Third Quarter 2015 Letter

October 20, 2015, By: Harris L. Kempner, Jr., President


In light of a number of shifting headwinds, we are reducing our U.S. economic growth estimates of 3 ¼-4% for calendar year 2015 to 2 ¾-3 ¼%.  In our opinion, the consumer, the bulwark of the U.S. economy, remains strong even in the face of some of the recent headlines.  U.S. manufacturing, due to a stronger dollar, slowdowns in petroleum related businesses, and weaker overseas economies, has slowed more than we had expected.    We will go into some of that in more detail in this report.


The United States

We believe the U.S. consumer is in very good shape, despite reports that retail spending was slightly negative for the month of September.  The September drop is due primarily to a 3.2% decrease in retail gasoline sales, which reflect a 28% year-over-year price decline.  However, in real inflation-adjusted, terms, we estimate that consumer spending has increased at a solid 3.5% rate for the 3rd quarter on an annualized basis.  Areas such as auto sales, building materials, e-commerce, and restaurant sales were quite strong.  This is due to the ever improving employment picture, which has led not only to real personal income growth, but also, according to a University of Michigan Consumer Sentiment report, to better consumer real income expectations since 2012, and thus an increased willingness to spend.  This latter is underpinning our estimates of future and ongoing consumer spending.  Please remember that consumer spending is 70% of the U.S. economy.


On the other hand, U.S. industrial production is in a slow-down, the severity of which we did not anticipate.  The strength in domestic consumer demand for manufactured goods is not sufficient to fully overcome present headwinds such as a stronger dollar and slow-downs in multiple other parts of the globe, which has reduced the markets for goods made in the United States.  Also, a more rapid than we expected U.S. inventory unwind has had its negative effect in the third quarter.  This is the primary reason for our reduction in overall GDP estimates for 2015.  It seems to us that this deep cyclical adjustment will impact industrial growth, and therefore GDP, for some quarters to come.


Finally, government statistics indicate government spending has increased in 2015, and is expected to increase in 2016 as well.  This combination of state, local, and federal spending seems to have made a turn toward the positive, which at least means that it is not going to be a negative for the U.S. economy over the next several years.  Much of spending that had been delayed is now being made.  



In the worldwide economy, there are ever increasing economic difficulties in certain areas of the world.  The exception is Europe, which is muddling through, with continuing strength in Germany.  France’s President recently projected on French radio (Oct. 18th) that his country will actually have economic growth of over 1% for 2015, which was a surprise to many.  Europe, it seems to us, all in, will grow at a much slower rate than the United States but,  particularly if you add England to the mix as well, will be a positive addition to world growth.


This is absolutely not true for major developing countries, such as Russia and Brazil.  These countries are in severe recessions and there is no foreseeable pull-out as long as energy and commodity prices stay relatively low.  


This brings us to China, which has been the primarily marginal consumer of commodities ranging from copper, to oil, to sugar, and cotton.  We view their recent official announcement that China’s economic growth was “only“ 6.9% with real skepticism.  Basic statistics that are widely available indicate to us that their growth was closer to 3-4%.  There have been over 100 different official easing measures ranging from financial to direct investments by the Chinese government in the last year, but we think this slow-down of theirs has further to run,  and the most likely scenario is for them to have a harder landing than what they have experienced this year. Their size means this kind of slow-down will tend to keep a lid on commodity prices worldwide.  This is good for worldwide consumers, but not great for the industries of many commodity provider countries.


So we find the worldwide economic picture more difficult than we had in previous quarters, and are braced for that to continue for some time.  The U.S. remains a beacon.



The U.S. stock market will be heavily influenced by the two major countervailing forces that we have discussed above.  We believe that the consumer, the 70% gorilla in the room, remains quite solid and that state and local government spending will also contribute to growth in the industries that serve these areas.  Manufacturing, a relatively small slice of the U.S. economy comparatively, will be pummeled by crosswinds in various markets and countries to which they try to sell.  It looks to us to remain stagnant at best during the next quarter of this year.  We believe this will present multiple questions about stock market earnings, which is as always, the main driver of stock prices, and we do not look for much growth in the market for the rest of this year.



Fixed income investments presently revolve substantially around what the Federal Reserve will do with regard to rates.  If our economic scenario holds, with continuing growth in the U.S. economy and continuing improvement of both employment and now real wages, we expect the Fed will raise rates by the end of this year.  If they do so, bonds will be somewhat weaker because of higher interest rates.



We have reduced our U.S. economic growth estimate to 2 ¾-3 ¼%.  With the exception of Europe, economies in most other parts of the developed world are struggling.  Consumers are benefitting from lower gasoline prices, but a stronger dollar is having a negative effect on exports and commodity prices are depressed.  The stock market will continue to be driven by earnings and we do not anticipate much growth in the market for the rest of the year.