October 19, 2018
By: Harris L. Kempner, Jr.
We see the economy for the latter part of this year much the same as we indicated in our second quarter letter – about 2 ½-3% growth. The current economy has considerable strengths.  Most particularly, unemployment is at a decades-long low, and wages are picking up to a certain extent, which provides more money for the consumer. Businesses in general are, for now, increasing both their sales and capital investment, and government policy has been shaped by the tax bill of 2018.  Ordinarily this would lead us to considerable optimism about the quarter and the next year, except for the obstacles that are beginning to undermine this picture severely.  We now believe that 2019 will be a year with much less GDP growth (about 2%) than this one (about 3%) for the U.S. economy, with risks of 2019 becoming stagnant at the end.

Again, we are concerned by the U.S. government and others using tariffs as a weapon in order to create trade deals. This process seems to have worked to some extent with Mexico and Canada, but already the President is undermining that accomplishment by threatening to cut off the border with Mexico because of his concern about immigration.  He is quoted today as saying he’s “more concerned with immigration than with trade.” That puts even the U.S. Mexican-Canadian deal in doubt.

Europe is our largest trading partner.  Several months ago, there was a general public understanding between the European Union and the United States on tariffs. However, there has been literally no progress made since then in pinning down details.  The chance of tariff difficulties with Europe still exist. And then there’s China.  For now, there are $250 billion of tariffs on the books and there is a likelihood of another $250 billion within weeks. There are no signs whatsoever that there is a chance that this burgeoning trade war has any clear-cut resolution. So in all, about 85-90% of our trade is still affected by some possibility of tariff difficulties.  

So why are we so concerned with this?  Because tariffs are essentially a tax on goods and services that they affect.  Already, in some instances, business margins are feeling the pinch because of rising prices. This will get much worse if the Chinese tariffs spread and these others are not resolved.  The most important effect of rising prices, however, is the way it will affect the American consumer. The American consumer is 70% of the U.S. economy. There could be a significant slow-down in our propensity to consume because of higher prices, and the economy will definitely suffer a slow-down because of it.

Another unsettling factor, in our opinion, is the probability that oil prices will increase throughout this period. Experts we rely on believe that OPEC really has very little excess capacity despite various statements to the contrary.  We believe this is correct, and that the oil prices will trend somewhat higher than present levels all through 2019.
And, of course, the Fed is on a course of rate increases, which are intended to slow the economy. They usually succeed in doing so.

Because of these negative factors, and despite the built-in strengths that the American economy is showing, we are increasingly pessimistic about the economy’s growth in 2019. Our present outlook is for a gradual slowdown all year, perhaps approaching a recession at the end unless the tariff war menace is lifted from the economy.