Second Quarter 2016 Letter
July 14, 2016, By: Harris L. Kempner, Jr., President
It’s unusual that one political event has a thoroughly destabilizing influence on major world economies. One exception to that rule, in our opinion, was the Brexit vote in England on June 23rd. The massive uncertainties and difficulties of that vote to separate have already begun to affect economies in Britain and Europe, and we think they will affect the United States. These currents of indecision are enough for us to modify our view of these major economies going forward. Specifically, we believe that Britain, which was growing at a 2 – 2½% rate will be in recession by the end of the 2016. We believe that growth in Europe will be impacted sufficiently to take its growth from 1½% overall, to 1%, and even in the United States we are now changing our estimates from 2¼ – 2¾ % real growth for the year down
to 2 – 2½%.

Why? Primarily significant uncertainty affecting business decisions in all three geographic areas. It’s clearest in Britain. Choices have been made almost immediately by multiple corporations to stop expansion. Companies are contemplating changing headquarters and manufacturing from Britain to other parts of the world, mostly towards Europe. There are clear financial pressures on funds in real estate and on British banks, and British consumer confidence has plunged since the vote. We think all this will lead to a significant slow-down in Britain, which may last for years, until the relationship with Europe and the rest of the world is resolved. We believe they are truly destabilized.

I want to remind readers that Britain is the 5th largest economy in the world and a major slow-down like that will affect many others. Western Europe, i.e., the OECD (Organization for Economic Cooperation and Development) countries, will be affected by this. Their plans for exports and profitable cross-border investments in Britain will be slowed as well. Thus, the short and medium difficulties for the Continent are marginal, but real.

Before Brexit, there was already a slow-down in U.S. companies’ activities marked by a statistical slow-down in capital investment all through this year. This negative corporate trend will be increased by the uncertainties of Brexit in our opinion, and earnings of the capital complex will be negatively affected. In addition, there will be considerable business uncertainty caused by our own disconcerting and divisive political campaign for the next 4 months. However, the strength of the U.S. economy, the reason we think we’ll continue to be a 2% grower, is still the U.S. consumer.

Hiring is robust as noted in the 287,000 jobs created in June. Wages are beginning to rise as we’ve mentioned before. (Bureau of Labor Statistics) The latest 12 months from those same figures is 2.6%+ and it is a classic pattern that once wages start to rise from 2%, they tend to keep on going for several years.

Borrowing costs are low. Consumer net worth is the highest it’s ever been and debt burdens, as a percent of total income, are quite low as well. We suppose all this could change if many companies in the U.S. cut back on hiring due to the Brexit uncertainties, but so far there is no sign of that occurring yet, and we don’t think it will be severe in any case. In fact, the ISM (Institute for Supply Management) factory survey published in late June indicated that a recovery in the manufacturing industry may actually finally be taking shape. The index climbed to 53.2, which is the highest level since February 2015, boosted by stronger bookings and production. (Institute for Supply Management)

All in, we think that Brexit will have an extremely negative effect on Britain for the next 6 months and a moderately negative effect on both Europe and the U.S., but that the U.S. will be still growing at a reasonable rate of 2 – 2½% in real terms.


In a month of exceptional occurrences, the stock market was down over 6% at its lowest on the week after Brexit was announced on June 23rd, and it’s recovered all of that and gone to new all-time highs in the Dow and S&P since then. We think there are three factors involved here.

1) It is clear that with Brexit, there are reduced chances of increases in interest rates by the Fed. In fact, we believe that major central banks including the Bank of England, the European Central Bank, and the Fed are in a mode of increasing economic stimulation through monetary policy. Stock markets generally like low interest rates for the foreseeable future and this episode is no exception.
2) Analysts generally believe that S&P earnings in the 1st Quarter of this year hit a low $105 rate, but increased in the 2nd Quarter due to increases in energy prices particularly, and also some commodity prices. We agree. Earnings will also be on the increase for this third quarter, we think, and by year end will be arising to approximately a $120 rate according to estimates from ISI (International Strategy and Investment/Evercore). This is a support for the market activity. Of course, the markets can find a good many reasons to drop off as well as stay up and we’re not predicting any specific market level for that reason.


We have lowered our expectations for tightening by the Fed during this year to, at most, one ¼% rise as compared to the two raises we expected in April. In face of Brexit and its destabilization, we also now expect a slower process for rising interest rates for the next 12 months than we did before. However, if wage growth follows its typical pattern going from around 2% to around 4%, there will be inflationary pressures that may modify this view significantly by the latter half of 2017.