Fourth Quarter 2013 Letter
January 9, 2014, By: Harris L. Kempner, Jr., President


Some economists have embraced the concept of a “New Normal” in the United States economy(Bloomberg 8/3/13). The theory, as voiced first several years ago by Bill Gross and Mohamed El-Erian of PIMCO, supports the premise that, since the 2008 economic crash, the U.S. economy has structural problems and is incapable of growing GDP over time at a rate of over 2-2 ½% in real terms.  This relative gloom has influenced a lot of decision-makers for the last three years.  We do not agree.  We believe the U.S. can and will do much better than that in terms of GDP growth over an extended period of time.

To begin with, the economy in the last two quarters of 2013 has grown substantially more than 3%(Cornerstone Macro 12/23/13).  For the calendar 2014 year, we are projecting real U.S. GDP growth of 3 ¼- 3 ¾%. In our opinion, this is now a self-sustaining recovery that will take place even as the Fed tapers (reduces) their rate of bond buying throughout the year.  We do not believe this economy needs the recent high monetary injections by the Fed to get to our projected level of GDP growth.

The Fed gave a signal (tapering) in December when they started to cut back their government bond purchases.  They now apparently believe the economy has a chance to be on a solid, sustaining growth path.  There are several positives that may have influenced their thinking.

  • The American consumer seems very solid.We have put our balance sheets in order over the last 3-4 yrs. The Labor markets (jobs) are solidly improving.  Unemployment rates have dropped from 7.9% to 7.00% during 2013.  Almost two million jobs have been created in calendar 2013 and, according to the Bureau of Labor statistics, we are close to the pre-crash high job number of January 2008.  Further, due to increases in housing prices and equities, consumer net worth is higher than before the crunch in 2007-2008. Consumer confidence, as recently measured by the Rasmussen Survey is a near six-year high. Consumer activity is about 55% of the U.S. GDP.
  • Inflation remains under control.Recent numbers indicate that the core CPI was up 1.7% year-on-year thru November, and the CPI with food and energy was up less – only 1.2% (Bloomberg 1/10/13). Wage increases are the biggest factor in U.S. inflation, and they do seem to be under control for the time being.  Our expectation is that as the economy grows, we will see a steady fall in the unemployment rate in 2014, but very little wage price pressure.  It may be a different story in 2015.  It is important to remember wages are about seventy percent of the cost in the U.S. economy.  As long as wages stay under control, no matter what happens in any other area, no real fly up in U.S. inflation is possible.  However, in addition, energy prices (due to the energy revolution we’ve discussed many times), particularly oil and gasoline prices, look as if they will stay roughly level just as they did in 2013.  This will help both consumer and inflation figures, and of course consumer and business confidence.
  • Beginning 2014, there is much lower economic drag from the Federal Government than we faced at the beginning of 2013.In January 2013 we increased Individual Withholding Taxes by over 40%.  Further, a substantial Sequester was newly in place.  We’ve learned to accommodate the increased withholding taxes.  The Sequester, due to the new Ryan-Murray bargain, is now more generous than it was at the beginning of 2013. Overall, the Federal drag, according to various economists, will be reduced from an estimated 1.9% of GDP in 2013 to an estimated .5% in 2014 (Cornerstone Macro 12/23/13). Growth will come easier with this headwind reduced.
  • The Fed is looking at a substantial growth in manufacturing, which is 12% of the U.S. economy – far more than, for example, housing, which is presently only 3% (Bloomberg News 1/3/14). Government statistics reported on Bloomberg, January 2, 2014, indicated manufacturing expanded in December at the second fastest pace in two years and is  “a sign industry will bolster growth in early 2014”.  This is another factor the Fed considered in reducing the tapering.
  • According to data released earlier this month, the U.S. trade gap continued the year’s improving trend.For November, it was the narrowest in 4 years (Commerce Department 1/7/14).  This is a specific statistical boost to the economy.
  • As mentioned in our second quarter newsletter, the United States is rapidly and massively reducing our Federal budget deficits.In May of 2013, the Congressional Budget Office was quoted by Bloomberg and others as projecting the budget deficit would improve to 4% of GDP in fiscal 2013, to 3.4% of GDP in fiscal 2014, and down to 2.1% of GDP in fiscal 2015.  The cost and revenue numbers that have come in since May indicate to us that these are actually conservative estimates for the potential reduction in the Federal budget deficit, and that the deficit is likely to be significantly lower than those current stated projections.  We are beginning to think it is feasible that we will begin to hear discussions of possible Federal budget surpluses by the end of 2015.


All of these are some of the bases for optimism about U.S. economic growth in 2014.  Several things could temper that optimism.

  • Interest rates are likely to increase over the next year because of increased economic growth.Ten-year U.S. Government bonds hit a recent high of 3.03%.  We think they could go higher, to over 3 ½% by the end of 2014. If the increase is much greater than this, it could put a damper on overall GDP growth. This would primarily affect housing, and marginally, consumer spending.  However, interest rates are still at a historically low level, so there is some room to run.
  • As a blast from the past, the question of raising the debt limit comes up again to Congress in late February/March. That would be a significant negative if it looks as if the conceptual idiocy of a Congressional standoff will be repeated.
  • Major strikes and social upheavals, centered around the questions of income inequality, would dim our optimism.


Worldwide, it looks as if there will be enough growth in areas that have been in recession that it will make up for projected slowdowns in economic growth in  the lesser developed countries.  This is particularly true in England and Continental Europe where country after country is apparently returning from recession to growth.  This includes Italy, Spain, Germany, Portugal – in fact everyone but France.  Thus China’s growth may be slowing, and overall the BRIC growth is slowing some, but there is enough elsewhere to have worldwide synchronized growth outside the U.S.  However, we believe the United States will be the main driver of the world economy this year – a change from the recent “New Normal” years.


The stock market again rose substantially in the fourth quarter, and as measured by the S&P, had a total return of over 30% last year, one of the best years in the decade.   Our estimates for S&P earnings per share for 2014 are now $118 per share, up from our 2013 estimate of $108 per share – an increase of about 9.2%.  If our estimates are correct, the S&P is trading at 15.5x forward earnings.  This is consistent with the forward P/E level that we observed quarter by quarter in 2013 as earnings estimates gradually increased during the year.  Due the strength that we perceive in the economy, these earnings estimates may be an undershot.  


The Fed has spoken, at least it sure sounds like it.  As previously indicated, we believe interest rates will be rising persistently throughout 2014.  At this writing it is not a good time to add to longer bond positions.  Our bond fund – totally in TIPS – is relatively short-term, with buying reserves to apply when we feel it is appropriate.


We are quite optimistic for the year ahead.  We think the U.S. economy in 2014 will begin to put paid to the idea of a “New Normal” and in fact we think it began to happen in the last two quarters of 2013.  This has no comment about markets, but we are more open than we have been to the possibility of relatively strong and consistent growth here, and believe that the United States will once again act as one of the main engines for the progress of the world’s economy.
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