisis plays out in the ensuing weeks and months.  It is another straw in the load Germany, the major economic driver of Europe, is trying to carry. We believe this negativity will cause lower German GDP than we previously expected and that in and of itself, will cause a greater slow-down in Europe that will affect our economy.



We continue to believe that China is facing greater headwinds than their government’s published announcements would have us believe. The Chinese government still claims that they will have real GDP growth of 7%.  We have been skeptical of this all year, but now as events have unfolded, we are far more so.  Despite massive government efforts in every direction, they have been unable to stem the overall economic slow-down from quarter to quarter.  Deflation is continuing.  Their debt has continued to grow substantially, and is a bigger cost burden, proportionately, than at the beginning of 2015.  We are now noting that companies in China are stating that they have serious inventory problems, which will have to be worked off before the economy can grow rapidly again. We think China’s real economic growth in 2015 will be closer to 4% than 7% and that this will be a major negative factor in worldwide economic growth.  This is the most significant reason for revising our estimates of growth in the U.S. economy.



At this writing in early July, the Iran nuclear deal is coming to a head, and outlines so far indicate it is almost a certainty that it will be opposed by the U.S. Congress. The kind of effects this could have on world economies are not significant unless tensions spiral out of control and conflict ensues.  We think this is an increasing probability as things appear now, and is certainly a detriment to business confidence everywhere.


United States

No question a slow-down in Europe will affect our industrial, export, and other activities to some extent.  No question a slow-down in China will do the same.  However, the U.S. economy has gotten stronger and stronger as 2015 progresses. Decoupling lives, but not as emphatically as we thought earlier.


Once again the U.S. consumer activity, which drives 70% of our economy, continues to improve.  Payroll gains over the last six months have averaged over 200,000 and seem to be accelerating somewhat. Consumer disposable income is increasing at an above 3% annual rate, which is quite healthy. Consumer confidence has been in a rising trend for several years. Thus far, consumer confidence has not been impacted by overseas trends and, in fact, it seems somewhat insulated from them.


In addition manufacturing, as measured by the PMI, strengthened in June to 53.5%, almost +1% for the month.  Stronger vehicle production and, above all, housing, were factors here.  In fact U.S. nominal construction spending in the second quarter is reported to be on track to increase at about 15% annual rate (for the 12 months ending 6/30/2015) as compared to a first quarter annual rate of about 6% (for the twelve months ending 3/31/15.)


These major factors give us continuing confidence to believe that the U.S. economy has enough momentum to continue to grow in a healthy fashion, despite increasing uncertainty outside it.



The stock market is the area that is most whipsawed by all the countervailing winds and the emotions they cause.  If the Greek and European problem is resolved in a compromise over the next several weeks, it is quite possible that the stock market will benefit, but the headwinds from China and Iran are still negatives with which the market will have to contend.  We believe domestic earnings will continue to grow throughout the year, but overseas earnings are more in question than they have been before.  Remember, that U.S. markets are at or near all-time highs in a year that has become far more uncertain.



We still anticipate the U.S. economy is strong enough they will raise interest rates in September, despite the uncertainties we have discussed.  As stated in previous quarters, any wage acceleration can cause inflationary pressures to materialize quickly.  For this reason, our fixed income portfolios continue to be invested in U.S. Treasury Inflation Protected Securities (TIPS).



The U.S. economy has been gaining strength all year.  However, concerns about worldwide economies and their effect on the United States, have caused us to lower our 2015 U.S. GDP growth outlook from 3/1/2-4% to 3-3 ½%.  It is possible the stock market will face challenges due to events happening in the rest of the world, but it is currently near all-time highs.  We expect the Federal Reserve to raise interest rates in September and remain invested in Treasury Inflation Protected Securities as our fixed income vehicle.