Don’t Count on a Rate Cut

Posted on Updated on

May 20, 2019

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

At the close of activity on Friday the futures market in federal funds was projecting a 75% chance of at least one rate cut this year. From now through the end of 2020, the market is projecting two rate cuts.

We thought markets stopped believing in Santa Clausa long time ago, but unfortunately it doesn’t appear so.

The US economy is nowhere even close to needing one rate cut much less two. Nominal GDP – real GDP plus inflation – was up at a 3.8% annual rate in the first quarter, is up 5.1% from a year ago, and is up at a 4.8% annual rate in the past two years, all well above the federal funds rate of 2.375%.

Yes, the yield on the 2-year Treasury security is only 2.21% – meaning the very short end of the yield curve is inverted – but that’s because many investors anticipaterate cuts. Hypothetically, if the Federal Reserve were to cut rates once this December and once in December 2020, then the average federal funds rate over the next two years would be very close to 2.1%, which is what’s holding down the 2-year yield in the first place.

But we don’t think the Fed is anywhere close tocutting rates, as we suspect the minutes from the last meeting (on April 30 and May 1) will show. Those minutes will be released this Wednesday, two days from now.

The last time the Fed issued one of its “dot plots”was on March 20. At the time, there were six Fed policymakers who thought the Fed would raise rates at least once later this year, while eleven thought the Fed would remain steady. As far as 2020 was concerned, not one policymaker saw rates lower at the end of that year than they are today.

Think of the environment in which the Fed made those projections. The S&P 500 was lower than the Friday close while the 10-year Treasury yield was higher. In other words, some analysts at the Fed should be thinking that current financial conditions are already more accommodative than they were on March 20.

It’s also important to recognize that on March 20 the Atlanta Fed’s GDP model was projecting a 0.6% real GDP growth rate for the first quarter while the New YorkFed’s model was forecasting a growth rate of 1.4%. As it turns out, real GDP grew at a 3.2% annual rate in Q1, although this figure may be revised down slightly next week.

In spite of all this, some on the Fed seem to be listening to the White House and are angling for a looser stance for monetary policy in the future. This includes Minneapolis Fed Chief Neel Kashkari and Fed Governor Lael Brainard, both of whom seem comfortable with letting measured inflation run consistently above 2.0% for several years.

We think that would be ill-advised but might end up happening anyhow. Monetary policy has been loose for a long time and, given the lags between Fed policy and inflation, will most likely result in inflation exceeding theFed’s 2% target.

To us, it looks increasingly likely that the Fed isn’tgoing to raise rates this year. However, we do expect that tight labor markets, rising wages, continued 3% real GDP growth and a boost in inflation will increase pressure for a rate hike and change the mind of any Fed doves. If theFed hasn’t lifted rates by mid-year 2020, then don’texpect one until December. The Fed has meetings scheduled for November 4-5th, 2020, right after the presidential election, and then mid December 2020. Raising rates days after the election would make the Fed appear very political.

We think that’s unfortunate because the economy could easily withstand a rate hike, and such a move would help stabilize the economy over the longer term by preventing an upward move in inflation in the future.

In the meantime, postponing short-term rate hikes probably means longer term interest rates stay relatively low, as well. While we think this is a mistake, low long- term rates are a positive for equities in the meantime.

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

5-21 / 9:00 am

Existing Home Sales – Apr

5.350 Mil

5.310 Mil

5.210 Mil

5-23 / 7:30 am

Initial Claims May 18

215K

217K

212K

9:00 am

New Home Sales – Apr

0.675 Mil

0.647 Mil

0.692 Mil

5-24 / 7:30 am

Durable Goods – Apr

-2.0%

-2.9%

+2.6%

7:30 am

Durable Goods (Ex-Trans) – Apr

+0.1%

-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.

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/5/20/dont-count-on-a-rate-cut

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Trade War Hysterics

Posted on Updated on

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

May 13, 2019

Since hitting new all-time highs two weeks ago, the S&P 500 has fallen about 2.2% as trade negotiations with China hit a snag. Last week, the US announced new tariffs on Chinese imports. This morning, China announced new tariffs on some US goods. Many fear a widening trade war.

Don’t get us wrong. We want free trade, and we understand the dangers of trade wars and tariffs (which are just taxes on consumers). At the same time, we think trade deficits themselves are not a reason for trade wars. We all run personal trade deficits with the local grocery store and benefit from that. Even if the entire world went to zero tariffs, the US would almost certainly still run trade deficits, even with China.

But today, the trade deficit with China is partly due to the fact that China has higher tariffs on imports than the US does –working to eliminate these lopsided tariffs is worthwhile.

In 1980, China was an impoverished nation. Then it began adopting tools of capitalism – property rights, markets, free prices and wages. Chinese businesses started to import theWest’s technology, and growth accelerated.

Initially, China didn’t have to worry about intellectualproperty. When you replace oxen with a tractor, all you have to do is buy the tractor, not reinvent the internal combustion engine. But China has now picked, and benefited from, the lowest hanging fruit. So, China decided to steal the R&D of firms located abroad. Some estimates of this collective theft run into the hundreds of billions of dollars.

That’s why normal free market and free trade principlesdon’t neatly apply to China.

Remember President Reagan’s old story supporting free trade? “We’re in the same boat with our trading partners,” Reagan said. “If one partner shoots a hole in the boat, does it

make sense for the other one to shoot another hole in the boat?” The obvious answer is that it doesn’t, and so our own protectionism would hurt us.

But China hasn’t just shot a hole in the boat, they’vebecome pirates. If Tony Soprano and his cronies robbed your house, would free market principles require you to trade with them to buy those items back? Of course not!

It’s true tariff increases will not help the US economy. But $100 billion of tariffs spread over $14 trillion of consumer spending is not a recession inducing drag. It’s true some business, like soybean farmers, are hurt. But the status quo means accepting hundreds of billions in theft from companies that are at the leading edge of future growth.

Either way, if tariffs nick our economy, China’s getshammered. Last year we exported $180 billion in goods and services to China, which is 0.9% of our GDP. Meanwhile, China exported $559 billion to the US, which is 4.6% of their economy. We have enormous economic leverage that they simply can’t match.

An extended US-China trade battle means US companies will shift supply chains out of China and toward places like Singapore, Vietnam, Mexico, or “Made in the USA.” If that happens, the Chinese economy is hurt for decades.

Anyone can invent a scenario where some sort of Smoot- Hawley-like global trade war happens. Realistically, though,that appears very unlikely. We’re not the only advanced country China’s piracy has victimized, and China may realize it’s more isolated than it thought. In the end, China wants to trade with the West, not North Korea, Russia, and Venezuela. China needs the West. And all these trade war hysterics just aren’t warranted.

 

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/2019/5/13/trade-war-hysterics

The Big Picture and the Fed

Posted on Updated on

May 6, 2019

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

If you take a long hike up a mountain, there’s plenty to appreciate along the way. But, sometimes, you just have to stop and enjoy the view. With that in mind, let’s forget aboutthe April employment report – which saw a combination of very fast payroll growth and moderate wage growth – and think about where the labor market stands in general.

Nonfarm payrolls have grown by 2.6 million in the past year, well ahead of the roughly 2.0 million jobs the consensus was forecasting a year ago.

Due to the rapid job creation, the unemployment rate has dropped to 3.6%, the lowest level since 1969. Some analysts claim the jobless rate is being artificially suppressed by lower labor force participation, but participation is higher now than it was in the late 1960s, when 3.6% was considered full employment.

Regardless, the labor force is up 1.4 million from a year ago, and the labor force participation rate has been essentially flat since late 2013. And that’s in spite of an aging population.

The unemployment rate for those with less than a high school degree has averaged 5.6% in the past twelve months, the lowest on record, and well below the previous cycle low of 6.3% reached during the internet boom two decades ago

The Hispanic unemployment rate has averaged 4.6% in the past year, while the Black unemployment rate has averaged 6.4%, both also record lows.

Meanwhile, wage growth has accelerated. Average hourly earnings are up 3.2% from a year ago, versus the gain of 2.8% in the year ending in April 2018, and 2.5% in the year ending in April 2017. And the gains in wages are not just tilted toward the rich. Among full-time workers age 25+, usual weekly earnings are up 3.5% for those in the middle of the income spectrum. But wages are up 4.9% for workers at the bottom 10% of earners, while up 1.7% for those at the top 10% of income earners. A rising tide is lifting all boats.

Some observers are claiming we should discount strong job creation because workers are taking multiple jobs. But, in the past year, multiple job holders have been just 5.0% of the total number of employed workers; that’s lower than at any point during the 2001-07 expansion, or during the previous longest recovery on record during the 1990s. Meanwhile, part- time jobs are down since the expansion started, meaning, on net, full-time jobs account for all the job creation during the expansion.

What’s interesting is that President Trump, Vice President Pence and NEC Chief Larry Kudlow all think things could be even better if the Fed hadn’t raised interest rates. President Trump, in fact, is calling for a 1% interest rate cut. This puts the Administration at odds with Fed Chair Jerome Powell, who thinks interest rates are at appropriate levels.

We don’t disagree with the theory behind the thinking ofTrump, Pence and Kudlow who say faster economic growth, by itself, doesn’t have to cause higher inflation. A “permanent”supply-side boost to “real” growth from deregulation and marginal tax rate cuts is not inflationary. In fact, as we’ve previously written, the growth potential of the US economy has accelerated. Productivity (output per hour) is up 2.4% in the past year, deep into this recovery, when normally productivity growth should slow.

But “nominal” GDP (real growth plus inflation) is still up 4.8% at an annual rate in the past two years, and is set to equal, or exceed, that in the year ahead. If we think of nominal GDP as the average growth rate of all businesses in the economy, then a federal funds rate of 2.375% is not holding anyone back. Even projects with a below-average return could justify borrowing, which is a recipe for disaster – what Ludwig vonMises called “mal-investment” – when people push investment into areas that are unsustainable at normal interest rates. Remember the housing bubble?

That’s why we want Powell and the Fed to resist calls tocut rates. The Fed is not tight. Interest rates are not discouraging investment. If anything, the Trump administration should work to cut government spending, which has grown so large it’s crowding out private sector growth.

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

5-7 / 2:00 pm

Consumer Credit – Mar

$16.0 Bil

$15.3 Bil

$15.2 Bil

5-9 / 7:30 am

Initial Claims – May 4

220K

215K

230K

7:30 am

Int’l Trade Balance – Mar

-$50.2 Bil

-$48.8 Bil

-$49.4 Bil

7:30 am

PPI – Apr

+0.3%

+0.2%

+0.6%

7:30 am

“Core” PPI – Apr

+0.2%

+0.1%

+0.3%

5-10 / 7:30 am

CPI – Apr

+0.4%

+0.4%

+0.4%

7:30 am

“Core” CPI – Apr

+0.2%

+0.2%

+0.1%

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/2019/5/6/the-big-picture-and-the-fed

Resilient Economy

Posted on Updated on

April 22, 2019

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

It wasn’t that long ago that some economists and investorswere seriously concerned about US growth going negative for the first quarter. Now, based on our calculations, which we discuss below, it looks like real GDP grew at a respectable 2.6% annual rate in Q1, meaning that US real output was 3.1% larger than Q1-2018.

What makes this even more impressive is that, in spite of attempts by the government to fix seasonal adjustment issues, the first quarter has been weaker than other quarters, averaging only 1.7% growth between 2010 and 2018 versus 2.5% growth for the other three quarters. Time will tell, but we think growth will be higher, on average, for the remainder of 2019 as well.

Remember all those obsessing about the “second derivate”of GDP? That is just a fancy way of saying whether the growth rate is getting faster or slower. The economy grew at a 2.2% annual rate in Q4, which was slower than the 3.4% pace in Q3, which, in turn, was lower than the 4.2% pace in Q2. The theory was that the trend would continue until we were back in recession.

But now it looks like real GDP re-accelerated in Q1. The“second derivate” argument doesn’t work unless fundamentals have changed enough to push the economy into recession.Clearly, this hasn’t happened.

Monetary policy is not tight, companies are still adapting to lower marginal tax rates, and the odds of a full-blown trade war are diminishing. In addition, deregulation is having a positive effect on the willingness to invest in businesses. The only major problem is an unwillingness to tackle the long-term spending path the federal government is following, but we don’t see thattaking down the economy in the near or medium term. We still have time to address spending before it seriously threatens growth.

Here’s how we get to our 2.6% real growth forecast:

Consumption: Automakers say car and light truck sales fell at a 13.4% annual rate in Q1 while “real” (inflation-adjusted) retail sales outside the auto sector slipped 0.1%. However, most

consumer spending is on services, where the data are more sparse. We estimate real personal consumption (goods and services combined) grew at a 1.0% annual rate, contributing 0.7 points to the real GDP growth rate (1.0 times the consumption share of GDP, which is 68%, equals 0.7).

Business Investment: Reports on durable goods shipments and construction suggest that all three components of business investment – equipment, commercial construction, and intellectual property – rose in the first quarter. A combined growth rate of 3.6% translates into adding 0.5 points to real GDP growth. (3.6 times the 14% business investment share of GDP equals 0.5).

Home Building: If there’s one area of the US that remains a conundrum it’s housing, where it looks like we had the fifth straight quarter of slowed activity. We expect that to change moving forward, but for the time being we see a decline at a – 2.6% annual rate, which translates into a 0.1 point drag on 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 Q1, 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 volatile in the past year, possibly because of companies front-running, and then living with, some tariffs and (hopefully) temporary trade barriers. First quarter data suggest net exports should add an unusually large 1.1 points to real GDP.

Inventories: We only have data for inventories through February, but what we have suggests companies continued the same rapid pace of inventory-building that was happening late last year. As a result, inventories should neither add to nor be a drag on real GDP growth in Q1.

Add it all up, and we get 2.6% annualized growth. The US economic expansion is alive and well.

 

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

4-22 / 9:00 am

Existing Home Sales – Mar

5.300 Mil

5.410 Mil

5.210 Mil

5.510 Mil

4-23 / 9:00 am

New Home Sales – Mar

0.650 Mil

0.634 Mil

0.667 Mil

4-25 / 7:30 am

Initial Claims – Apr 20

200K

200K

192K

7:30 am

Durable Goods – Mar

+0.7%

+0.7%

-1.6%

7:30 am

Durable Goods (Ex-Trans) – Mar

+0.2%

+0.3%

-0.1%

4-26 / 7:30 am

Q1 GDP Advance Report

2.2%

2.6%

2.2%

7:30 am

Q1 GDP Chain Price Index

1.2%

1.6%

1.7%

9:00 am

U. Mich Consumer Sentiment- Apr

97.0

97.0

96.9

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/2019/4/22/resilient-economy

New Highs, Still a Buy

Posted on Updated on

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

The Dow Jones Industrials Average and S&P 500 are breathing down the neck of record highs set last Fall. Some take that as a sign to sell, time to shift out of equities and realize gains. We think that would be a mistake.

At the end of last year, we forecast the Dow would finish this year at 28,750 while the S&P 500 hit 3,100. At the time, those goals seemed outlandishly optimistic to many investors.We wrote that “We do best by our readers when we tell them exactly what we think is going to happen, without altering our projections so we can run with the safety of the herd. Grit your teeth if you have to; those who stay invested in the year ahead should earn substantial rewards.”

Now we think we were too pessimistic.

Through Friday’s close, the Dow is up 13.2% year-to-date, while the S&P 500 is up 16.0%. To reach our year-end targets, the Dow would have to gain another 8.9% while the S&P 500 would have to rise 6.6%.

We think investors should be undeterred by new record highs. To assess market valuations, we use a capitalized profits model, which takes the government’s measure of profits from the GDP reports and divides by interest rates. Think of it this way: if profits are higher, stocks should be higher, too; if interest rates are higher, stocks should be lower, as they compete against an alternative with a higher rate of return.

Our traditional measure – using a current 10-year Treasury yield of about 2.57% – suggests the S&P 500 is still massively undervalued. At the end of last year we used 3.40% for the 10- year yield, and generated a fair value on the S&P 500 of 3,100. Now that looks like an aggressive call for long-term yields. Using, say, 3.00% for the 10-year puts fair value at 3,500. The model needs a 10-year yield of nearly 3.6% to conclude the S&P 500 is already at fair value, with recent profits.

What would obviously throw the cap profits model for a loop would be a recession, but we don’t see one on the horizon. As we wrote last week, the US economy is on very solid ground, with Q1 real GDP estimates up from near-zero to now over 2%. In addition, we lack the imbalances we often see before recessions. Household debts are near a multi-decade low relative to assets, and household debt service is very low relative to after- tax income. Banks, meanwhile, have ample capital, and are no longer tied to the overly strict mark-to-market accounting rules that exacerbated the financial crisis.

In addition, the economy is still adapting to lower tax rates, particularly on corporate profits. We expect a continued shift of corporate operations toward the US.

Another angle to consider is that recessions often follow drops in home building, but the US is still building fewer homesthan we’d expect given population growth and the scrappage of homes (knockdowns, fires, floods, hurricanes, tornadoes,…etc.).In other words, we think the number of housing starts, which have grown every calendar year since bottoming in 2009, will rise again in 2019.

Notice, however, what we’re not worried about: quantitative tightening, which is one of President Trump’s favorite recent targets. We still don’t think quantitative easing helped equities, because the extra reserves in the banking system sat on balance sheets earning near-zero returns. Withdrawing those previously inert reserves won’t hurt markets either.

To be sure, we are not saying stocks will go up today or this week, or even this quarter. Corrections happen. But, given the level of corporate profits and our outlook for economic growth, it looks more likely than not that equities will move substantially higher in the year ahead.

page1image4016263232

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

4-15 / 7:30 am

Empire State Mfg Survey – Apr

8.0

11.5

10.1

3.7

4-16 / 8:15 am

Industrial Production – Mar

+0.2%

+0.1%

0.0%

8:15 am

Capacity Utilization – Mar

79.2%

79.1%

79.1%

4-17 / 7:30 am

Int’l Trade Balance – Feb

-$53.5 Bil

-$53.4 Bil

-$51.1 Bil

4-18 / 7:30 am

Initial Claims Apr 13

205K

204K

196K

7:30 am

Retail Sales – Mar

+1.0%

+1.1%

-0.2%

7:30 am

Retail Sales Ex-Auto – Mar

+0.7%

+1.0%

-0.4%

7:30 am

Philly Fed Survey – Apr

11.0

10.2

13.7

9:00 am

Business Inventories – Feb

+0.3%

+0.5%

+0.8%

4-19 / 7:30 am

Housing Starts – Mar

1.230 Mil

1.232 Mil

1.162 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/2019/4/15/new-highs,-still-a-buy

Economy on Very Solid Ground

Posted on Updated on

April 9, 2019

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

What a difference a month makes.

Last month many economists had pushed down their estimates for first quarter economic growth to near zero.The Atlanta Fed’s “GDP Now” model was projecting realGDP growth at a 0.2% annual rate in Q1, which would have been the slowest growth since the weather-related negative reading in the first quarter of 2014. But this time it was seen as a new trend leading us toward a recession.

Now, just four weeks later, the economy hasn’t cooperated with the pessimists. Just think about all the positive news we’ve had lately.

Last Friday showed payrolls rose 196,000 in March after a temporary lull in February. And while average hourly earnings rose a smaller than expected 0.1% in March, they’reup 3.2% in the past year, an acceleration from the 2.8% gain in the year ending in March 2018.

At least one analyst noted that the average change in payrolls in the last three months (180,000 per month) is theslowest since late 2017. This is 100% true…and 100%irrelevant. The three-month average bounces around all the time; since 2014 that average has been as high as 291,000 and as low as 136,000. What these analysts are doing is exploiting the fact that payrolls grew only 33,000 in February, pulling down the short-term average.

Meanwhile, new claims for unemployment insurance fell to 202,000 last week, the lowest reading since 1969. If you expect a recession to start soon, this data doesn’t support it. Claims usually start to creep up before a recession starts; no sign of that now.

Another piece of good news was that auto sales (cars and light trucks, both included) increased 5.3% in March to a 17.5 million annual rate. As a result, our early estimate for retail sales for March is an increase of 1.0%.

Given the strong data, forecasters have been ratcheting up their Q1 real GDP estimates, which now stand around 2.0%. That’s a far cry from the 0.2% estimate a month ago, and strong retail sales growth for March means a higher starting point for the economy in Q2.

More solid news came from the ISM Manufacturing report, which showed the overall index rising to 55.3 for March. Yes, the ISM Non-Manufacturing index declined to 56.1, but both indexes are above their average levels since the economic expansion began in mid-2009, almost ten years ago.

Some analysts are worried about housing, but we have not wavered, and continue to believe the recovery in housing is not yet over. Recent data supports our case, with new single-family home sales surging to a 667,000 annual rate in February, the fastest pace in almost a year. Expect that surge in sales to translate into more home building in the months ahead.

None of these reports mean the economy is booming like it was in the mid-1980s or late-1990s. It’s not. But the US economy is no longer a Plow Horse, and it’s nowhere close to a recession.

Right now, the market on future policy decisions by the Federal Reserve suggests zero chance of a rate hike in 2019 and greater than 50% odds of a rate cut. Look for that to change. At the end of 2017, the market put the odds of four or more rate hikes in 2018 at 10-1 against. In the end, rates went up four times.

As we continue to get better than expected data in the coming months, look for investors to rethink their expectations for the Fed, as well.

 

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

4-8 / 9:00 am

Factory Orders – Feb

-0.5%

-0.3%

-0.5%

0.0%

4-10 / 7:30 am

CPI – Mar

+0.4%

+0.3%

+0.2%

7:30 am

“Core” CPI – Mar

+0.2%

+0.2%

+0.1%

4-11 / 7:30 am

Initial Claims – Apr 6

210K

210K

202K

7:30 am

PPI – Mar

+0.3%

+0.3%

+0.1%

7:30 am

“Core” PPI – Mar

+0.2%

+0.1%

+0.1%

4-12 / 7:30 am

Import Prices – Mar

+0.4%

+0.3%

+0.6%

7:30 am

Export Prices – Mar

+0.2%

+0.3%

+0.6%

9:00 am

U. Mich Consumer Sentiment- Apr

98.1

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.

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/4/8/economy-on-very-solid-ground

Don’t Cut Rates, Cut Spending

Posted on Updated on

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

We’ve been “Comrades in Supply-side Arms” with Stephen Moore (now a Federal Reserve nominee) and Larry Kudlow (Administration Economist) for decades, with very few disagreements on economic policy. However, with both having called for a 50 basis point cut in short-term rates, we find ourselves in total disagreement with their conclusion.

They both make supply-side arguments. Kudlow toldCNBC on Friday, “the [Fed] should not tighten just because of prosperity.” We agree! While Moore, in an op-ed, argued that a 15% drop in a basket of commodity prices during Q4 showed the Fed was too tight. We’ve supported price targeting in the past.

It’s true the yield curve is flat – inverted in some places – but that’s because the market is pricing in a rate cut. We don’tsee it, nor do we see the reason for it. Our model is simple: add inflation and real growth to get nominal GDP growth. Then look at it over the past two years to remove volatility. If the Fed lifts rates too close to nominal GDP growth, or over it, thenit’s too tight. Nominal GDP is up 4.9% annualized in the past two years while the federal funds rate is 2.375%. The Fed is at least 200 basis points away from being too tight.

From 1913 until 2008, the Fed had to make reserves in the banking system scarce in order to lift rates. It did this by selling bonds to banks and removing the cash from the

system. When rates moved above nominal GDP, it was a signal the Fed had removed too many reserves. It was the lack of money, not the higher rates or the inverted yield curve, that caused the recession. Then, the Fed would reverse course and buy bonds to inject reserves into the system, making them plentiful, which lowered rates. It was the extra money that lifted economic growth, not the lower interest rates.

The Fed has now changed the system. During the Crisis, the Fed injected trillions into the banking system, and there arenow $1.5 trillion in “excess reserves.” Normally this would automatically keep rates low. But the Fed is paying banks interest on those reserves – currently 2.4%. But this is an experiment. No one knows if paying interest on reserves will keep banks from lending them out. And, no one knows the exact interest rate needed to keep those excess reserves from creating inflation. And as long as those excess reserves exist, the Fed isn’t “tight.”

Short-term rates are low, and there are other policies that risk slowing growth. Government spending is growing faster than GDP and is projected to reach around 21% of GDP this year, taking resources from the private sector. Tariffuncertainty doesn’t help either. Bad policies are the most salient threat to growth. Shifting blame to the Fed is not the answer.

 

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/2019/4/1/dont-cut-rates,-cut-spending

The Wizard of Oz

Posted on Updated on

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

It feels like we are living in the Land of Oz and the Fed is the “all-powerful” wizard in control.

From just about every significant group of thought leaders– the press, politicians, economists, analysts, and government officials – the narrative of the past twelve years has been all about government and nothing about the entrepreneur. They say the crisis ended because of government bailouts and easy money. It’s an artificial sugar high, covering up fundamental problems that still exist and could come back without the Fed’s support.

Those who believe in this narrative had a field day in the fourth quarter, with the Fed raising rates and unwinding Quantitative Easing while equities fell nearly 20% and economic data weakened. Now, with the Fed simultaneously eliminating hikes from its outlook for 2019 and announcing the end of reductions in its balance sheet (Click here for more of our thoughts from last week), the narrative has new legs.

Already, many investors think the Fed has raised rates too far, and the market odds of at least one Fed rate cut in 2019 have risen to 68%, while the odds of any further hikes have fallen to zero. This is based on a belief that economic growth will remain weak and corporate earnings may decline.

We think this is a huge mistake for several reasons.

First, QE and TARP didn’t save the market or create the nearly 10-year long economic recovery or the bull market in stocks. The bottom of the crisis happened when mark-to- market accounting rules were changed. Since then, new technology – the cloud, smartphones, tablets, apps, fracking, the genome, and 3D printing, among other things – have lifted margins and profits.

Second, the Fed isn’t even close to being tight. There are still $1.5 trillion in excess reserves in the system. Never, in the history of the US, has a recession started with anywhere near this level of excess reserves in the system. And the federal funds rate (at 2.375%), stands well below the 4.9% trend growth rate in nominal GDP.

The yield curve (from 3-months to 10-years) inverted onFriday, but this didn’t happen because the Fed got too tight, it happened because the market believes the Fed may cut rates this year. Since the late 1960s, prior recessions have only happened when the 10-year Note yield has been at least 50 basis points below the federal funds rate, a point that remains far off.

Third, many say the point of QE was to bring rates down further. But if you look at the data, each QE period saw the 10- year and 30-year Treasury yield rise, the exact opposite of what was predicted! The Fed doesn’t want to fully remove excess reserves from the system (true “normalization”), even though it should. It seems the Fed has convinced themselves that they – through QE – have been the saviors of the economy, not the entrepreneur.

With so many obsessed with the narrative that government saved the economy and created growth, it’s no wonder more people are interested in socialism. It’s time to pull back the curtain on the Wizard and reveal it to be far less powerful than so many believe. The true (and under appreciated) wizards of growth, entrepreneurs, continue to drive us forward. Technology is making things better and more efficient every day. Its when government gets out of the way that growth can flourish. Taxes have been cut, regulations reduced, and corporations are more profitable than ever before.

After some weird data covering the end of 2018 (which will lower Q1 GDP), the data are set to improve. Employment, wages, housing, and inflation will all head higher in the weeks and months ahead. There is no recession in sight. The markets, and the narrative, are in for a surprise, which will push both bond yields and stocks higher.

page1image2280519728page1image2280520000

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

3-26 / 7:30 am

Housing Starts – Feb

1.213 Mil

1.225 Mil

1.230 Mil

3-27 / 7:30 am

Int’l Trade Balance – Jan

-$57.0 Bil

-$58.0 Bil

-$59.8 Bil

3-28 / 7:30 am

Initial Claims – Mar 23

220K

224K

221K

7:30 am

Q4 GDP Final Report

2.3%

2.1%

2.6%

7:30 am

Q4 GDP Chain Price Index

1.8%

1.8%

1.8%

3-29 / 7:30 am

Personal Income – Feb

+0.3%

+0.3%

-0.1%

7:30 am

Personal Spending – Jan

+0.3%

+0.3%

-0.5%

8:45 am

Chicago PMI – Mar

61.0

60.6

64.7

9:00 am

New Home Sales – Feb

0.620 Mil

0.622 Mil

0.607 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/2019/3/25/the-wizard-of-oz

Buybacks Aren’t the Problem!

Posted on Updated on

March 19, 2019

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

The environment on Capitol Hill has made populism a bipartisan affair, with Republican Senator Marco Rubio now joining the fray with a call to tax corporate stock buybacks.

His argument? Corporations are buying back stock insteadof making productive investments. He’s not alone in arguing that weak investment is the reason the economy isn’t growingfaster. Meanwhile others argue the corporate tax cut of 2017 fell flat as tax savings went towards a surge in buybacks, not investment.

Rubio also bemoans that stock buybacks face a lower tax rate than dividends. But qualified dividends (which are the vast majority of dividends paid by public companies) are taxed at the same rate as capital gains, so we’re not quite sure how he comes to this conclusion.

Let’s break down the issues with his argument. To start,companies have been investing. Think about it. If companies were under-investing, there would be shortages, and that is simply not the case.

Another reason his argument fails scrutiny – and probably the most common misperception when it comes to corporate investments – is that people mistake nominal investment for real investment.

The price of technology has fallen dramatically while its capabilities have surged. You can buy a smartphone or tablet today for hundreds of dollars, while just a decade ago those embedded technologies would have cost millions of dollars (and required a suitcase to lug around). Airlines can now book passengers using an App instead of a ticket office. Brick and mortar stores are being replaced by logistics software and delivery vehicles. A decade ago it took more than two months to frack a well, now it takes two weeks.

In other words, the price of production is falling while profit margins have improved. The declining costs for improved performance make it appear that companies aren’tinvesting, when in reality they are. In fact, productivity at the corporate level is booming, and that’s exactly why corporations can return so much capital to shareholders. On a nominal basis, business investment was 13.7% of GDP in the last quarter of 2018, exactly where it was in 2001 and 2008. But on a real basis (where inflation – or in the case of technology, deflation – is accounted for), business investment was 14.7% of GDP, the highest on record.

It’s this lack of perspective that has people pining for the past. And it makes no sense. If it took longer to frack a well,

companies needed office space to sell airline tickets, or we had no online retail, then yes, investment would be higher, but then profits would be lower. But we guess Rubio’s “problem”would be fixed, as companies wouldn’t have the profits forstock buybacks or dividends.

Now to address the second misperception. Both buybacks and dividends reduce cash on corporate balance sheets. As economist John Cochrane has explained, a buyback does not necessarily leave a remaining shareholder in a better position.Let’s say a company has two shares in circulation, $100 in cash, and assets capable of producing future profits worth $100 today. Each of the two shares should be worth $100. If the cash is used to buy back one share, there would only be one share remaining and $100 in future profits, so the share should still be worth $100. If the company paid a dividend of $100 ($50 per share), the price of each share would fall from $100 to $50, creating a capital loss of $50. If the shareholder took the loss it would offset the tax on the dividend. Either way, the government captures zero dollars.

Simple math says that, either way, profits for shareholders and tax receipts should not be different as long as capital gains and dividends are taxed equally. And if a politician believes one is taxed less than the other, we think that politician should find a way to reduce the higher tax rate, not raise the lower one. Cutting tax rates is the best way to boost incentives for work, savings and investment.

Finally, the government has proven itself a terrible fiduciary. In 2017, after eight years of economic recovery, and before the Trump corporate tax cut went into effect, the budget deficit was $680 billion. Even John Maynard Keynes must have been rolling over in his grave. So, why would anyone trust government to start telling private citizens what to do with their own money?

Can you imagine politicians telling you that you aren’tallowed to pay down your mortgage because your after-interest income would be too high if you did?

In the end, government needs to focus on fixing its own fiscal house rather than trying to manage the private sector.While it’s always possible to find some corporate managerswho make bad decisions, a vast majority of them are very responsible in their fiduciary duties. In the past decade they have done well by their shareholders. It’s politicians that havefailed in their fiduciary duties. No matter which side of the aisle they hail from, interfering with private decisions is wrong.

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

3-19 / 9:00 am

Factory Orders – Jan

+0.3%

+0.6%

+0.1%

3-21 / 7:30 am

Initial Claims Mar 16

225K

225K

229K

3-22 / 9:00 am

Existing Home Sales – Feb

5.100 Mil

5.040 Mil

4.940 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/2019/3/18/buybacks-arent-the-problem

Ten Years Ago…

Posted on Updated on

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

It’s March 8, 2009. The market’s down 56% from its all-time high, unemployment is over 8% and hurtlingtoward 10%, it’s just been reported that real GDPdropped at a 6.2% annual rate in Q4 of 2008, and it feels like the world is coming to an end. You’re tired, exhausted from living though this, and you fall into a deep sleep. So deep, in fact, that you don’t wake upuntil today, 10 years later.

First thing you do is run to your computer and see the S&P 500 is up 305% since the bottom. You are blown away. No way this could be true! Things were so bad when you fell asleep. Little did you know the S&P 500 bottomed the next day.

So you run over to your friend’s house and knockon the door. Your friend answers, wondering whereyou’ve been for 10 years! You ask what possibly could have happened to drive the stock market up more than 300%.

Your friend pulls out a list. Let’s call them the “golden geese.”

After-tax economy-wide corporate profits are at record highs, up 175% since the bottom, or around 11% annualized growth.

Then your friend tells you about Apple. When you fell asleep, Apple had been selling the iPhone for about a year and a half. Over that period, they sold a record- breaking 17.4 million of them. But since you’ve beenasleep, Apple has sold about 1.3 billion of them. Every calendar quarter Apple sells about three times what it sold in that first year and a half.

Then there’s Uber. Your friend tells you how you can press a button on a phone and a few minutes later a car will come by and, before you get in, you know who the driver is, his rating, how much it’ll cost, and how long it will take to get to your destination. All cheaper than a taxi. It seems like science fiction!

You see unemployment is only 3.8% and think it’s a typo, because when you fell asleep it was more than double that.

Your friend shows you a video of a self-driving semi-truck that Budweiser used to carry 51,744 cans of beer from Fort Collins, CO, to Colorado Springs, CO. About 130 miles on I-25 with no driver! Now Amazon is deploying similar trucks.

But what may be most amazing is that that there have been several years over the last 10 that the US has run a trade surplus with OPEC. You wonder how this can be since the US was in an energy crisis when you fell asleep. In fact, oil production had been on a declining trend for about 50 years. Your friend tells you it’s all changed. Since you have been asleep, because of new technology, oil production has more than doubled, from about 5 million barrels per day to around 12.1 million barrels per day. In fact, the US is now the world’s biggest oil producer. Bigger than Russia and Saudi Arabia! The state of Texas, by itself, just surpassed Iran to become the world’s fifth biggest oil producer!

You continue through the list and are more and more blown away. It’s been only 10 years and the world is completely different, for the better! You barely recognize it, so many things have happened that you wouldn’t have even dreamt possible.

And notice, you have no idea who is President, what’s been going on with interest rates, Quantitative Easing, China, or North Korea. You’ve never heard of “AOC” and you missed the whole Greek debt crisis. All you know about are these “golden geese.” And that’s all you need to know. The entrepreneur, alive and well, has continued to revolutionize the world over the past 10 years. That’s what has been driving economic growth and the stock market.

Imagine where we will be 10 years from now. Our guess is that it will be better than you can think.

    ********************************************************

As a side note, celebrating the 10-year anniversary of the current recovery and bull market is very satisfying to us.

We believed the Panic of 2008 was made significantly worse (trillions of dollars worse) than it needed to be because of overly strict mark-to-market accounting. Forcing banks and other financial institutions to write the value of assets down to fire sale prices based on frozen markets put the whole financial system at risk.

No amount of money from the Federal Government would have ever stopped it. Private investors stopped investing in banks. Markets stopped trading. All because assets were being written down well below the amount of cash they generated.

Quantitative Easing and TARP were both unnecessary, and useless. QE was started in September of 2008 and TARP was passed in October. During the next five months, the S&P 500 fell an additional 47% and financial stocks declined 70%. There is no evidence (unless you value self-proclaimed victories) that either worked.

The market turned on March 9, 2009, when the House of Representatives decided to push the Financial Accounting Standards Board to reverse the damaging mark-to-market rules. The change wasn’t made untilApril 2009, but the market knew it was coming. The change allowed banks to use cash flows to value investments. And guess what, private investors came back. They invested in banks and other equities and that was the turning point.

While government will tell you that it saved the economy, it didn’t. Once mark-to-market accounting rules returned to the way they were from the late 1930s through 2007, the economy could recover. And that’s exactly what it did. This recovery and the bull market are based on entrepreneurship. It’s not – and never was – a Sugar High.

TARP would have never been enough to save the system because assets would have continued to be marked down. And QE was unnecessary because the problem wasn’t due to a lack of money in the system.

Some members of the Federal Reserve try to compare 2008/09 to the Great Depression, and argue Milton Friedman would have wanted QE. But in the Great Depression, the money supply was declining. It never declined in 2007 or through September 2008, when QE was started. The problems in the system were capital problems, not liquidity problems.

In fact, it is our belief that without those overly strict mark-to market accounting rules, Bear Stearns, Lehman Brothers, WAMU and Wachovia would never had needed to go under.

Thank goodness the rules were changed, allowing the free market and entrepreneurship to once again work the magic that has transformed this great country since its start.

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:

http://www.ftportfolios.com/commentary/economicreaserch/2019/3/11/ten-years-ago