Third Quarter 2014 Letter
October 7, 2014, By: Harris L. Kempner, Jr., President


Recently, the most striking feature of the economic world map is the United States economic decoupling from Europe and China. The U.S. economy is growing more rapidly now than at any time in the entire recovery that began in 2009. In the second quarter the real GDP, somewhat in rebound from the first quarter, grew at +4.6. We expect +4% or above in the third quarter. In contrast, Europe’s economic engine, Germany, is moving forward very slowly and large European economies, such as France, are presently in decline.
China is still growing, but slowing down, and Japan is barely moving at all. The question is whether or not this difference in performance can continue. We think so, though perhaps with slower U.S. momentum. This is primarily because there are so many strong internal economic activities in the U.S. that are not dependent on international sales. For example:


  • The often discussed increase of domestic U.S. energy production in both oil and natural gas. Natural gas particularly provides a competitive advantage, as a cheaper industrial fuel allows the creation of less expensive industrial products and therefore more direct investment in process industries, such as chemicals.


  • The gradual weight of increased U.S. oil production on world oil prices has been sufficient to lower gasoline prices throughout the latter part of this year. Lower gasoline prices are a major supporter of the economy in this country, as more dollars are freed up for discretionary spending.


  • Housing and construction have gradually improved throughout 2014. It is lumpy, but the trend is there. This is domestic spending, pure and simple.


  • The U.S. economy is dominated by service industries. The service industry PMI for September was a very high 58.6. This indicates strong growth. In contrast, the Euro Zone service industry PMI declined to 52.6.


  • According to government statistics, 671,000 jobs were added in the last three months. As importantly, real income is increasing because, though wage increases are low, inflation rates are even lower. This is another boost to the potential for consumer spending going forward.


  • Because so much U.S. strength is based on internal economic activity, the separation of economic performance can continue. However we believe, because of worldwide slowdowns, U.S. growth will probably be slightly less than 4% in the 4th quarter. Still our country is giving a fine account of itself in the world just following a period where the U.S. was considered permanently stagnant.



All the above means that domestic earnings growth for U.S. companies will be strong, but there will be questions about companies that have large overseas earnings because of slow-downs in Europe, Japan & China.  The market has already begun to discount this trend on a stock-by-stock basis.  However, we are looking hard at stocks with substantial overseas earnings since our approach is a deep value one and many of them are being severely sold off, which often creates a long-term buying opportunity for us.



If history is any guide, increased interest rates await wage inflation.  There has been very little wage inflation so far in the five year recovery, but remember that wages are about 70% of the cost of the U.S. economy. If they start to accelerate, then there can quickly be inflationary pressures.  Everybody is trying to figure out when this might begin.  That is why we think it is useful to have the insight provided by Nancy Lazar of Cornerstone Macro, who observes that “During the last two (economic) cycles, AHE (average hourly earnings) started to accelerate relatively sharply once unemployment declined to 5.5%.”  If our labor participation rate does not increase soon, this point could be reached in early 2015.  That would make Fed tightening and higher interest rates much more likely from that point forward.


The United States continues to be the brightest spot economically in the world.  We believe this will persist due to the internal dynamics.  The stock market seems to be beginning to pick and choose among stocks that have greater or lesser domestic exposure. If our domestic employment trends continue, it is probable we will see higher interest rates during 2015.
Click here to view Disclosures