KEMPNER CAPITAL MANAGEMENT, INC.
January 11, 2018
By: Harris L. Kempner, Jr.
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This year we’re expecting U.S. real GDP to grow at a rate of about 2.5%. There are many economists who are calling for higher growth in 2018, in some cases 3% real GDP or above. This is based on the strength in jobs in the manufacturing sector particularly, on possible effects of the U.S. tax cut and on a remarkable worldwide confluence of economic growth in every major region. All this exists, but we believe there are headwinds which will slow us down some.As usual, we start with the U.S. consumer and all our buying activity, which is somewhere between 2/3 and 70% of the U.S. economy. Jobs have grown by 2.06MM this year, and the most recent jobs indication was 148,000 created in December. These are solid but not spectacular numbers, which should continue in 2018. Wages are starting to increase some for the first time in years and are now around the 3% level. There’s high consumer confidence that this will continue. On another note, as far as the individual consumer is concerned, it doesn’t seem to me that the tax bill will have much effect on consumer spending. The after-tax effect of it is relatively small for most consumers and for those that it helps most, many of them are already in a category that will not be spending the incremental income but investing it. The overarching question for 2018 is, will the consumer spend most of the wage increases and/or the tax savings? I really don’t think so because of what has been happening to the savings rate in the last half of 2017. Consumer savings rates have averaged between 5% – 6% for the last several years during the recovery, but in the last 6 months we now seem to be moving toward significant overspending. The savings rate has been gradually coming down all year but it dropped significantly from 4%+ in September to 2.9% in November. We haven’t seen low levels like this since 2007. We believe that the consumer will be building that savings rate back up during 2018, not spending freely, and that we will not be as strong an impetus to the U.S. economy as might be expected from wage growth and tax decreases.

At the U.S. corporate level, there are quite some positives. Manufacturing was strong at year end due to both the U.S. economy and overseas economies. In fact, most overseas economies continue to be in-sync as far as expansions are concerned for the first time in a decade. The tax bill will add to overall U.S. profitability, particularly due to the rate drop from a nominal 35% to a nominal 21% but that drop massively overstates the actual effect on U.S. corporations since most of them have not paid anything like 35% due to various tax relief measures. Some corporate areas, particularly services, will seriously benefit from the tax decrease and should be stronger. Further, there is one area which will definitely be enhanced from the bill and that is capital goods. The new ability to write off the entire capital investment in machinery and equipment in one year, which will exist for the next 5 years, will definitely give a boost in my opinion to those sectors of corporates. However, remember that less than 20% of the total economy is attributed to corporations and their increased contribution will be therefore somewhat marginal.

Government spending is expected to be about level with 2017. A push.

Finally, there are a couple of headwinds that will have the effect of reducing the real GDP as the year progresses. One is that we believe the Fed will continue to raise short-term interest rates in 2018. We expect as many as three times. This raising of short-term interest rates will have a headwind effect, particularly on areas of the economy where heavy borrowing is a consistent piece of their activities. Secondly, statistically as we have grown, the trade deficit has substantially increased. The latest numbers in November 2017 from the federal government are that we have a larger trade deficit through November than we did all of 2016 through December, with a big negative month to come. We expect this will continue and worsen during 2018, as usually happens when the U.S. economy is strong. We expect the trade deficit to reduce real GDP overall by as much as 1% during this year. Finally, a NAFTA breakup in 2018 could have a negative effect on U.S. growth this year. All in, therefore, despite a strong worldwide economics, job creation, and the tax bill, we expect that we will have enough headwinds in the U.S. economy that the growth will end up about 2 ½%.