Where’s the Recession?

Posted on Updated on

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

Whatever happened to the recession calls?

Seems like just a few weeks ago that the correction in the stock market as well as the partial government shutdown had convinced many analysts and investors the US was about to enter a recession.

Fortunately, the data haven’t cooperated. Ten days agowe got the employment report for January, which showed a payroll increase of 304,000 and the highest share of adults working since 2008. Yes, February has seen both initial and continuing unemployment claims average higher than in January, but only slightly. In other words, job growth looks set to continue shutting down economic naysayers.

Meanwhile, the ISM Manufacturing index, which had moved down to a still-solid 54.3 in December, rebounded to a robust 56.6 for January. Traditionally, this measure needs to fall to 45.0, or below, to signal a US recession, and we’renot even close. The ISM Non-Manufacturing (services sector) index fell to 56.7 in January, which is still robust relative to historical standards. And that index, compared to the one for manufacturing, tends to be more sensitive to temporary shifts in sentiment rather than changes in underlying business activity.

Last week we started clearing out some of the major backlog of government economic data created by the partial shutdown, including the report on international trade which showed a much smaller trade deficit than anticipated. This further strengthens our expectation that the economy grew at a 2.5% annual rate in the fourth quarter of last year and will

continue to grow at around that pace in the first quarter of 2019.

This week, we’ll get several reports to keep an eye on.In particular, we’ll finally find out about retail sales inDecember and also get industrial production in January, both of which play key roles in estimating real GDP growth.

Superficially, we’re not optimistic about retail sales,estimating that they were unchanged for the month. But that was back in December when gas prices were plummeting. Excluding gas, retail sales were likely OK. Industrial production comes out Friday and we expect a modestincrease of 0.2%. If we’re right, that’ll mean production isup about 4.5% from a year ago, another sign we’re nowhereclose to recession.

And in the meantime, we continue to get reports on corporate profits as well as forward guidance. Profits compared to a year ago are doing well; estimates for the future, not so much. But those estimates for the future appear excessively pessimistic. The recession many anticipated isn’t happeningand consumers and businesses have plenty of purchasing power, which means top-line growth should offset any pressure on margins.

In addition, the power of improved incentives has only begun to play out. Dropping the corporate tax rate to 21% from 35% means companies have more reason to shift operations tothe US. But these shifts take time and it’s only been a year.

Those predicting the next recession are going to be waiting for a while before they finally get one “right.”

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/2019/2/11/wheres-the-recession

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2008 Myth and Reality

Posted on Updated on

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

We’ve written about it over and over, and while many advisors seem to understand, the media, politicians, and manyanalysts don’t…or won’t. So, we thought we’d try again to explain why so many people don’t understand the nearly ten- year long bull market in U.S. equity values.

Conventional Wisdom places the blame for the 2008 Financial Panic at the feet of Wall Street, and heaps praise on QE, TARP, and bank stress tests for saving the world. It has been repeated so often that even many conservative/libertarian analysts have succumbed to thinking the crises was papered-over by government money and that any day now the “sugar high” will come to an end.

This is why “corrections,” like the US stock markets experienced late last year generate so much fear. There is a cadre of traders, media-types, and just plain old hangers on who can’t wait to be the next Nouriel Roubini and make one great call in a row.

What makes it worse is that the truth is there for the taking, but the conventional wisdom simply ignores it. In Peter Wallison’s book “Hidden in Plain Sight,” he very clearly shows it was Fannie Mae and Freddie Mac who pushed the subprime loan space. Congress and HUD urged mandated that Fannie and Freddie buy more subprime paper, and by 2007 – along with the federal government – they owned 76% of it. Yes, Wall Street is culpable too, but government drove the marketplace. Wall Street simply wouldn’t have been issuing these bondswithout Fannie and Freddie’s voracious appetites.

Even Ben Bernanke has argued that subprime loansthemselves weren’t large enough to take down the system. He blames derivatives, undercapitalization, and interconnected banks. By his verdict, the government gets off scot-free.

But this completely ignores the role that FASB 157, otherwise known as mark-to-market accounting, played. Mark- to-market accounting forces banks to take a few bids from the marketplace and use those bids to value assets. Cash flowdoesn’t matter, underlying asset values don’t matter. And what happened was a disaster. The market for loans froze, and even assets that were still paying on time sold at fire-sale prices.

If a bank owned a pool of 1000 mortgages and 300 of them defaulted (which given the collapse in underwriting standards by Fannie and Freddie wasn’t impossible to expect), then that pool still payed 70 cents on the dollar. But, because the market was frozen, bids fell into the teens for an asset paying 70 cents in cash. FASB 157 forced banks to take the “bid,” push it through their income statement, and subtract the losses from capital. This, in turn, created the bigger problems. There was no willingness to invest in banks when, at any time, they could be wiped out by mark-to-market losses. The fire became an inferno.

This was a capital problem, not a liquidity problem. But, the Federal Reserve started Quantitative Easing anyway in September 2008. Hank Paulson pushed the $700 billion TARP bill through that October. Nonetheless, the market kept falling. The S&P 500 fell an additional 40% after TARP – bank stocks fell 73%. QE and TARP weren’t the cure.

It was March 9, 2009, when Barney Frank’s FinancialServices Committee announced a hearing with FASB on this really dumb accounting rule, that the market turned around. Yes, it’s true that the actual rule wasn’t reversed until April, but on March 9th the financial markets realized the change was coming.

What happened after that is recorded for history. The market is up 300%, banks healed, asset values rose, and a“normal recovery” began. New technology – fracking, apps, 3D printing, the cloud, smartphones – lifted productivity and profits, and stocks responded. It was not QE that lifted the stock market; TARP didn’t save the banks.

Unfortunately, because so many Republicans back the government-led version of history, many younger Americans have come to believe that free markets fail, and governments can engineer growth. No wonder there are so many fine young thinkers who seem to back socialism these days. After all, even Republicans support government intervention. PresidentGeorge W. Bush defended TARP by saying we had to “violate free market principles in order to save the free market.”

Nothing could be further from the truth. Either you believe in free markets, or you don’t. The Bush administrationand its supporters bowed to the popular, but false, narrative. They have yet to find a way to explain their positions. As a result, socialist tendencies are rising in America.

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Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

2-4 / 9:00 am

Factory Orders – Nov

+0.3%

-1.2%

-0.6%

-2.1%

2-5 / 9:00 am

ISM Non Mfg Index – Jan

57.1

57.2

58.0

2-6 / 7:30 am

Int’l Trade Balance – Nov

-$54.0 Bil

-$53.6 Bil

-55.5 Bil

2-7 / 7:30 am

Initial Claims – Feb 1

221K

220K

253K

2:00 pm

Consumer Credit– Dec

$17.0 Bil

$15.6 Bil

$22.1 Bil

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/2019/2/4/2008-myth-and-reality

Solid Growth to Finish 2018

Posted on Updated on

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

Normally, the end of January sees the government’s firstestimate of real GDP growth for the fourth quarter. But with no end in sight for the shutdown, which has already seen numerous other data releases postponed – including figures on retail sales, international trade, inventories, construction, and durable goods – it’s very unlikely the GDP report will arrive on time.

Our GDP model looks at each major component of GDP –consumer spending, business investment, home building – and adds those parts up to get the big picture of what happened to the economy in that quarter. But with less data to put into the model, that means less accuracy. In turn, that means we need touse not only our usual “add-em-up” framework, but also look at the economy from a “top-down” view as well. And thatperspective suggests we did quite well in Q4.

For example, industrial production at factories, mines, andutilities grew at a 3.7% annual rate in the fourth quarter. That’s important because industrial production measures “units” ofoutput – in other words it’s a measure of “real” output – andover the past nine years, there’s been almost zero difference, onaverage, between the growth rate of industrial production and real GDP growth on a year-over-year basis.

And another reason to be optimistic is that the number of hours worked in the private sector increased 2.1% in the fourth quarter. Tack on some modest add-factor for productivity growth (the increase in output per hour) and we could easily be at a growth rate of 3.0%, at least for the private sector.

Maybe this is why the stock market is up despite the lack of data. Investors can see the economy is not falling off a cliff. In fact, it remains very close to the above-trend growth rate of the past year. Right now, we’re estimating real GDP grew at a2.5% annual rate in Q4, which would bring the growth rate for 2018 to 3.1% (comparing the fourth quarter to the fourth quarter of 2017), the fastest pace since 2005.

But don’t expect everyone to hail this as good news.Some analysts are obsessed with the “second derivative” ofGDP, which is just a fancy way of saying whether the growth rate is getting faster or slower, regardless of whether real GDP is still growing. So if we get a 2.5% growth rate for Q4, expect to hear about why this is really bad news because the growth rates in Q2 (4.2%) and Q3 (3.4%) were faster. The thinly- veiled idea is that the pace of growth is slowing, and that trend will continue until we find ourselves back in recession.

Don’t buy it. A look back at quarterly GDP growth ratessince 2009 shows this “second derivative” argument neverworked. Real GDP slowed from quarter to quarter multiple times, but no recession occurred. Instead of over-using thephrase “second derivative,” more analysts should get familiarwith a more relevant phrase: “statistical noise.” Growth on a quarterly basis always bounces around a trend, but it’s thetrend, not the bounces, that matter.

All that said, here’s how we get to our 2.5% real growthforecast for Q4:

Consumption: Automakers say car and light truck sales rose at a 13.6% annual rate in Q4. Meanwhile, chain store sales soared, up 7.7% from a year ago in the last week of December. But most consumer spending is on services, where the data is sparse. We’re estimating real personal consumption (goods andservices combined) grew at a 4.0% annual rate, contributing 2.7 points to the real GDP growth rate (4.0 times the consumption share of GDP, which is 68%, equals 2.7).

Business Investment: Limited reports suggest equipment, commercial construction, and intellectual property growing at a 4.0% pace, which should add 0.6 points to real GDP growth. (4.0 times the 14% business investment share of GDP equals 0.6).

Home Building: Residential construction looks flat inQ4, which means it’ll neither add to nor subtract from GDPgrowth for the quarter.

Government: Looks like a modest 0.8% increase in real public-sector purchases in Q4, which would add 0.1 points to the real GDP growth rate. (0.8 times the government purchase share of GDP, which is 17%, equals 0.1).

Trade: We only have data through October, but are guessing that net exports subtract 0.4 points from the real GDP growth rate.

Inventories: Again, reports are only through October, but it looks like a slowdown in inventory accumulation will trim 0.5 points from real GDP growth.

Add it all up, and we get 2.5% annualized growth. In the context of tax cuts and deregulation, look for this growth to keep pushing profits higher. The bull market is poised to push higher in 2019.

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

1-22 / 9:00 pm

Existing Home Sales – Dec

5.240 Mil

4.970 Mil

4.990 Mil

5.330 Mil

1-24 / 7:30 am

Initial Claims – Jan 19

220K

218K

213K

1-25 / 7:30 am

Durable Goods – Dec

+1.5%

+2.3%

N/A

7:30 am

Durable Goods (Ex-Trans) – Dec

+0.2%

+0.5%

N/A

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/2019/1/22/solid-growth-to-finish-2018

The Endless Debt Fret

Posted on Updated on

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

For the more than three decades we have been involved in analysis of the economy, one nagging constant has been pessimistic prognostications over the U.S. debt. Now once again, debt is the news de jour. Consumer, business, and government debt are all at record highs, and, therefore, the theory goes, the economy is tempting fate.

We have some very basic problems with this theory. Debt has been rising for decades, as it usually has since the US was founded more than 200 years ago. But just like debt, assets, incomes and profits have hit record highs too. While it’s true that debt is usually at a record high when a recession starts, debt itself doesn’t cause recessions. And debt itself doesn’t cause growth either. If it did, then Puerto Rico and Greece would be economic power houses; instead, they’re basket-cases.

Debt is a transfer of assets from someone who wants to spend less than they earn today, to someone who wants to spend more. When this debt fuels investment in entrepreneurial ventures that boost growth, then debt helps lift the economy. But if spend thrift consumers or governments borrow money for non-productive activities, then debt goes up while production stagnates. That’s a problem, as there are no extra goods and services to offset the cost of larger debt payments as they come due.

The other thing about debt is that it can sometimes spur on more production. Imagine you wake up tomorrow and are $10,000 more in debt. Are you going to work more hours or fewer to pay that off?

In other words, investors should neither be “debtophobes” or “debtophiles.” Instead, investors should be agnostic about debt, looking into the underlying reasons for the debt as well as its sustainability relative to asset levels and income. Take, for example, the national debt of Japan, which is about 235% of GDP. That’s a lot of debt! But Japan’s interest rates have been hovering around 0% for years, which means the carrying cost of the enormous debt is minimal (for now).

Another example is the US consumer. Household debts are at a record high of $15.9 trillion, beating even the $14.7 trillion record set in early 2008 before the financial crisis and Great Recession. This includes mortgages, home equity loans, student loans, auto loans, credit card debt,…etc. So, the thinking goes, if we had a crisis after the last record high and now we’re even higher, there must be a new crisis lurking around the corner.

The problem with this theory is that it ignores asset values. Back at the old peak in household debt in 2008, debts were 19% of assets; now they’re 12.7% of assets, the lowestshare since the mid-1980s. Meanwhile, households’ debtservice is the lowest share of after-tax income since at least the 1980s. Corporate debt, too, is low relative to assets in historical comparisons, and interest costs as a percent of profits are well within the normal range.

Faster growth in recent years may have coincided with higher debts in some areas, but it wasn’t caused by higher debts. Growth has picked up thanks to a mix of better policies and entrepreneurship. Bottom line is we don’t see anything about the current level of debt that’s going to cause a recession anytime soon. Let the pouting pundits kick and scream but focus your attention on more important things.

 

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/2019/1/14/the-endless-debt-fret

No Sign of Recession

Posted on Updated on

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

Talk about destroying a narrative. On Friday, the Labor Department reported 312,000 new jobs in December, with an additional 58,000 from upward revisions to prior months. Recession talk got crushed.

The Pouting Pundits of Pessimism claim jobs are a lagging indicator, but the pace of payroll growth starts declining well before a recession starts. In the twelve months ending in June 1989 nonfarm payrolls increased a robust 225,000 per month. In the next twelve months payrolls rose a softer 153,000 per month and then a recession officially started in July 1990.

A similar pattern happened before the next two recessions, as well. In the twelve months ending in February 2000, payrolls rose 250,000 per month before decelerating to 137,000 per month in the next twelve months. A recession started in March 2001.

In the twelve months ending in November 2006, payrolls rose 173,000 per month and then slipped to 101,000 per month in the following twelve months. After the financial crisis started, the National Bureau of Economic Research dated the start of the Great Recession to December 2007.

By contrast, nonfarm payrolls are up an average of 220,000 in the past twelve months versus a gain of 182,000 per month in the twelve months before that. On a quarterly basis, from Q2-2017 to Q4-2018, job growth has been 473,000, 553,00, 556,000, 632,000, 634,000, 623,000 and 670,000. In other words, no sign of the kind of slowdown in job creation that normally precedes a recession; instead, job creation appears to be accelerating.

Yes, the unemployment rate did rise to 3.9% in December from 3.7% in November, but that’s because the growth of the labor force was a healthy 419,000. A slower decline in the unemployment rate combined with faster economic growth signals that potential GDP growth has increased, exactly the response we would expect with lower marginal tax rates and deregulation.

If the partial government shutdown continues into the employment survey week, the unemployment rate may rise in January, but that’ll be temporary, unwinding when the political showdown ends. Perhaps the best part of Friday’s report was that workers’ wages are accelerating. Average hourly earnings rose 0.4% in December and are up 3.2% from a year ago. And that’s excluding extra earnings from irregular bonuses and commissions like those paid out after the tax cut was passed.

Another piece of hard data and good news last week also undermines the recession theory: automakers reported that Americans bought cars and light trucks at a 17.55 million annual rate in December, the fastest pace since November 2017, when sales were still surging in the aftermath of Hurricanes Harvey and Irma. We don’t expect auto sales to stay this strong, but recent strength shows consumers are not under stress.

Yes, the ISM Manufacturing report for December fell short of consensus expectations, but since this is a survey, it’s easier to pick up temporary noise, as human emotion can be a factor over the short term. Still, even at 54.1, it still shows healthy expansion and is well above recession territory. The last three recessions started with the ISM at 46.6 (July 1990), 43.1 (March 2001), and 50.1 (December 2007). In the past year manufacturing jobs are up 24,000 per month, as opposed to the contraction in these jobs usually seen before a recession starts.

Monetary policy is not tight and is unlikely to be anytime soon. Companies are still adapting to lower tax rates, full expensing, and less regulation. Consumers will be surprised with their larger than anticipated tax refunds. A trade deal has been struck with Mexico and Canada and negotiations with Europe and Japan should result in lower tariffs on US exports. The sore spot is China, but the US has lots of leverage given the large trade deficit.

At some point the US will have a recession. But none of the data we’re looking at suggests a recession will start anytime in the near future. In turn, we think profits will continue to grow and that even at the current level of profits, US equities remain cheap.

 

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

1-7 / 9:00 am

ISM Services Index – Dec

58.5

58.5

57.6

60.7

1-8 / 7:30 am

Trade Balance – Nov

-$54.0

-$53.6

-$55.5

2:00 pm

Consumer Credit – Nov

$16.0

$12.7

$25.4

1-10 / 7:30 am

Initial Claims, Week of 01/05/19

225K

224K

231K

1-11 / 7:30 am

CPI – Dec

-0.1%

-0.2%

0.0%

7:30 am

Core CPI – Dec

+0.2%

+0.2%

+0.2%

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

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/1/7/no-sign-of-recession

The Long-Term Yield Conundrum

Posted on

December 10, 2018

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

Last Friday, the 10-year Treasury Note closed at a yield of 2.85%. That’s up from 2.41% at the end of 2017, but down from the peak of 3.24% on November 8th, and well below where fundamentals suggest yields should be.

In the last two years, nominal GDP growth – real GDP growth plus inflation – has run at a 4.8% annual rate. Normally, we’d expect yields to be close to nominal GDP growth, but Treasury yields have remained stubbornly low.

Some analysts are spooked by the recent movement of 3- year yields above 5-year yields, thinking this “inversion” signals a recession. We think this is sorely mistaken. With a lag, recessions have often (but not always) followed periods when the federal funds rate exceeds the 10-year yield. If anything, that’sthe inversion to look out for; feel free to ignore the rest. But, at present, the 10-year is yielding about 70 basis points above the funds rate, well within the normal range.

One reason that the 10-year yield has remained below where economic fundamentals suggest it should trade is that the Federal Reserve set short-term interest rates near zero. Longer- term bonds, including the 10-year reflect the current level of short-term rates as well as the projected path of those rates in the future. So, back when yields were essentially zero, and the Fed was signaling they could stay there for a long time, this pulled down longer-term yields. The Fed has now lifted short-term interest rates by 200 basis points from where they were, but investors still don’t believe they will go much higher.

Part of the issue is that many think low rates themselves are the only reason the economy came out of the Great Recession. So as the Fed lifts rates, many investors expect the next recession is a small tip of the scale from returning in force.

If you’re buying 10-year Notes under the premise that a recession will happen sometime in the next ten years – and you also expect the next recession to tie (or beat) ’08-’09 for the title of worst recession since the Great Depression – then the yield on the 10-year Treasury makes a lot more sense.

But we whole heartedly disagree with your assessment. We think the bond market is anticipating a far weaker economy over the next ten years than the data justifies.

No matter how many believe it, the bond market is not all- knowing. In November 1971, the 10-year Treasury was yielding 5.81%. Over the next ten years, inflation alone increased at an 8.6% annual rate and nominal GDP grew at a 10.7% annual rate. In other words, 10-year note investors got hammered as yields soared. And notice that back in 1971 we had a Republican president (Richard Nixon) leaning heavily on the Fed to maintain a loose monetary policy. Sound familiar?

The next recession is unlikely to be like the last. Our calculations suggest national average home prices were 40% overvalued at the peak of the housing boom – pumped up by government rules and subsidies artificially favoring home buying. Meanwhile overly stringent mark-to-market accounting rules created a once in a 100-year panic. Mark-to-market rules have now changed to allow cash flow to be used to value assets, plus banks are much better capitalized. In other words, fundamentals suggest another panic is not in the cards.

What’s more likely is that, when the next recession hits – and we don’t see one happening until at least 2021 – it will be softer than usual, more like 1990-91 or 2001, than 1973-75, 1981-82 or 2007-09. As investors realize data trumps the rhetoric, we expect bond yields to rise. In the end, math wins.

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

12-11 / 7:30 am PPI – Nov 0.0% 0.0% +0.6%

7:30 am “Core” PPI – Nov +0.1% +0.2% +0.5%

12-12 / 7:30 am CPI – Nov 0.0% 0.0% +0.3%

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

12-13 / 7:30 am Initial Claims – Dec 8 227K 228K 231K

7:30 am Import Prices – Nov -1.0% -0.7% +0.5%

7:30 am Export Prices – Nov -0.3% -0.5% +0.4%

12-14 / 7:30 am Retail Sales – Nov +0.1% -0.1% +0.8%

7:30 am Retail Sales Ex-Auto – Nov +0.2% -0.1% +0.7%

8:15 am Industrial Production – Nov +0.3% +0.2% +0.1%

8:15 am Capacity Utilization – Nov 78.6% 78.5% 78.4%

9:00 am Business Inventories – Oct +0.6% +0.6% +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:

Scapegoating Powell

Posted on

December 3, 2018

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

New Narrative Alert: Fed Chief Jerome Powell is to blame for the volatility in stocks. Back on October 3rd, with stock markets near their record highs, Powell said “we’re a long way from neutral.” That was not long after the Fed had moved the federal funds rate to a range of 2.00% to 2.25%, so the implication was that the Federal Reserve was going to maintain a pace of rate hikes in 2019 similar to 2018.

Then came the correction – which, by the way, seems to have ended the day after Thanksgiving – just a few trading days before Powell adjusted his language and said short-term interestrates set by the Fed are “just below” neutral.

Conventional wisdom says it’s all about the Fed. This thinking began back in 2008/09 when many pundits, analysts and investors decided it was QE and zero percent interest rates that saved the markets during the Great Recession. Forget about entrepreneurship, forget about profits, forget about tax rates and regulation. Just read the Fed tea leaves or listen to those who read them for you.

Count us skeptical. No matter how bullish we’ve been the past several years, we’ve always told investors that it’s aboutentrepreneurship, profits, and policy, not the Fed. If printing money and low rates were really the answer, European stockmarkets wouldn’t have under-performed the US by so much in the past decade. And no one can consistently predict corrections. Investors could save a lot of headache (and a lot of money) simply by focusing on fundamentals rather than trying to time the market.

After a correction happens, plenty of people come out of the woodwork to tell us what caused it, even though they never predicted the correction in the first place. There’s always someexplanation – after the fact – that seems to fit the limited data available. So, it’s not surprising some analysts are blaming Powell. Heck, the pouting pundits have been predicting near constant doom and gloom since 2009, and they’ll take anychance they can (no matter how temporary) to pop champagne and gloat.

Regardless, neither of Powell’s statements were out ofline. Back in September the “median dot” suggested a neutralrate of 3.0% for federal funds, which is about four rate hikesaway or a “long way from neutral.” But the range for neutral extends from 2.5% to 3.5%, possibly only one or two more ratehikes away, consistent with “just below.”

We think the news that really drove the market higher last week was the report that economy-wide pre-tax corporate profits were up 10.3% from a year ago (and up 19.4% after taxes – thank you tax cuts!). Focus on fundamentals, not post- event explanations. The former tell us the trend, the latter are little more than a distraction.

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/2018/12/3/scapegoating-powell

Consumers Stay Strong

Posted on Updated on

November 26, 2018

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

It’s that time of the year again. Holiday sales data show surging online sales while foot traffic at brick and mortar storesremains tepid. If you have a sense of déjà vu, it’s because youheard the same stories last year.

Black Friday had a 23.6% increase in online sales this year, according to Adobe Analytics, which tracks sales at 80 of the top 100 internet retailers, with one-third of the sales via mobile devices – that’s up from 29.6% in 2017. Looks like more people are getting comfortable with making buying decisions on the go rather than at a desk.

Online sales on Thanksgiving Day itself were up 28%, while the average online order is up 8.5% this year to $146. So,we’re getting both more orders and orders for bigger-ticket items. Many of those orders are picked up in stores.

Meanwhile, according to ShopperTrak, foot traffic at brick-and-mortar stores was down 1.0% this year on Thanksgiving and Black Friday, combined. However, that’s smaller than the 1.6% decline on the same days last year.

Look, you could spin this data anyway you like, but instead of getting bogged down in the day-to-day figures, we like to focus on fundamentals, and those fundamentals are very strong. Total retail sales are likely to be up 6%+ this year over last year. That’s very strong.

The unemployment rate is 3.7%, the lowest since the NY Jets were reigning Super Bowl champs in 1969, and trending lower. Yes, the participation rate – the share of adults who are either working or looking for work – is hovering at levels lower than in the 1980s, 1990s, or 2000s. But the participation rate is higher than it was in the 1960s, back when many say theeconomy was at “full employment.”

The “U-6” unemployment rate, sometimes referred to as the “true unemployment rate,” which includes discouraged workers and those working part-time who say they want full- time jobs, is 7.4% right now. That rate was lower from late 1999 to early 2001 at the peak of the original internet boom, bottoming at 6.8%. So, by that standard the economy could be doing better. But the gap between 7.4% and 6.8% is relatively small in a data sense, and a huge decline from the peak in 2010 of 17.1%. In other words, the labor market has improved markedly on all fronts. And, remember 6.8% was the lowest level recorded at the peak of the 1990s boom; the current expansion is still intact, with the peak potentially years away.

Another key fundamental pointing towards the positive is the acceleration of wage growth, with average hourly earnings up 3.1% from a year ago, the fastest growth since 2009. Meanwhile the employment cost index, an alternative measure of worker compensation, is up 2.8% from a year ago, also the largest increase since 2009. And don’t let anyone tell you that this just shows the “rich getting richer.” The fastest gains in weekly earnings are being made near the bottom of the income spectrum, not the top.

In addition, gas prices are down. Remember how concerned demand-side economists get whenever gas prices go up? They look at it like a tax hike. But now gas prices have dropped and we notice barely a peep about how this will lift purchasing power for consumers.

As of mid-year, household debts were the lowest relative to household assets since the mid-1980s. Meanwhile, financial obligations – think debt service on consumers’ loans plus recurring payments like rent, car leases, homeowners’ insurance, and property taxes – are still hovering near the lowest share of after-tax income since the early 1980s.

None of this suggests that every consumer is in the best financial position they’ve ever been in. But very many are, others are very close, and we expect this to be reflected in continued robust gains in consumer spending in both November and December as well as the year ahead.

So while, yes, the market is down, in correction territory in fact, it’s just a correction, not a recession. Don’t get sidetracked. The consumer, the producer, the entrepreneur – the economy as a whole – are all moving forward at a very healthy pace.

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Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

11-28 / 7:30 am

Q3 GDP Second Report

3.5%

3.7%

3.5%

7:30 am

Q3 GDP Chain Price Index

1.7%

1.7%

1.7%

9:00 am

New Home Sales – Oct

0.575 Mil

0.585 Mil

0.553 Mil

11-29 / 7:30 am

Initial Claims – Nov 24

220K

215K

224K

7:30 am

Personal Income – Oct

+0.4%

+0.5%

+0.2%

7:30 am

Personal Spending – Oct

+0.4%

+0.5%

+0.4%

11-30 / 8:45 am

Chicago PMI – Nov

58.5

58.5

58.4

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/2018/11/26/consumers-stay-strong

“Fading” Fiscal Stimulus; Really?

Posted on Updated on

November 20, 2018

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

Fed Chair Jerome Powell and others have started a new narrative about economic “headwinds.” They think past rate hikes, slower foreign growth, and “fading fiscal stimulus” shouldslow the Fed’s rate hikes. But is fiscal stimulus really fading?

Powell and others think the growth benefits of both the 2018 tax cuts and increased federal spending are winding down.This is pure Keynesian analysis and we think it’s wrong. In our view it reflects a misunderstanding of both how tax cuts work and the actual path of federal spending.

The difference is between demand-side (Keynesian thinking) and supply-side thinking. Keynesians think demand drives growth. In other words tax cuts work by putting more money in people’s pockets, which increases consumption and,therefore, GDP. They say the first year of a tax cut boosts after- tax incomes and demand, but then, stimulus fades as this boost is removed and income falls back to the previous (slower) trend.

Keynesians also believe federal government spending stimulates growth because it, too, is part of demand. In fact, government purchases are a direct part of GDP accounting and so it appears like government spending is a stimulus.

By contrast, supply-siders think incentives for entrepreneurship and investment drive growth. It is the supply of new goods and services that leads to faster economic activity.Say’s Law says “supply creates its own demand.” In otherwords, the tax cut led to better incentives to invest, work, and invent. And, as long as tax rates remain low a “permanent”change in incentives has been initiated, which will boost growth rates permanently. There is no “fade.”

Before the tax cut, the corporate tax rate in the US was approximately a combined 40% (federal, state, and local). In 2017, Canada had a corporate tax rate of 26.5%. So, there was a 13.5% incentive to invest in Canada over the US. And, at the margin, more investment went to Canada (and other countries with lower corporate tax rates) than would have been the case if the US tax rate was not the highest in the developed world.

Now the combined U.S. corporate tax rate is approximately 27%, radically changing incentives. In other words, at the margin, as long as tax rates stay where they are, there is a

permanent incentive to invest more in the US. This does not mean growth will accelerate from where it is now (roughly 3% GDP), but it will not automatically revert back to 2%, where it was from 2010-2017.

The more curious and misguided argument is that fading government spending will slow and reduce GDP. We think this comes from a misunderstanding of the budget deal which was passed last year. Yes, that budget deal increased spending, butso far it hasn’t shown up as a boost to GDP growth.

In Fiscal Year 2018, nominal GDP rose 5.0% over FY2017, while total federal spending went up just 3.2%. Government purchases, which feed directly into GDP, rose just 4.0%. In other words, relative to the private sector, government demand grew more slowly.

On top of this, total federal revenue was up 1% in FY2018. While corporate tax receipts fell 22%, total individual receipts were up 6%. In other words, while it’s true that the federalgovernment collected fewer tax receipts in FY2018 than it budgeted prior to the tax cut, it still collected more revenue than it did in FY2017.

The bottom line is that the entire demand-side basis for the fiscal stimulus argument has no data to support it. Government spending grew slower than GDP and actual tax receipts went up.As a result, any argument that there will be “fading” fiscalstimulus is based on a data that does not exist.

The reason growth has accelerated is because lower tax rates, and less regulation, increase entrepreneurial activity – a supply-side acceleration in growth, not Keynesian. Anyonewaiting for slower economic activity as fiscal stimulus “fades”will be waiting in vain.

The one worry we have is the exact opposite of what Keynesians argue. A new divided government adds to pressure for bipartisan legislation. Bipartisanship often means more government spending. As supply-siders, we view increased government spending as a drag on growth, not a boost.

The more government spends as a share of GDP, thesmaller the private sector. That’s how growth will really fade.

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

11-20 / 7:30 am

Housing Starts – Oct

1.225 Mil

1.267 Mil

1.201 Mil

11-21 / 7:30 am

Initial Claims – Nov 17

215K

215K

216K

7:30 am

Durable Goods – Oct

-2.5%

-2.8%

+0.7%

7:30 am

Durable Goods (Ex-Trans) – Oct

+0.4%

+0.9%

0.0%

9:00 am

Existing Home Sales – Oct

5.200 Mil

5.300 Mil

5.150 Mil

9:00 am

U. Mich Consumer Sentiment- Nov

98.3

98.3

98.3

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/2018/11/19/fading-fiscal-stimulus-really

The Plentiful Job Market

Posted on Updated on

November 5, 2018

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

Growth is determined by a perpetual tug-of-war between entrepreneurship and government redistribution. When President Obama was in office, we believed incredible technological innovation would allow for economic growth in spite of Obamacare, greater redistribution, higher taxes and increased regulatory burdens. We thought it would be a Plow Horse Economy, and that things would get better if we did not grow government so much.

From mid-2009 through early 2017, real GDP grew at a 2.2% annual rate, with plodding growth in wages. It certainly wasn’t an economic boom, but it wasn’t recessionary either. For us, this meant we were shunned by both sides of the press.

We consistently repeated that the economy would grow faster with a better set of policies. So we became pariahs: liberal commentators didn’t want to hear about the free market policies we thought would improve economic growth; while conservative commentators didn’t want to hear about the economy being anything other than awful.

Now, thanks to the long-awaited corporate tax cut and deregulation, policies are more pro-growth.

In the past year, non-farm payrolls are up 210,000 per month while civilian employment, an alternative measure that includes small-business starts-ups, is up 200,000 per month. Some say, “Hey, that’s not any faster than recent years” and that’s true, but the longer expansions go, the tougher it is to sustain rapid job growth as the pool of available workers shrinks. In other words, today’s job growth is more of an achievement than it was during earlier stages of the recovery.

More important is the acceleration in workers’ paychecks. Average hourly earnings are up 3.1% from a year ago, the fastest wage growth for any 12-month period dating back to 2009. Factor-in robust gains in the total number of hours worked, and total cash earnings for workers are up 5.5% in the past year (even excluding one-time bonuses and commissions, like those paid after the tax cut was enacted late last year). That’s the fastest growth in cash earnings since recording began in 2006.

Meanwhile, the Employment Cost Index, a different measure of workers’ earnings, has also accelerated. Wages and salaries for private industry workers are up 3.1% from a year ago, the fastest pace since 2008. A year ago, in the third quarter of 2017, this measure of wages was up 2.6%. The ECI holds the weight of each industry and occupation the same over time, so the boost to wage growth is more likely to reflect faster pay increases for workers at the same job, rather than pay increases due to a shift in the mix of jobs towards those already paying higher wages.

Here’s the best part. A survey from the Labor Department on workers’ usual weekly earnings shows the fastest wage growth is for the bottom tenth of earners. Rising wages appear to be drawing more workers back into the labor force, with the number of people either working or looking for work up 162,000 per month in the past year, even as the US continues to face the demographic headwind of an aging Baby Boom generation.

It wasn’t that long ago that some analysts were complaining about too much of the job growth coming from part-time jobs. We never bought into that argument, and the data supporting it was weak. The number of people working part-time for economic reasons peaked at about 9.2 million in 2010 and now it’s down to 4.6 million. In the past eight years, part-time jobs in the economy are down 56,000, while we have added more than 17 million full-time positions.

So, now, some argue that faster job growth is due to multiple job holders. But the data don’t show that, either. Multiple job holders are 5.2% of all workers, which is lower than it was, on average, in both the prior economic expansion (2001-07) and the expansion of the late 1990s.

If someone tortures the data enough, we’re sure they could twist it into some new argument claiming things aren’t as good as they seem. And we stand ready to keep reviewing their claims to see if they make sense. So far, they haven’t. We don’t expect that to change anytime soon.

 

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

11-5 / 9:00 am

ISM Non Mfg Index – Oct

59.0

59.1

60.3

61.6

11-7 / 2:00 pm

Consumer Credit– Oct

$15.0 Bil

$14.9 Bil

$20.1 Bil

11-8 / 7:30 am

Initial Claims – Nov 3

213K

213K

214K

11-9 / 7:30 am

PPI – Oct

+0.2%

+0.3%

+0.2%

7:30 am

“Core” PPI – Oct

+0.2%

+0.2%

+0.2%

9:00 am

U. Mich Consumer Sentiment -Nov

98.0

99.1

98.6

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 Review:

https://www.ftportfolios.com/Commentary/EconomicResearch/2018/11/5/the-plentiful-job-market