We’re All Keynesians Now

Posted on Updated on

September 16, 2019

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, Strider Elass – Senior Economist, Andrew Opdyke, CFA – Economist, Bryce Gill – Economist

“We are all Keynesians now,” is a phrase that caught on inthe late 1960s and early 1970s, variously attributed to Milton Friedman and President Richard Nixon. Uncle Milty was commenting on the general political/economic environment, not saying he was a Keynesian. Richard Nixon, on the other hand, actually said “I am now a Keynesian.”

We bring this up because it’s happening again. While we won’t explain the entire theory of economics proposed by John Maynard Keynes, it was a “demand-side” belief system. A key tenant was using government spending, budget deficits, and loose money to let bureaucrats exert control over the economy.

After its failure in the 1970s, Ronald Reagan and Margaret Thatcher changed the world by moving it back toward a supply- side, small government mentality. The U.S. and U.K. moved from high inflation, high unemployment, and slow growth, to low inflation, low unemployment, and strong growth.

But, since the crisis of 2008, the commanding heights of economic control have once again shifted toward big government. Quantitative easing, zero percent interest rate policy (ZIRP), negative interest rate policy (NIRP), TARP, infrastructure spending, minimum wages, and new ideas for wealth taxes, free healthcare,…etc., have all been either proposed or tried.

The result?  Ever since government assumed the high ground, global growth has slowed. Especially when compared to what it was in the 1980s and 1990s when government was reducing its role in the economy.

Does the consistent failure to create growth matter to those who are proposing bigger government? Absolutely not. They ignore it and call for even more government intervention.

Just this past week, Mario Draghi, in his last action as head of the European Central Bank, cut the interest rate it pays on excess reserves to -0.5% from -0.4%. But negative interest rates have been little short of a disaster. European and Japanese banks are suffering. Their loans and economic activity haven’t budged. There is zero evidence that negative interest rates help economic activity, but plenty of evidence they hurt.

 

Draghi, himself, called for “fiscal” policy help for theeconomy, but he wasn’t suggesting tax cuts and regulatory relief, he meant more government spending – a purely Keynesian prescription.

Here’s the problem. Demand-side, Keynesian policiesdon’t work. Growth comes from the supply-side – from inventions, innovation, and entrepreneurship. In fact, between 2009 and 2016, without the tremendous tailwinds from the likes of fracking, smartphones, apps, and 3-D printing, it is easy to believe that two major tax hikes, increases in regulation and spending, and massive fines on financial institutions would have pushed real GDP growth negative.

Government is bigger and tax rates and regulation more burdensome in Europe. That’s why it’s lagged U.S. growth for decades. What the world learned in the 1980s was quickly forgotten by Europe, and now it’s being forgotten by thought leaders in the U.S.

These old ideas have also transfixed investors, who cannot think about the economy without coming at it from a government policy point of view. How much new QE will the ECB propose?And what about President Trump’s tweet that the U.S. should have negative interest rates?

This is all dangerous for long-term economic growth in both the U.S. and abroad. People will suffer to the extent these policies are followed. The good news is that, in the near-term, corporate tax cuts in the U.S. and a continued reduction in regulation are positives for the supply-side, more than offsetting the cost of trying to bring China in-line with global norms. Thanks to these supply-side policies, the U.S. does not face a recession. New technology is continuing to lower costs, increase profit margins, and boost earnings.

None of this positive news is from government spending. In fact, government spending only crowds out the private sector and reduces investment and opportunity. If the U.S. does not change course, and follows Europe through the Keynesian looking-glass, it will eventually pay a price. A damaging price.  But for now, it’s just words and fear. And profits and growth beat out words and fear every day.

page1image2766247440

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

9-16 / 7:30 am

Empire State Mfg Survey – Sep

4.0

5.4

2.0

4.8

9-17 / 8:15 am

Industrial Production – Aug

+0.2%

+0.1%

-0.2%

8:15 am

Capacity Utilization – Aug

77.6%

77.5%

77.5%

9-18 / 7:30 am

Housing Starts – Aug

1.247 Mil

1.255 Mil

1.191 Mil

9-19 / 7:30 am

Initial Claims – Sep 14

212K

212K

204K

7:30 am

Philly Fed Survey – Sep

11.0

15.5

16.8

9:00 am

Existing Home Sales – Aug

5.370 Mil

5.440 Mil

5.420 Mil

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/9/16/were-all-keynesians-now

Advertisements

Rorschach Economics

Posted on Updated on

September 9, 2019

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, Strider Elass – Senior Economist, Andrew Opdyke, CFA – Economist, Bryce Gill – Economist

We’ve all heard of the Rorschach test – you know, the one where you look at an ink blot and say what you see. The theoryis that it’s a tunnel into someone’s subconscious thoughts ordesires. If you’re obsessed with hockey you might look at an ink splotch and see hockey sticks, or pucks, a Stanley Cup, or even Bobby Orr; if someone is obsessed with outer space, she could look at the same picture and see flying saucers or aliens.

These tests come to mind because lately, three dominant types of economic thought seem to analyze every data point and come to conclusions that always support their particular interpretation of the US economy.

One group is obsessed with President Trump’s tariffs, thinking they are slowing the economy. They even search the internet and earnings calls to find mentions of “trade uncertainty”to prove their point. But uncertainty is one thing, data are quite another. Total US trade in goods and services (exports plus imports, combined) was $4.9 trillion in 2016. In the past twelve months, it’s been $5.7 trillion, an increase of 14.5%. In other words, trade has grown faster than the overall economy.

Yes, we know trade tensions with China are real and important for some companies. And yes, we look forward to the US reaching an agreement with China. But the Middle Kingdom is not the be-all end-all when it comes to world trade. Supply chains are moving – trade is dynamic – which is why the costs to the US economy have been far less than static analysis predicted.

So far this year, US imports from China are down 12.3% from the same period in 2018, but imports from Vietnam are up 33.2%, and they are up 20.2% from Taiwan, 9.8% from South Korea, 9.7% from India, and 6.3% from Mexico. Meanwhile, we’re confident that Congress will pass the new version ofNAFTA by early 2020, facilitating stronger trade ties with Canada and Mexico. Trade is moving forward, not dying.

The second major thought group consists of those whoop pose the president’s policies in general and are looking for any way they can to discredit the tax cuts and deregulation. They love to focus on supposedly weak business investment, which they say signals the ineffectiveness of the president’s policies.

The problem with this theory is that, since the tax cut was enacted at the end of 2017, “real” (inflation-adjusted) business investment in equipment has grown at a 3.4% annual rate, while real business fixed investment (equipment, structures, and intellectual property) has grown at a 4.5% annual rate. These are respectable numbers. It was inventories that held down GDP growth back in Q2, and this can’t last with a strong consumer.

Moreover, productivity growth (the growth in worker output per hour) has accelerated, growing at a 1.7% annualized rate since the start of 2018 (and up at a faster 2.9% annualized rate so far in 2019), versus a 0.9% annualized rate for the four years ending in 2016.

The last of the three thought groups have been obsessing about the next recession since the moment the last one ended. Any day now they expect the “sugar high” to end.

They celebrated when the ISM Manufacturing index dropped to 49.1 last week, but then the ISM index for the much larger service sector surprised on the high side at 56.4. For every data point that signals a slow down, there are nine that don’t.

For example, a soft 130,000 gain in headline payroll growth for August dominated headlines, but civilian employment (which includes small business) surged 590,000, wage growth picked up, labor force participation moved higher, initial claims remained low, and auto and truck sales rose. Not exactly negative news.

If someone has an axe to grind about the US economy, we’re sure they’ll see a recession in whatever blot or piece of data they look at. They can always find something to worry about. Nonetheless, we continue to believe that optimism should be the default position for investors when it comes to the US.

 

 

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

9-9 / 2:00 pm Consumer Credit– Jul $16.0 Bil $16.2 Bil $14.6 Bil

9-11 / 7:30 am PPI – Aug +0.0% +0.1% +0.2%

7:30 am “Core” PPI – Aug +0.2% +0.1% -0.1%

9-12 / 7:30 am Initial Claims – Sep 7 215K 216K 217K

7:30 am CPI – Aug +0.1% +0.1% +0.3%

7:30 am “Core” CPI – Aug +0.2% +0.2% +0.3%

9-13 / 7:30 am Retail Sales – Aug +0.2% +0.1% +0.7%

7:30 am Retail Sales Ex-Auto – Aug +0.1% 0.0% +1.0%

7:30 am Import Prices – Aug -0.5% 0.0% +0.2%

7:30 am Export Prices – Aug -0.3% +0.1% +0.2%

9:00 am Business Inventories – Jul +0.3% +0.4% 0.0%

9:00 am U. Mich Consumer Sentiment- Sep 90.4 90.3 89.8

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/9/9/rorschach-economics

Business Uncertainty

Posted on Updated on

August 26, 2019

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, Strider Elass – Senior Economist

 

Analysts were very quick to pin the blame for weakness in stocks late last week on the trade war with China. We agree that uncertainty regarding the future of US-China trade relations were a drag on equities, but think it was far from the only reason for weakness. In fact, it wasn’t even the most negative news of the week.

The US exported $171 billion of goods and services to China in the four quarters ending in Q1 (the latest data currently available), representing about 7% of total US exports. By contrast, about 12% of US exports went to Mexico, 14% to Canada, and 23% to the European Union. Yes, China is also a key location for production (and, therefore, profits) by US companies, but other areas are capable of picking up much of the slack, including India, Vietnam, and Mexico.

The trade war with China is costly, but unlikely to go global like it did during the Great Depression. Instead, intensifying the trade war with China would make it politically more favorable for the Trump Administration to strengthen trade ties with others, and be more inclined to relieve tariff pressure and threats on other countries. For example, the US announced Sunday that it had an agreement in principle with Japan on a new trade deal that could be signed in September.

To us, the most worrisome news of the week wasn’t the trade issues or the debate about monetary policy, which is a consistent obsession of financial journalists and social media. The most worrisome news was the Business Roundtable announcing that almost all of its CEOs signed a statement saying they were no longer going to run their companies with the primary goal of serving shareholders. Instead, CEOs would lead their companies to benefit all “stakeholders,” including “customers, employees, suppliers, communities, and shareholders.”

This is an outright rejection of what’s come to be known as the Friedman Doctrine, named after free-market icon Milton Friedman, which suggests that a firm’s only objective should be to act on behalf of its shareholders. In turn, if shareholders want to use their wealth to pursue pet personal or social causes, they’re free to do so themselves with their earnings from corporate profits. “Insofar as a [corporate manager’s] actions, in accord with his ‘social responsibility,’ reduce returns to shareholders, he is spending their money,” Friedman wrote.

Imagine if Tom Brady and Bill Belichick announced that their primary goal was no longer to win ballgames. We’re thinking Bob Kraft would not be happy and the New England Patriots football team wouldn’t be worth quite as much after the announcement as it was before. Well, that’s part of what we think happened to the stock market last week.

Some analysts have argued that, in today’s world, demoting the importance of the shareholder is the only way companies can hire “top talent.” That crowding out of the normal corporate mission, by letting workers pursue some projects that have no apparent direct link to the company’s bottom line, is, supposedly, the best way to maximize shareholder value.

But workers, just like shareholders, are always free to pursue these missions on their own time, and on their own dime. When companies decide to support a mission based on their “top talent’s” conception of social responsibility, it marginalizes those at the company who think the mission is a low priority or just plain wrong. And it may undermine profitability and therefore the sustainability of those actions. Without profits, acompany can’t pursue any social agenda.

Part of this is political correctness, but it’s also about elite business managers looking for an excuse to exploit their managerial positions (and control of corporate assets) to further their own personal goals. This is just age-old rent-seeking under the corporate umbrella. Either way, this shift in thinking is not good for the long-term value of corporate equities.

 

page1image4225347072page1image4225347344

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

8-26 / 7:30 am

Durable Goods – Jul

+1.0%

+1.4%

+2.1

+1.9%

7:30 am

Durable Goods (Ex-Trans) – Jul

0.0%

-0.1%

-0.4%

+1.0%

8-29 / 7:30 am

Initial Claims – Aug 24

215K

213K

209K

7:30 am

Q2 GDP Preliminary Report

2.0%

1.9%

2.1%

7:30 am

Q2 GDP Chain Price Index

2.4%

2.4%

2.4%

8-30 / 7:30 am

Personal Income – Jul

+0.3%

+0.3%

+0.4%

7:30 am

Personal Spending – Jul

+0.5%

+0.5%

+0.3%

8:45 am

Chicago PMI

47.9

46.2

44.4

9:00 am

U. Mich Consumer Sentiment- Aug

92.3

92.5

92.1

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/8/26/business-uncertainty

This Is Not 2008

Posted on Updated on

August 19, 2019

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, Strider Elass – Senior Economist

The threat of a recession is on the minds of investors. Some traditional measures of the yield curve are inverted and, in the past, those have preceded recessions. The link between an inverted yield curve and a recession has so dominated recent financial news that for some investors it’s no longer a matter of whether we get a recession, but how long until it starts.

What these investors are ignoring is how different recent circumstances are from the environment that preceded prior recessions.

Think about the Panic of 2008. The bubble in home prices in the prior decade pushed national home values more than $6 trillion above “fair value” (based on the normal relationship between home prices and rents). At the time, that over-valuation was the equivalent of about 50% of annual GDP.

The process of unwinding that massive over-valuation happened when bank capital ratios were significantly lower than they are today. And, more importantly, the unwinding happened when banks had to use overly strict mark-to-market accounting standards that required them to value mortgage-related securities at “fire sale” prices regardless of how solid the actual cash flow was on many of these instruments.

Pretty much everyone agrees that housing isn’t grossly overvalued like it was in the years before the Panic. But some think we now have overvaluation in the stock market, so a downdraft in equities will play at least part of the role previously played by real estate, perhaps like back in the 2001 recession.

The problem with this theory is the capitalized profits model we use to assess “fair value” on the stock market says stocks were substantially over-valued at the peak of the first internet boom before the 2001 recession but are still under-valued today.

The price-to-earnings ratio on the S&P 500 peaked at 29.3 in June 1999 (end-of-month, based on trailing 12-month operating earnings). At the end of July 2019, the same ratio was 19.3, more than one-third lower. Meanwhile, the 10-year Treasury yield finished June 1999 at 5.81%. Investors today would kill to get that kind of safe yield, versus the 1.55% we had at Friday’s close. In other words, the stock market is nowhere near the situation it was in about twenty years ago.

Let’s also think about the recessions of 1990-91 and 1981- 82, both also preceded by inverted yield curves, but also preceded by a heck of a lot else. Before the stock market crash of 1987, the Federal Reserve had been gradually raising rates. But the October crash temporarily threw the Fed off course, getting it to cut rates, instead. Once it was clear the crash wasn’t the onset of another Great Depression, which some believed at the time, the Fed started raising rates again in early 1988.

By early 1989, the Fed was targeting short-term rates near 10% and the yield curve was inverted all the way out through the 30-year Bond. Unfortunately, the consumer price index was up 5.4% in May 1989 from the year prior. Even “core” prices, which exclude food and energy, was up 4.6%. The Fed was tight but justifiably so, because tight money was the only way to reduce higher inflation. Remember, this was only a decade removed from bouts of double-digit inflation, and so, back then, it was tougher to wrestle higher inflation expectations out of the minds of investors, workers, and consumers.

By contrast, the largest 12-month change in the core CPI since the expansion started is 2.4% and the Fed hasn’t adopted policy tightness to squeeze this out; if anything, with overall CPI inflation now at 1.8%, the Fed has hinted they’d like to see higher inflation.

The same goes for the recession of 1981-82, but even more so. CPI inflation peaked at 14.8% in 1980 and was still hovering above 10% early in President Reagan’s first year in office. So Fed Chairman Paul Volcker jacked up short-term rates to about 19% to smash inflation. By contrast, the 30-year Treasury Bond was yielding about 13%. You want to know what an inverted yield curve looks like? That’s an inverted yield curve.

The bottom line is that yes, the yield curve inverted prior to each of the recessions we discussed, but there were a lot of other things going on, not just the inversion. This time around we search in vain for a housing bubble, low capital ratios among US banks, mark-to-market rules that can turn a downturn into an inferno, a bursting stock market bubble, or a stubborn rise in inflation that the Fed has had to choke off with tight money. Without any of those ingredients, we still believe those predicting a recession in the near term are way too pessimistic.

The only bubble we see right now is in the bond market, with yields way too low given solid economic fundamentals.But, with the Fed unlikely to raise rates, that bubble’s notbursting anytime soon. More likely is a gradual deflating as investors get better returns elsewhere and yields eventually move higher.

 

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

8-21 / 9:00 am

Existing Home Sales – Jul

5.390 Mil

5.400 Mil

5.270 Mil

8-22 / 7:30 am

Initial Claims – Aug 17

216K

215K

220K

8-23 / 9:00 am

New Home Sales – Jul

0.645 Mil

0.643 Mil

0.646 Mil

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/8/19/this-is-not-2008

Those Crazy Negative Interest Rates

Posted on Updated on

August, 12th 2019

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, Strider Elass – Senior Economist

More than five years ago the European Central Bank adopted negative interest rates as a policy tool to address economic weakness in the Eurozone. Starting at -0.1%, eventually the target short-term rate fell to -0.4%.

In Europe, as in every country or region that has tried Quantitative Easing, banks have not increased loans by the amount that QE suggested. As a result, central banks (like the ECB) have attempted to force banks to lend by “charging” banks(with negative rates) to hold these excess reserves. Negative interest rates are “man-made”,” not something that has happened organically. More importantly, they prove QE didn’t work. If QE worked, then negative interest rates wouldn’t be necessary.

Now policymakers are nearly in a panic because some key Eurozone economies are sputtering. Germany’s industrialproduction was down 5.2% in June versus a year ago, the largest drop since 2009. Meanwhile, many now expect that German real GDP contracted in Q2. Italy’s economy hasn’t grown in the past year and France’s economy is up only 1.3% from a year ago. Some economies in Europe are doing well, particularly Polandand Hungary, but these aren’t large enough by themselves to power the whole Eurozone higher.

It’s time for Europe to recognize that neither negative interest rates nor quantitative easing have saved their economies. By using negative rates, the ECB has been trying to punish banksinto lending, and it hasn’t worked. Worse, negative rates are, in effect, a tax on the financial system. As a result, they undermine bank profitability and weaken the financial system.

Instead of looking toward monetary policymakers to rescue their economies, they needed to point their fingers at the real culprits all along, bad fiscal and regulatory policies. Germany, for example, is still running budget surpluses even though investors buying their debt are willing to accept negative rates. This is absurd.

This isn’t to say the German government should spendmore, spending is already too high. But Germany has room for deep tax cuts oriented toward boosting incentives for investment and economic growth. Increasing the incentive to produce would, in turn, generate the growth in lending that negative interest rates were supposed to encourage.

On top of tax cuts, we’d recommend cutting governmenttransfers to non-workers (yes, that includes limiting the generosity of future government retirement benefits) and regulations that have stifled entrepreneurship.

Hopefully the US learns the right lessons from Europe’scrazy negative rate approach, which is an admission of failure by government officials. In the 1980s, the US saw real GDP growth of 4% – not because of low (or negative) interest rates – but because of better fiscal policies. Paul Volcker actually held interest rates high while President Reagan pushed through tax rate and regulatory reductions and spending restraint. Those policies strengthened the dollar and the economy. That’s what works.

 

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

8-13 / 7:30 am CPI – Jun +0.3% +0.2% +0.1%

7:30 am “Core” CPI – Jun +0.2% +0.2% +0.3%

8-14 / 7:30 am Import Prices – Jul -0.1% -0.2% -0.9%

7:30 am Export Prices – Jul -0.1% 0.0% -0.7%

8-15 / 7:30 am Initial Claims Aug 10 212K 211K 209K

7:30 am Retail Sales – Jul +0.3% +0.2% +0.4%

7:30 am Retail Sales Ex-Auto – Jul +0.5% +0.3% +0.4%

7:30 am Q2 Non-Farm Productivity +1.4% +2.1% +3.4%

7:30 am Q2 Unit Labor Costs +1.8% +2.5% -1.6%

7:30 am Empire State Mfg Survey – Aug 1.9 6.0 4.3

7:30 am Philly Fed Survey – Aug 10.0 16.4 21.8

8:15 am Industrial Production – Jul +0.1% +0.2% 0.0%

8:15 am Capacity Utilization – Jul 77.8% 78.0% 77.9%

9:00 am Business Inventories – Jun +0.1% 0.0% +0.3%

8-16 / 7:30 am Housing Starts – Jul 1.253 Mil 1.260 Mil 1.253 Mil

9:00 am U. Mich Consumer Sentiment- Aug 97.4 98.9 98.4

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

 

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/8/12/those-crazy-negative-interest-rates

The Flailing Fed

Posted on Updated on

August 5th, 2019

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, Strider Elass – Senior Economist

The Fed is flailing.

For the past several years, under the leadership of both Jerome Powell and, before that, Janet Yellen, the Fed claimed itwas “data dependent.” But the decision last week to reduceshort-term rates by 25 basis points tore that narrative to shreds.

At the prior Federal Reserve meeting in mid-June, a slender majority of Fed policymakers projected no rate cuts this year. After that, the data flow on the economy was generally better than expected, including solid reports on jobs, retail sales, manufacturing production, and real GDP. These figuresundermined the Fed’s forecast that real GDP would grow only2.1% this year. In addition, both consumer and producer prices rose more than expected. If the Fed were really data dependent then, if anything, these data should have moved it away from a rate cut.

The oddest part of the Fed’s decision was Powellacknowledging how little its rate cut means. “(W)e don’t hear that from businesses. They don’t come in and say we’re not investing because…the federal funds rate is too high. I haven’t heard that from a business. What you hear is that demand is weakfor their products.” And yet, the US consumer looks pretty strong. Core retail sales, which exclude volatile items like autos, building materials, and gas, are up 4.4% from a year ago and up 10.6% annualized so far this year.

Powell said at the press conference following the meeting that the Fed wants to “ensure against downside risks to the outlook from weak global growth and trade tensions.” Yes, Europe and China have experienced slower growth. But some of the slower growth abroad, particularly in China, is a result of changes in trade policy so that the US no longer subsidizes Chinaby turning a blind eye to that country’s piracy of intellectual property. And slower growth in Europe is largely a function of structural issues that US monetary policy can’t solve: too much redistribution, too much regulation, too much socialism. Moreover, it’s not clear that slower growth overseas is a negative for the US; some of the slower growth abroad is because tax cuts and deregulation have made the US a better place to do business.

Another possibility is that the Fed is very concerned about the inverted yield curve, but is too scared to say it. Maybe the Fed thinks very low long-term rates are, in part, a function of weak expectations of future growth (regardless of today’s solid growth) and that if short-term rates stay above long-term rates, then eventually businesses and consumers will have an incentive to postpone economic activity because short-term rates will eventually move lower, as well.

But if that’s what the Fed thinks then deciding to cut ratesonly 25 basis points might have been the worst decision it couldhave made. If the Fed didn’t cut rates at all and the Fed’sstatement and press conference focused on the bright side of the US economy, it could have spurred an increase in long-term interest rates that would help unwind the inversion of the yield curve. Or, as an alternative, the Fed could have cut rates more drastically, in the 50-100 bp range, to make sure short-term rates go below long-term yields, and then make it clear in the statement that the Fed was simply reacting to the yield curve and that the prospects for the economy remain bright. Instead, by reducing rates only 25 bp and letting the markets assume further rate hikes ahead, it did very little to end the inversion.

Our view remains that last week’s rate cut wasn’t needed,nor are further rate cuts in the months ahead. Nominal GDP is up 4.0% in the past year and up at a 5.0% annual rate in the past two years. Gold is up 12.3% so far this year. There are plenty of excess reserves in the banking system. The Fed is not tight.

At a deeper level, we think the Fed’s recent flailing is an inevitable result of the experiment that began during the Panic of 2008 when it started paying banks interest on reserves. The Fed then shifted to implementing monetary policy by directly targeting interest rates rather than managing the supply of money and deciding what short-term interest rate was appropriate given its target for the money supply.

Either way, it looks like the flailing Fed is headed for another rate cut at the meeting in September. The Fed is under enormous pressure to reduce rates, both political and from thebond market. Maybe that’s why it’s having so much troublearticulating a rationale. Eventually, inflation will rise as a result. In the meantime, equities remain very cheap.

 

page1image201021824

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

8-5 / 9:00 am

ISM Non Mfg Index – Jul

55.5

55.8

53.7

55.1

8-7 / 2:00 pm

Consumer Credit– May

$16.1 Bil

$15.4 Bil

$17.1 Bil

8-8 / 7:30 am

Initial Claims – Aug 3

215K

213K

215K

8-9 / 7:30 am

PPI – Jun

+0.2%

+0.2%

+0.1%

7:30 am

“Core” PPI – Jun

+0.2%

+0.1%

+0.3%

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/8/5/the-flailing-fed

 

Solid GDP Report

Posted on Updated on

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, Strider Elass – Senior Economist

July 29th 2019

A cottage industry has sprung up in the past decade with the sole focus of discrediting any good news on the economy. When President Obama was in office, the attacks mostly came from the right. With President Trump in Office, the attacks mostly come from the left. Since March 2009, regardless of who was in office, we have stridently argued that this recovery has legs. The result? We have been attacked from both sides of the political aisle.

The latest debate is over real (inflation-adjusted) GDP, which grew at a better than expected 2.1% annual rate in Q2. Some say it showed soft spots from the trade war and weak business investment.

It’s true that net exports (exports minus imports) trimmed the Q2 real GDP growth rate by 0.65 percentage points. But that follows the Q1 boost to growth of 0.73 points. In the past year, trade has subtracted an average of 0.58 points each quarter. For comparison, we saw larger drags from net exports in 2010, 2014, and 2015, all years without “trade wars.” Our conclusion: this is statistical noise.

That leaves real business fixed investment, which declined at a 0.6% annual rate in Q2, the first drop since 2016. Many have taken this as proof that tax cuts and deregulation didn’t work.

But the Q2 decline was almost entirely due to a drop inbrick and mortar investment (what economists call “structures”).In the age of the Internet, software and computers are replacing brick and mortar. We buy airline tickets online, not in an office.

 

Blockbuster was replaced by Netflix. You don’t need to leave the comfort of your home, the stores come to you. As a result, investment in structures has slowed in recent years while investments in technology and equipment have continued to rise. Strip out structures, and real fixed investment rose at a 1.9% annual rate in Q2 2019.

More importantly, business investment ex-structures has clearly picked up under the Trump Administration compared to Obama’s second term.

Why only use the final four years of the Obama Presidency? Because the first four years were driven by a V-shaped recovery from the Panic of 2008. His second term illustrates the impact of tax hikes and more business regulation.

Real business investment, excluding structures, grew at a 3.8% annualized rate between Q4 2012 and Q4 2016, but accelerated to a 5.9% annualized rate since Trump took office. Real Investment in software and R&D grew at a 5.5% annualized rate in the final four years of the Obama Administration versus 7.5% since the start of 2017. Tax cuts and deregulation have indeed boosted “animal spirits.”

In addition, Core GDP – combining personal consumption, business investment, and home building – grew at a very solid 3.2% annual rate in Q2. Meanwhile, profit reports are widely beating expectations. The economy is much stronger than conventional wisdom thinks and has been since 2009.

 

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

7-30 / 7:30 am Personal Income – Jun +0.4% +0.4% +0.5%

7:30 am Personal Spending – Jun +0.3% +0.3% +0.4%

7-31 / 8:45 am Chicago PMI 51.5 50.1 49.7

8-1 / 7:30 am Initial Claims – Jul 27 212K 212K 206K

9:00 am ISM Index – Jul 52.0 51.8 51.7

9:00 am Construction Spending – Jun +0.3% +0.2% -0.8%

8-2 / 7:30 am Non-Farm Payrolls – Jul 169K 152K 224K

7:30 am Private Payrolls – Jul 166K 139K 191K

7:30 am Manufacturing Payrolls – Jul 5K 6K 17K

7:30 am Unemployment Rate – Jul 3.7% 3.7% 3.7%

7:30 am Average Hourly Earnings – Jul +0.2% +0.2% +0.2%

7:30 am Average Weekly Hours – Jul 34.4 34.5 34.4

7:30 am Int’l Trade Balance – Jun -$54.6 Bil -$55.1 Bil -$55.5 Bil

9:00 am Factory Orders – Jun +0.8% +0.4% -0.7%

9:00 am U. Mich Consumer Sentiment- Jul 98.5 98.4 98.4

afternoon Total Car/Truck Sales – Jul 16.9 Mil 16.5 Mil 17.3 Mil

afternoon Domestic Car/Truck Sales – Jul 13.1 Mil 12.8 Mil 13.4 Mil

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/7/29/solid-gdp-report

 

Temporary Tepid Growth for Q2

Posted on Updated on

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, Strider Elass – Senior Economist

July 22, 2019

 

This Friday, the government will release its initial estimate of real GDP growth in the second quarter, and the headline is likely to look soft. At present, we’re projecting an initial reportof growth at a 1.8% annual rate.

If our projection holds true, we’re sure pessimistic analysts and investors will latch onto the slowdown from the 3.1% growth rate for the first quarter, implying that we’re back to slower Plow Horse growth for good. They will argue nothing has substantially changed since Trump took office, despite tax cuts and deregulation.

It’s true that an annualized growth rate of 1.8% would be the slowest pace since the first quarter of 2017. But, as we will explain below, growth in the second quarter was likely held down temporarily by businesses returning to a more sustainable pace of inventory accumulation following the rapid pace of inventory building in the second half of 2018 and first quarter of this year. Excluding inventories – focusing on what economists call final sales – we estimate that real GDP grew at a 3.1% annual rate in Q2.

We also like to follow what we call “core GDP,” which is real growth in personal consumption, business investment, and home building, combined. Core GDP looks like it grew at a 4.1% annual rate in the second quarter, the fastest pace in a year. In other words, while the economy may not be booming like the mid-1980s or late-1990s, the underlying trend remains quite healthy, and certainly much better than the Plow Horse period from mid-2009 through early 2017.

Here’s how we get to our 1.8% real growth forecast for Q2:

Consumption: Automakers say car and light truck sales grew at a 2.8% annual rate in Q2 while “real” (inflation-adjusted) retail sales outside the auto sector grew at a 3.9% rate. Combined with some less up-to-date figures on consumer spending on services, real personal consumption (goods and services combined) looks to have grown at a 4.0% annual rate, contributing 2.7 points to the real GDP growth rate (4.0 times the consumption share of GDP, which is 68%, equals 2.7).

Business Investment: Reports on durable goods shipments and construction suggest all three components of business investment – equipment, commercial construction, and intellectual property – rose in the first quarter. A combined growth rate of 5.1% adds 0.7 points to real GDP growth. (5.1 times the 14% business investment share of GDP equals 0.7).

Home Building: After five straight quarters of contraction, it looks like home building – a combination of new housing as well as improvements – increased at a 2.6% annual rate in Q2. Expect more gains in the quarters ahead as home builders are still constructing too few homes given population growth and the scrappage of older homes. In the meantime, a 2.6% pace translates into a boost of 0.1 point to real GDP growth. (2.6 times the 4% residential construction share of GDP equals 0.1).

Government: Looks like a relatively large 2.3% increase in real public-sector purchases in Q2, which would add 0.4 points to the real GDP growth rate. (2.3 times the government purchase share of GDP, which is 17%, equals 0.4).

Trade: Net exports’ effect on GDP has been very volatilein the past year, probably because of companies front-running – and then living with – tariffs and (hopefully) temporary trade barriers. Net exports added 0.9 points to the GDP growth rate in Q1, but should subtract an almost equal 0.8 points in Q2.

Inventories: Inventories are a potential wild-card, because we are still waiting on data on what businesses did with their shelves and showrooms in June. We get a report on inventories on Thursday, the day before the GDP report arrives, which may change our final GDP forecast. In the meantime, it looks like the pace of inventory accumulation got back to more normal levels in Q2, which should temporarily subtract 1.3 points from real GDP growth.

Add it all up, and we get 1.8% annualized real GDP growth. Don’t let this tepid headline number spoil your day; the trend remains strong where it matters most, and prospects are bright for the US economy.

 

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

7-23 / 9:00 am

Existing Home Sales – Jun

5.330 Mil

5.240 Mil

5.340 Mil

7-24 / 9:00 am

New Home Sales – Jun

0.660 Mil

0.638 Mil

0.626 Mil

7-25 / 7:30 am

Initial Claims – Jul 22

218K

217K

216K

7:30 am

Durable Goods – Jun

+0.7%

+0.8%

-1.3%

7:30 am

Durable Goods (Ex-Trans) – Jun

+0.2%

+0.2%

+0.4%

7-26 / 7:30 am

Q2 GDP Advance Report

1.8%

1.8%

3.1%

7:30 am

Q2 GDP Chain Price Index

2.0%

1.9%

0.9%

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/7/22/temporary-tepid-growth-for-q2

 

Lifting Our Target for Stock Prices

Posted on Updated on

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, Strider Elass – Senior Economist

July 8th, 2019

The S&P 500 is up 27% from its Christmas Eve low, and 19.3% this calendar year through the close on Friday – not including dividends. Last December, our forecast for 2019 was3,100. We’re just 3.7% away.

As a result, and in combination with our continued bullishness, we are raising our year-end 2019 S&P 500 target to 3,250 from 3,100, with the Dow Jones Industrials Average now estimated to finish the year at 29,250.

Our starting point for setting a stock market target is always our Capitalized Profits Model, which continues to scream BUY. The model takes the government’s measure of profits fromthe GDP reports divided by interest rates to measure fair value for stocks. It looks at every quarter dating back to the early 1950s and uses each of those quarters to tell us where the stock market would be today if equities had increased as much as the ratio of profits to the 10-year Treasury yield. We then take the median of all those predictions (each historical quarter generating its own

prediction) to estimate fair value today.
Using a 10-year Treasury yield of 2.03% combined with

corporate profits from the first quarter suggests a fair value on the S&P 500 of 5,080!!! This is absurd, and the market will not price it in because it knows the Fed is holding interest rates artificially low.

In fact, the stock market has been significantly below our model’s estimate of “fair value” for a decade because everyoneknows that interest rates are artificially low. In other words, our model says that the analysts who argue that asset values are in a bubble because of the Fed are wrong. If the market fully incorporated these low rates it would be significantly higher.

Another way to think about this is to ask what interest rate would put the market at fair value with current corporate profits. The answer is a 10-year yield of 3.45%, which is an interest ratewe haven’t seen since early 2011 and doesn’t look likely anytimein the near future.

The interest rate that would make 3,250 fair value is 3.175%, which is also higher than yields are likely to hit. Moreover, corporate profits are likely to rise in the quarters

ahead, which suggests room for equities to rise above our 2019 target in 2020 and beyond.

If, on the other hand, corporate profits were to drop by 15% and the 10-year yield rose to 2.7%, fair value would be 3,250, which shows how robust our stock market target is to changes in the economic and financial outlook.

Another reason to be bullish about equities is that the Federal Reserve has made it clear it will cut short-term rates if the economy falters or if inflation stays low. We think cutting short-term rates is unnecessary, but we have to factor-in what the Fed is likely to do, not what it should do. Even just talk about or expectations of future rate cuts will help hold down the 10-year Treasury yield relative to where it should be based on economic fundamentals.

And last, we think the next several months are more likely to lead to trade deals than an expansion of tariffs, as the election in 2020 approaches.

Some analysts and investors are concerned about the stockmarket because they can’t see corporate profits going much higher. We think that’s mistaken; the growth rate of corporate profits will be slower in 2019 than in 2018, but the level of profits has further to go up as businesses continue to adapt to a much lower tax rate on corporations and continued improvements in productivity.

Raising our target doesn’t mean there can’t be a correctionat some point, perhaps even in the near future. Corrections comeand go and we’re not in the business of trying to predict themonthly or quarterly variation in equities, nor do we think anyone else can do it on a systematic basis. What it means is that we think equities are headed much higher and that the S&P 500 is more likely to blow through 3,250 by the end of the year than it is to fall short.

We know people call us perma-bulls. We’ve been bullishsince March 2009. But this bullishness is based on our Capitalized Profits Model and our outlook for profits and economic growth. Call us what you want, but the fundamentals still point to rising stock prices. Tally ho!

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

7-8 / 2:00 pm

Consumer Credit– May

$16.5 Bil

$19.0 Bil

$17.5 Bil

7-11 / 7:30 am

Initial Claims – July 6

220K

221K

221K

7:30 am

CPI – Jun

0.0%

+0.1%

+0.1%

7:30 am

“Core” CPI – Jun

+0.2%

+0.2%

+0.1%

7-12 / 7:30 am

PPI – Jun

+0.1%

0.0%

+0.1%

7:30 am

“Core” PPI – Jun

+0.2%

+0.1%

+0.2%

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

 

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/7/8/lifting-our-target-for-stock-prices

The Longest Expansion

Posted on Updated on

Brian S. Wesbury – Chief Economist, Robert Stein, CFA – Dep. Chief Economist, Strider Elass – Senior Economist

July 1st, 2019

As of today, the current economic expansion is thelongest in US history. Ten years and a day. But just because it’s the longest doesn’t mean it’s the best. The expansions of the1960s, 1980s, and 1990s, all beat it out both in terms of the pace of growth as well as the total growth during the cycle, whether you measure from peak to peak or cycle bottom to the top.

What’s more, all the prior long booms had something incommon: major shifts toward freer markets in at least some area of public policy. In the 1960s it was the Kennedy tax cut, passed posthumously in 1964, which reduced income tax rates roughly 20% across the board, including a cut in the top rate to 70% from 91%. In the 1980s, the federal government again cut income tax rates across the board, with the top rate on the highest earners dropping to a low of 28%. In the 1990s, the capital gains tax was slashed both directly and indirectly (via lower inflation), while policymakers held down government spending, increased free trade with foreign economies, and reformed welfare.

By contrast, the current expansion happened in spite of tax hikes, more regulation and the aging Baby Boomer demographic headwinds. No wonder it was slow, what we called a Plow Horse.

That doesn’t mean we haven’t grown, or that we won’t continue to do so. Consider the litany of horror stories analysts and investors have obsessed over during the past ten years, datingback to the oft predicted “double-dip” recession. There werefears over foreclosures, defaults on muni debt, commercial real estate, the banking crisis in Cyprus, a China slowdown (multiple times!), Greece leaving the Euro, the Fiscal Cliff, Brexit, Obamacare, hyperinflation from Quantitative Easing, a recession

from Quantitative Tightening,….and on and on and on. Regardless of whether your personal politics were conservative or liberal, the bombardment was enough to send many headed for financial cover.

The story that should have held the spotlight these past ten years is entrepreneurs overcoming political obstacles to keepthe US economy growing. But that doesn’t make for a sexy headline, so don’t expect the financial media to give it muchheed.

In the past few years, the direction of policy has finally shifted pro-growth, with a deep cut in corporate tax rates, full expensing for plant and equipment, and deregulation. And the US economy responded, with growth accelerating in 2017 and 2018, and on-track for another year of growth near 3.0%.

As long in the tooth as the current expansion is, we don’tsee anything threatening to derail it anytime soon. Tax rates have been cut, regulatory policy is still headed in a better direction, and monetary policy is not tight. This is consistent with work by the San Francisco Federal Reserve Bank that showed the age of an expansion has virtually no influence on the probability of entering a recession.

We have concerns about international trade disputes but are optimistic that deals will be struck later this year. And government spending is still a problem, but not enough – at least not yet – to tank the economy.

The one thing we can count on is that the next 12 months will include stories of impending doom. We think investors who resist those stories will prosper.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

7-1 / 9:00 am ISM Index – Jun 51.0 51.3 51.7 52.1

9:00 am Construction Spending – May +0.0% +0.4% -0.8% 0.0%

7-2 / afternoon Total Car/Truck Sales – Jun 17.0 Mil 17.0 Mil 17.3 Mil

afternoon Domestic Car/Truck Sales – Jun 13.1 Mil 13.2 Mil 13.4 Mil

7-3 / 7:30 am Initial Claims – Jun 29 221K 223K 227K

7:30 am Int’l Trade Balance – May -$53.5 Bil -$53.2 Bil -$50.8 Bil

9:00 am ISM Non Mfg Index – Jun 56.0 56.1 56.9

9:00 am Factory Orders – May -0.5% -0.9% -0.8%

7-5 / 7:30 am Non-Farm Payrolls – Jun 160K 165K 75K

7:30 am Private Payrolls – Jun 155K 150K 90K

7:30 am Manufacturing Payrolls – Jun 2K -2K 3K

7:30 am Unemployment Rate – Jun 3.6% 3.6% 3.6%

7:30 am Average Hourly Earnings – Jun +0.3% +0.2% +0.2%

7:30 am Average Weekly Hours – Jun 34.4 34.5 34.4

Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/7/1/the-longest-expansion