Do the Least Harm

Posted on Updated on

April 6, 2020

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

Doctors think differently than economists. They put patients with a potential for brain damage in an artificial coma to stop swelling, and when it stops, they bring them out. This fits with the Hippocratic Oath all doctors take, which states “First, do no harm.” The idea is to “limit” damage and then “restart” a more normal body with fewer problems.

The economy doesn’t work that way.  You can’t just “turn it off” and then “restart it” as if nothing happened.  When you turn off an economy you create permanent damage. While this is impossible to prove – there is no precedent in history from which to judge – it is easy to surmise.

We have all heard news stories about small business owners (or know them ourselves) who have been moved to close their businesses for good. They will never re-open. Some studies say the median small business has enough cash to last less than a month. That’s the median. And there are 30 million small businesses.

Shutdowns of restaurants and bars started in mid-March, and now cover most of the United States. These shut downs spread to “non-essential” (as deemed by government) businesses over the past month. It is now April. In other words, many of those 30 million small companies are already in serious trouble. Many will be forced to close their doors for good before this is all over.

Simply put, shutting down the economy has serious consequences. If the economy were to reopen by Easter, which seems impossible now, it would probably open with, at most, 97% of its original capacity. It’s like a muscle, without use it atrophies. And when it does, it needs physical therapy to recover. The longer it’s sedentary, the worse the atrophy, the more difficult (and painful) the recovery.

If we wait until the end of April, it will be, say, 92%. The end of May and it’s 85%. The end of June and it’s even less. These are just guesstimates, we know that, but it’s what we think is the right framework to look at things. The longer the shutdown lasts, the more permanent damage to the economy. Capacity would eventually come back, but it would take time, perhaps years. Businesses that had just the right  mix of managers, workers, and suppliers, can’t just magically re-create that mix by snapping their fingers when this is done. The US economy is not Sleeping Beauty, ready to wake up at first kiss by the government.

 

During the Great Depression, the suicide rate in the US hit the highest level in history. Recessions are traumatic, both physically and emotionally. Anxiety and depression multiply the problems of being jobless. The consequences are very real, though often hard to track.

The faster the economy opens again, the less the long- term damage. But this would mean government has to do a cost-benefit analysis of economic damage as well as the health costs of Coronavirus. So far, that’s not happened. It’s time government set up a Coronavirus Economic Task Force.

It’s true that $2 trillion in government bailout money, and trillions more from the Fed, will blunt the damage. But it won’t stop the atrophy. It just slows it down. More importantly, it significantly grows the power of government. It also boosts demand for goods, while the shutdowns artificially hold back supply, which causes inflation because demand exceeds supply.

One thing to remember is that even leaving parts of the economy open – grocery and drug stores, gas stations, restaurants for take-out, etc. – risks spreading the virus. So, by choice, we are already taking risk. Let’s expand that risk assessment and take into account all the risks, including the economic ones.

Things need to change. Why can’t landscapers work? Construction crews in many states are still working. Why can’t factories or machine shops that normally produce 8 hours a day, go to 24-hour production schedules – three, 8- hour shifts with fewer employees? If I can pick up food, why can’t I eat somewhere 6 feet away from others? There have to be a million ideas. Let’s start thinking about them, because the costs of the shutdown must be balanced with the benefits. It may not be possible to “do no harm” in the response to this pandemic, but we can at least try to “do the least harm.”

Screen Shot 2020-04-06 at 12.15.24 PM.png

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/2020/4/6/do-the-least-harm

 

The Coronavirus Threat

Posted on Updated on

March 30, 2020

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

Total deaths in the US from COVID19 look like they’ll hit at least 3,000 by the end of March. A potentially brutal April lies ahead.

In the meantime, the measures taken to limit deaths have temporarily tanked the US economy. Initial claims for jobless benefits soared to 3.283 million per week, easily the highest ever. The prior record was 695,000 in October 1982; the highest during the Great Recession was 665,000.

Policymakers have reacted to the economic damage with massive measures. The Federal Reserve has reduced interest rates to nearly zero, has begged banks to use the discount window, embarked on unlimited quantitative easing, and is backstopping an unprecedented array of markets, including commercial paper, money markets, commercial mortgages, and municipal securities.

Meanwhile, we have a newly enacted “stimulus” bill that could total $2 trillion, possibly more. These include IRS checks, a major expansion in unemployment benefits, as well as a broad combination of grants, loans, and loan guarantees for businesses (large and small), hospitals, schools, and state and local governments.

The federal budget deficit for this fiscal year, previously estimated by the Congressional Budget Office to be about $1.1 trillion, could easily run around $2.5 trillion, and that’s without other major spending bills. Since World War II, the largest budget deficit relative to GDP was 9.8% in 2009; but a $2.5 trillion deficit this year could be about 11.8% of GDP.

Of course, these monetary and fiscal measures are on top of the massive economic interference – designed to stem the virus –by governments at all levels. The longer these measures persist, the greater the risk of atrophy setting in for small business across the country, making them less able to reopen in the future. The loss of intangible capital would be enormous, the internal knowledge of how to get things done. Slower economic growth in the post-COVID19 world would be the result.

 

It’s important that the expansion of government is not made permanent. The New Deal took annual federal spending from about 3% of GDP to about 10% of GDP (before World War II) and we never went back, or even close. Policymakers need to avoid making COVID19 an excuse for another permanent leap upward in the size of government, which would erode future living standards versus where they would otherwise go.

Once we have a vaccine, some things have to change. Governments at all levels should consider “strategic health reserves” of masks, ventilators, respirators,…whatever is needed in an emergency, so we don’t have to take drastic measures again. Our recent response should not be a periodic feature of American life.

Dr. Fauci recently said there could be 100,000 – 200,000 deaths. The mid-point would be 47 people per 100,000 residents, not much different from the number of people the US lost to the flu in early 1953, late 1957, early 1960, the peak of the 1968-69 Hong Kong Flu, or early 1976.

Those episodes didn’t permanently expand government and neither should this one. In order to be better prepared in the future, we need a vibrant private sector, not a permanent expansion in government.

Screen Shot 2020-03-30 at 11.34.51 AM.png

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/2020/3/30/the-coronavirus-threat

The Coronavirus Contraction

Posted on Updated on

March 23, 2020

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

Due to fears about the Coronavirus – more specifically, the forceful government measures designed to halt its spread, the US is on the front edge of the sharpest decline in economic activity since the Great Depression.

The US economy was on track to grow at around a 3.0% annual rate in the first quarter before fears and response measures escalated. Don’t just take our word for it, the GDP model used by the Federal Reserve Bank of Atlanta is still projecting real GDP growth at a 3.1% annual rate in the first quarter. That model generates a forecast based on the reported data available through March 18th, which reflects all the key economic reports for January as well as some of the key reports on activity for February.

But we all know the reports for March are going to be horrible. Initial unemployment claims recently increased 70,000 to 281,000. We’re projecting an increase to 1,500,000 for last week. To put this in perspective, the peak for any week during the Great Recession of 2008-09 was 665,000. The record high was 695,000 in October 1982. In other words, it’s getting ugly out there.

The hard data for March will show severe declines in business activity across many sectors: hotels, restaurants, airlines, autos, you name it. Small businesses are getting killed – murdered really – as government smothers them with restrictions stiffer than anything seen during the notorious Spanish Flu of 1918, the Asian Flu of 1957-58, or the Hong Kong Flu of 1968-69.

Our best guess – and, at this point, given the unprecedented nature of the situation, anyone who calls it anything other than a “guess” should be taken with a grain of salt – is that the US economy will contract at about a 35-40% annual rate in both March and April, stabilize in May, and then start growing again, gradually, in June. Translating this into quarterly changes, we’re projecting a 1.5% annualized decline in Q1, a massive 20% annualized drop in Q2, but with the economy growing at a 3.0% annual rate in Q3 and a 3.5% rate in Q4 and beyond.

To put this in perspective, the fastest drop in real GDP in any quarter in the past 73 years (so, since 1947) was the first quarter of 1958, when the US was hit by the Asian flu and fell at a 10% annualized rate.

 

It’s important to remember that certain parts of GDP will not feel a pinch, like the rental value of homes, health care,government purchases, or groceries. We’re guessing businessinvestment in intellectual property will hold up well, too.

We don’t have to fully eradicate the Coronavirus to start growing again. The largest downward pressure on the economy is likely to be felt when the number of new cases is peaking.  Once new cases have peaked, we’re likely to see a combination of either an easing of government restrictions or, informally, fewer businesses and customers complying with those restrictions. Implicitly, we’re projecting the growth in new cases will peak by mid-April, which is why we’re forecasting that economic activity levels off in May and grows beyond.

In the meantime, economy-wide corporate profits are likely to temporarily plummet, dropping by 60-80% in the second quarter. Policymakers have a number of imperatives that need to be addressed ASAP, including preventing job losses, helping those who lose jobs and customers due to the government’s restrictions, and expanding tests and quarantines for the ill so restrictions can be loosened on the rest of us. We are not typically big supporters of expansive unemployment benefits, but the situation is much different when the government is forcing businesses to shut down.

Time is of the essence. Free-market capitalism, the American way of economic life, is not consistent with mass government-imposed shutdowns of business activity. Those shutdowns, if they last too long, will erode future living standards and may end up killing more people than the Coronavirus itself. The faster we can end the shutdown, consistent with general health and welfare, the better. Therapeutics and, eventually, a vaccine are needed, and will help stem an economic downturn that could lead to a permanent (and ultimately harmful) expansion of the federal government.

The days ahead are going to be tough, no doubt about it. But in the end, the spirit of America will prevail. It always does.

Screen Shot 2020-03-23 at 11.57.46 AM.png

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/2020/3/23/the-coronavirus-contraction

Fed Fires Bazooka at Coronavirus

Posted on Updated on

March 16, 2020

 

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

Back in July 2008, then-Treasury Secretary Hank Paulson said he wanted a “bazooka” to deal with financial threats to Fannie Mae and Freddie Mac. Paulson wanted Congress to give him an unlimited credit line for these enterprises. This time around, it’s the Federal Reserve firing a bazooka at the Coronavirus, with more possibly to come.

Instead of waiting until the meeting scheduled for Wednesday, the Fed announced a broad set of new policies on Sunday. First, the Fed cut the funds rate by a full percentage point (100 basis points) to a range of 0.00% – 0.25%. That’s where it was after the financial crisis, from December 2008 through December 2015. Second, the Fed will buy an additional $700 billion in securities ($500 billion in Treasury debt and $200 billion in mortgage securities). That’s on top of the recent expansion of repurchase agreements.

Third, the Fed cut the discount rate by 150 basis points to 0.25%. That’s the rate banks pay when they borrow directly from the Fed. Notice the Fed had to cut that rate more deeply to get down to 0.25%. Normally, the Fed charges a premium at the discount window, but the Fed is now bending over backwards to remove the stigma of using the discount window. It wants to see “active use” of the window by banks with unexpected funding needs, with loans lasting up to 90 days, and with banks having the right to prepay them early or renew them at will.

Fourth, the Fed noted that banks have ample capital and liquidity and signaled regulatory forbearance for those that use these buffers to help households and businesses. Fifth, the Fed acted in concert with global central banks to make sure there’s ample liquidity for dollar swap lines, including a reduced interest rate and swaps that run to seven-week maturities versus just one week, as they do now.

But that’s not all! The Fed’s statement made it clear it is going to keep rates near zero until the economy has weathered the Coronavirus and is on track to meet the Fed’s targets for the job market and inflation. In the press conference, Fed Chief

Jerome Powell said the Fed will be “patient,” which means it’s going to be a while before we see rates go back up.

Powell also made it clear the Fed is considering using the full extent of its legal power. We think these moves could include serving as a backstop for businesses issuing commercial paper and, perhaps, municipalities issuing debt, as well. Why is this relevant now? Because if you’re a large commercial landlord, for example, whose tenants can’t pay their rent (restaurants, movie theaters, hotels…etc.), you’d be able to issue debt to get you over the Coronavirus hump. The same potentially goes for municipalities that need emergency cash. Meanwhile, banks could borrow at the discount window if the businesses they lent to (temporarily) go delinquent.

In our view, these kinds of measures make today’s rate cuts unnecessary. A discount window with no stigma would be just as useful at 1.75% as 0.25%. The same goes for potentially buying commercial paper and lending to municipalities. The good news is that the Fed looks unlikely to use negative rates, and is very unlikely to go to Congress for permission to buy equities.

We still expect positive real growth in Q1, at around a 1.5% annual rate. However, the deep and pervasive health measures to stem the spread of the Coronavirus will have a major economic impact regardless of how widespread the illness becomes. As a result, we now think the economy will take a huge hit in the second quarter, contracting at an annual rate of around 10% (like in the first quarter of 1958, during the Asian Flu) with growth returning to a 4.5% to 5.0% average rate in the second half of 2020 and all of 2021. That’s only one quarter of negative growth, but it’s a doozy. Look for the jobless rate to hit 4.5% by year end, returning to 3.5% by the end of 2021.

A Coronavirus Recession may sound like a reason to sell, but it’s not. Stocks typically rise starting 3 – 6 months before a recovery. We’re already in that window. Those who sell now are likely to regret it.

Screen Shot 2020-03-16 at 11.21.35 AM.png

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/2020/3/16/fed-fires-bazooka-at-coronavirus

A Coronavirus Recession?

Posted on Updated on

March 9, 2020

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

No one knows with any real certainty how much, or for how long, the Coronavirus will impact the US economy. What we do know is that it will have an impact. And, after data releases of recent weeks, we also know that the US economy was in very good shape before it hit.

Nonfarm payrolls grew by a very strong 273,000 in January and another 273,000 in February. The unemployment rate was 3.5% in February and initial claims for jobless benefits were 216,000 in the last week of February. Retail sales in January were up 4.4% versus a year ago. In February, sales of cars and light trucks were up 1.9% from a year ago and were above the fourth-quarter average. This suggests that total retail sales for February rose as well.

Industrial production fell 0.3% in January, but likely rebounded sharply in February. After all, hours worked in manufacturing durable goods rose 0.9% in February and colder weather likely lifted utility output.

Housing starts have been particularly strong lately, coming in at an average annual pace of 1.597 million in December and January, the fastest pace for any two-month period since 2006. Yes, part of the surge in home building was due to good weather, so February will likely fall off to around a 1.49 million pace, which excluding December and January, would be the fastest pace of building for any month since 2007.

The ISM Manufacturing index slipped to 50.1 in February from 50.9 the month before, but a level above 50 still suggests growth in factory activity nationwide. The ISM Non- manufacturing index, which measures a much larger share of the economy, rose to 57.3 in February, signaling strength.

Putting all of this data into their model, the Atlanta Fed projects real GDP is growing at a 3.1% annual rate in the first quarter. That’s not a typo. However, March data, which isn’t available yet will likely bring this number down.

The early economic headwinds from the Coronavirus are coming from slower production in China, which likely led to a big drop in inventories. We expect this to pull first quarter real GDP down to a 2.0% growth rate and we are now thinking growth will be zero in the second quarter. After that, given previous episodes of rapidly spreading viruses, inventory replenishment should boost growth to the 3.5 – 4.0% annual rate range in the second half of the year.

 

This may seem optimistic, but keep in mind what happened when the “Hong Kong flu” hit the US from September 1968 through March 1969, killing around 34,000 people in the US according to the Centers for Disease Control. During the last quarter of 1968 and first quarter of 1969, real GDP grew at an average annual rate of 4.0%. The “Swine Flu” in 2009 also did not lead to a recession.

However, a much more negative story unfolded in late 1957 and early 1958 when the US was hit by the “Asian flu,” which killed almost 70,000 in the US and didn’t spare younger people as much as the Coronavirus. Real GDP was growing around 3% annually in 1957, but as the flu started to peak in Q4, the economy shrank at a 4.1% annual rate, followed by an annualized 10.0% plunge in the first quarter of 1958, the deepest drop for any quarter in the post-World War II era (from 1947 through 2019).

But then, right after the plunge, the economy rebounded at a 7.8% annual rate for the next five quarters.

Before the Coronavirus hit we thought the odds of a recession in the next twelve months were about 10%. Now we think they’re around 20%. Higher, but not high. There is no precedent for the first social media panic regarding the flu. Either way, here’s a simple rule of thumb: if the unemployment rate goes up 0.4 percentage points or more compared to where it was three months prior then the US is probably in a recession, otherwise it’s probably not. The jobless rate was 3.5% in December, so unless it goes above 3.9% soon the economy is still growing.

The bottom line is that we’ve had severe flus before without a recession and when we did have a downturn, the economy bounced back very quickly. The stock market is pricing in a steep drop in profits, which is certainly possible. A strong recovery, which we expect, will reverse this as it has in the past.

Screen Shot 2020-03-09 at 12.05.01 PM.png

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/2020/3/9/a-coronavirus-recession

 

Fed Should Be Decisive

Posted on Updated on

March 2, 2020

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

By the time you read this, the Fed may already have cut rates. That is the situation we find ourselves in given the recent correction in equities, which were at a record high only eight trading days ago but were down 12.8% from that peak as of the market close on Friday.

Fears about the economic effects of the Coronavirus have driven equity prices lower and led to calls for the Federal Reserve to cut rates. But we think a rate cut – any rate cut – would be a mistake. Nominal GDP – real GDP growth plus inflation – is up 4.0% versus a year ago and up at a 4.4% annual rate in the past two years. These growth rates suggest short-term interest rates should be higher, not lower. If people become less productive because they’re scared of getting sick, lower interest rates won’t change that.

Part of the problem is that the Fed spent much of 2019 agonizing over potential trade wars and Brexit, resulting in three rate cuts of 25 basis points each. Yet, in the end, key trade agreements were reached and Brexit didn’t tank the UK economy, much less hurt the US. The Fed didn’t need to cut rates last year and shouldn’t now.

However, the Fed looks poised to move, either at the next meeting on March 18 or perhaps before. That’s the upshot of Fed Chairman Jerome Powell’s Friday statement that the virus “poses evolving risks” the Fed is “closely monitoring developments,” the Fed will “act as appropriate to support the economy.” Clearly, a rate cut isn’t going to be able to cure a virus. However, the Fed believes that the higher asset prices that

may result from lower rates will generate a “wealth effect” that boosts consumer spending and underpins demand.

Meanwhile, the futures market in federal funds is pricing in one 25 bp rate cut by March 18 and the market consensus is for three or four such cuts by the end of the year. The absence of any Fed pushback against these expectations suggests policymakers would be comfortable with this outcome, even though they’re not yet committed to fulfilling them.

This may sound odd at first. But if the Fed ends up cutting rates – again, a policy we think is unneeded and unhelpful – we think it should go big. Instead of trickling out measly little rate cuts of 25 bp each at the next few meetings, the Fed should cut rates by something like 75-100 bps all at once on or before March 18.

The key is that the Fed would then pair that one big rate cut with a statement, a “dot plot,” and a press conference that shows the Fed is committed to lifting rates back up once we’re past the economic fears related to the Coronavirus.

The problem with the drip, drip, drip approach is that if the Fed cuts rates only 25 bp while the market expects more rate cuts later on, it incents households and businesses to postpone activity and decisions. Why act now, when we all know rates are going even lower?

Again, the best option is doing nothing; monetary policy isn’t a flu vaccine and rates, as low as they are already, are not an impediment to economic growth. But if the Fed is ready to act, decisive would be much better than wishy-washy.

Screen Shot 2020-03-02 at 1.11.10 PM.png

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/2020/3/2/fed-should-be-decisive

Yes, There Was a Housing Bubble, But Not Now

Posted on Updated on

February 24, 2020

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

One of the worst bipartisan policy decisions in the past generation was the aggressive government push in the 1990s and 2000s to promote homeownership, beyond what the free market could handle. Policymakers encouraged Fannie Mae and Freddie Mac to gobble up lots of subprime debt, in turn boosting lending to borrowers who couldn’t handle their loans.

But now a bizarre idea is making the rounds that, looking back on it, maybe there wasn’t a housing bubble at all!

The theory is that home prices are already up substantially from where they were at the prior peak during the “bubble,” so maybe those “bubble” prices were not that high after all. Compared to the prior peak in 2007, the national Case-Shiller index is up 15%, while the FHFA index, which measures the prices of homes financed with conforming mortgages, is up 24%.

But a great deal has changed since the prior peak, which makes it much easier to justify the higher prices of today. To assess the “fair value” of homes, we use a Price-to-Rent (P/R) ratio, which compares the asset value of all owner-occupied homes (calculated by the Federal Reserve) to the “imputed” rental value of those homes (what owners could fetch for their homes if they rented them, as calculated by the Commerce Department). Think of it like a P/E ratio: the price of all owner- occupied homes, compared to what those same homes would earn if they were rented.

For the past 40 years, the median P/R ratio is 16.0. At the peak of the housing bubble, the ratio hit a record-high of 21.4. In other words, prices were 34% above fair value. During the housing bust, the ratio plunged to 14.1, meaning national average home prices were 12% lower than you’d expect given rents. Temporarily, that made sense: prices had to get below fair value to clear the excess inventory.

Today, the P/R ratio stands at 17.0, which means home prices are 6% above their long-term average relative to rents.

That’s well within the normal historical range, and no reason to sell.

Comparing home values to replacement costs shows a similar pattern. That median ratio in the past forty years has been 1.58, compared with 1.59 today (almost exactly fair value) and 1.94 at the peak in 2005 (23% above fair value).

Either way you slice it, bubble era home prices really were far in excess of what you’d expect given rents and replacement costs, while prices today look reasonable.

We expect home prices to keep moving higher, but not as fast as in the last few years. Meanwhile, the climb in average home prices will diverge at the local level. Due to the limit on state and local tax deductions, expect high tax states to show flat home prices (on average), while low-tax states experience stronger price gains.

One of the reasons we remain optimistic about economic growth in general is the continued recovery in home building.

Housing starts bottomed in 2009, when builders began just 554,000 homes, 73% below the 2.073 million pace at the peak of the housing boom in 2005. Since 2010, the number of housing starts has increased in every year, hitting 1.300 million in 2019.

Starts have been much higher in recent months due to the unusually mild winter weather throughout much of the country. And while we may see a pullback in the coming months as weather patterns return to normal, we anticipate at least a few more years of gains in home building. Given population growth and scrappage (knock downs, fires, floods, hurricanes, tornadoes…etc), builders have simply started too few homes since the bust. Now it looks like they need to overshoot to make up for lost time. In turn, expect new home sales to follow starts higher.

Screen Shot 2020-02-24 at 12.29.31 PM.png

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/2020/2/24/yes,-there-was-a-housing-bubble,-but-not-now

Lessons from Japan?

Posted on Updated on

February 18, 2020

 

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

Thirty years ago, many in the US were in fear that a rising power in Asia was on the verge of eclipsing the US. Now it’s China, back then it was Japan.

Back in the late 1980s Japan had become the second largest economy in the world after the US and seemed like a juggernaut that couldn’t be stopped. Many center-left economists thought that the post-World War II experience of Japan proved that industrial policy could work, with the government picking winners and losers and making sure favored industries and companies always got the credit they needed to grow. They were eager to bring that approach to the US.

History, however, had other plans. Japanese government policies bottled up capital in favored industries and pulled it away from widespread entrepreneurship. This meant the massive savings generated by Japanese workers were misallocated into a limited pool of domestic assets, with capital gains tax rates that favored listed stocks and drove up real estate prices. The result was dual massive bubbles, with stocks far more overvalued than US stocks were in 2000 while Japanese real estate was far more overvalued than the US was in 2005. As a sign of how large that bubble was, the Nikkei is still about 40% below the high set in 1989.

That peak in asset prices also coincided with a dramatic slowdown in economic growth that has lasted thirty years. To put an exclamation point on that, Japanese real GDP fell at a 6.3% annual rate in the fourth quarter of 2019. This was before any impact from the coronavirus and the largest quarterly decline in six years. While pandemics are serious and scary, the real cause of the drop was a national sales tax hike from 8% to 10%. Real GDP is now down 0.4% from a year ago.

It’s deja vu. Japan keeps trying over and over again to boost economic growth with government policy – a combination of high government spending, high budget deficits, high taxes, quantitative easing, and, beginning in 2016, negative interest rates. Sounds exactly like what policymakers in Europe have tried, but more of it and for longer.

None of this has worked, and it won’t work in the US, either. Not now, and not if we eventually go into a recession, which, thankfully we don’t foresee anytime soon.

In contrast to Japan, the US has lower taxes, lower (but still too high) government spending, a central bank that maintains positive short-term interest rates, and a much healthier economy, with equities at or near record highs while the jobless rate heads toward what could be the lowest unemployment rate since the Korean War.

Instead of more of the same, we think Japan would benefit from shifting the mix of policies toward the supply- side, with big tax cuts on business investment and profits, and ending negative interest rates like Sweden just did. And, given a falling population, this could be coupled with much larger tax deductions for parents.

Meanwhile, instead of raising the sales tax, with long- term interest rates at essentially zero, Japan should take a page from Great Britain’s history and convert their debt into “perpetual” securities (called “consols”), paying whatever interest rate the market demands (near zero!) but without the need to repay principal.

Don’t hold your breath waiting for this kind of policy shift. Instead, Japan looks poised to continue to muddle through continuing to believe that government can manage economic growth and not trusting entrepreneurs and freedom. Unless Japan starts trusting supply-side policies instead of demand-side fallacies, they will continue to be doomed to make the same mistakes.

Screen Shot 2020-02-18 at 12.21.38 PM.png

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/2020/2/18/lessons-from-japan

Jobs, Coronavirus, and the Budget

Posted on Updated on

February 10, 2020

 

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

In January, US payrolls expanded by 225,000, not only beating the consensus forecast, but also forecasts from every single economics group. Since January 2019 (12 months ago), both payrolls and civilian employment – an alternative measure of jobs that includes small-business start-ups – are up 2.1 million. The labor force – those who are either working or looking for work – is up 1.5 million, while the jobless rate fell to 3.6% from the 4.0%.

The labor force participation rate (the share of adults who are either working or looking for work) increased to 63.4% in January, the highest reading since early 2013. Participation among “prime-age” adults (25 to 54) hit 83.1%, the highest since the Lehman Brothers bankruptcy in 2008.

Meanwhile initial claims for unemployment insurance hit 202,000 in the last week of January, and initial claims as a percent of all jobs are at the lowest level ever. In other words, the job market and the economy look strong.

Only a few months ago, some analysts were saying that the inversion of the yield curve – with short-term interest rates above long-term rates – was signaling the front edge of a US recession. Now a recession seems nowhere in sight.

Lately, financial markets have become very jumpy on any news – good or bad – regarding the coronavirus. We aren’timmunologists (or doctors) and would never make light of a virus that has killed more than 900 and infected over 40,000, but data released by the World Health Organization (WHO) cautiously suggests a positive turning point has been reached.

So far, the virus has had minimal impact outside of China, and the growth rate of new cases worldwide has slowed. Yes, these numbers must be taken with a grain of salt, given that the news is coming from China. But China’s leaders have an interest in limiting the spread of the virus and the economic damage it causes, and they have allowed the WHO access.

 

China’s President Xi Jinping has been able to accumulate more power than any leader since at least Deng Xiaoping, perhaps since Mao. We assume he is well aware that a major failure to contain the virus could give his political opponents an opening to vent their frustration with the current leadership, and perhaps push for change.

It’s true that the Chinese economy has slowed precipitously, and this is affecting many companies’ sales and production. However, we do not believe that this will damage global growth in a significant way, and the US stock market suggests that global investors agree.

Meanwhile President Trump is presenting his budget plans to Congress this week, and early reports suggest some proposals to rein in entitlement spending. We wouldn’t hold our breath waiting for these policies to get implemented. No matter who controls Congress, the one bi-partisan thing DC is able to do is spend more taxpayer money. And even with a slowdown in spending growth for entitlements, the President’s budget proposal still won’t balance the budget until 2035.

To be clear, we do not think deficits are the proper tool to use for economic forecasting. What matters is spending, and federal spending has grown to be too large a share of US GDP. The bigger the government, the smaller the private sector.

In 1983, according to the OMB, federal spending was 22.9% of GDP. In 1999, under President Clinton, it had fallen to 18%, and from 1983 through 1999, real GDP grew 3.7% at an annual rate. This trend was reversed with government spending rising to 21.1% of GDP in 2019, and from 2002 to 2019, real GDP grew just 2.1% annualized. Bigger government leads to slower growth.

Taking all of this together, no recession on the horizon and improving news about the coronavirus suggests corporate profits will continue to grow in spite of moderate growth. Stay bullish!

Screen Shot 2020-02-10 at 1.25.46 PM.png

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/2020/2/10/jobs,-coronavirus,-and-the-budget

 

 

No Need for Fed Rescue

Posted on Updated on

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

February 3, 2020

Fears about the coronavirus knocked down equities last week, while a flight to safety brought the yield on the 10-year Treasury down to 1.51% at the Friday close versus 1.69% the week prior and 1.92% at the end of 2019.

The consensus in the futures market is that the Federal Reserve will cut the federal funds rate by 50 basis points this year.

We think that is ridiculous. The economy doesn’t need rate cuts. Rate cuts won’t fight uncertainty, and certainly won’t stop a virus.

Last Thursday’s GDP report showed that the economy grew at a 2.1% annual rate in the fourth quarter, in spite of an unusually large slowdown in the pace of inventory accumulation. Real GDP was up 2.3% versus a year ago. This morning, the January ISM manufacturing index rose back into expansionary territory, suggesting that the recovery is on solid footing. Auto sales, too, look healthy, and our early read on Friday’s jobs report is that nonfarm payrolls will be up arespectable 165,000.

We repeat, none of these data suggest a need for rate cuts. Investors – as well as the Fed – need to realize that rate cuts aren’t going to “fix” economic growth.

Europe went to negative interest rates and more QE, and not only did economic growth fall behind the US, but so did stock market returns. From October 2015 through September 2019 the Fed shrank its balance sheet while the European Central Bank became even more accommodative. What happened? The S&P 500 rose 55% over that period while the Euro Stoxx 50 was up just 16%. In other words, it’s clear that negative rates and more QE don’t help the economy create growth!

While we doubt politicians and the Fed actually understand that reality, we do think worries about global growth will subside and the Fed will most likely keep the stance of monetary policy steady, with neither rate hikes nor rate cuts, while it gradually lifts the size of the balance sheet like it did (but didn’t need to) late last year.

That said, it is not the Fed that will drive stocks in the year ahead, but profits, which continue to grow. US equities looked cheap to us a month ago, and higher profits have them looking even cheaper today. It’s another great buying opportunity.

Screen Shot 2020-02-03 at 12.11.20 PM.png

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/2020/2/3/no-need-for-fed-rescue