Heartburn, Not a Heart Attack

Posted on Updated on

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

October 15, 2018

Not long ago, many investors were kicking themselves for not investing more when the stock market was cheaper. But when stocks fall, like they did last week, many investors have a hard time buying for fear stocks may go lower still.

Who knows, maybe they’re right. We have no idea where stocks will close today, nor at the end of the week. Corrections (both small and large) happen from time to time. In hindsight, many claim they knew it was coming, but we don’t know anyone who has successfully traded corrections on a consistent basis – we certainly won’t try.

We’re also skeptical when analysts try to attribute corrections to a particular cause. It’s a basic logical flaw: post hoc ergo propter hoc. Because the correction happened after a certain event, that event must have been the cause. But important news and economic events happen all the time. Sometimes the market goes up afterward, sometimes down, and similar events at different times have no discernible impact.

Now some are blaming the Federal Reserve, and specifically statements from Chairman Powell, for the downdraft in equities. But, according to futures markets, the outlook for monetary policy has barely changed. The markets are still pricing in a path of gradual rate hikes and continued reduction in the size of the Fed’s balance sheet.

Let’s face it, fretting over the Fed is as old as the Fed itself. In recent years alone, we faced the “Taper Tantrum” and calls for a fourth round of quantitative easing. And remember when the Fed first raised rates and then announced it would reduce its balance sheet? Each time, analysts predicted the apocalypse was upon us – that a recession and bear market were right around the corner. How did those calls pan out?

Exactly, they were wrong, and this time looks no different. QE never lifted stocks, taking it away won’t hurt; and interestrates are still well below neutral. The biggest pain has been felt by those who followed the false prophets of doom.

The odds of a recession happening anytime soon remain remote, we put them at 10%, or less. And a recession is what it would take for us to expect a full-blown bear market. In other words, the current drop is just heartburn, not a heart attack.

We’ll publish a piece next week about our exact forecast for economic growth in Q3, but it looks like real GDP rose at about a 4.0% annual rate. Profits are hitting record highs and businesses are still adapting to the improved incentives of lower tax rates and full tax expensing for business equipment. Home building is still well below the pace required to meet population growth and scrap page (roughly 1.5 million units per year). Household debts are low relative to assets and debt service payments are low relative to income. These are not the ingredients for a recession.

That’s why we love Jerome Powell’s response to the recent gyrations in the market. Many pundits were calling for him to back off his tightening and his “hawkish” language, but he didn’t take the bait. He’s focused on monetary policy, and the economy and won’t be pushed around by hysterics or market gyrations. The S&P 500 fell about 6% from its intraday all-time high to Friday’s close. This isn’t earth-shattering, and the Fed shouldn’t respond. Investors need to stop obsessing about the Fed. Instead, they should focus on entrepreneurship and profits. The fundamentals are what matter.

Meanwhile, some investors are concerned about President Trump tweeting or speaking out on the Fed and monetary policy. If this were any other president, we’d be concerned, as well. But we all know Trump isn’t the kind of president to hold his opinions close to the vest on any topic. If he thinks it, he says it. Please take his comments on the Fed in that context. That certainly seems to be what Jerome Powell is doing.

The bull market in equities that started in March 2009 isn’t going to last forever. But we don’t see anything that’s going to bring it to a screeching halt anytime soon.

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

10-15 / 7:30 am

Retail Sales – Sep

+0.6%

+0.6%

+0.1%

+0.1%

7:30 am

Retail Sales Ex-Auto – Sep

+0.4%

+0.3%

-0.1%

+0.2%

7:30 am

Empire State Mfg Survey – Oct

20.0

21.4

21.1

19.0

9:00 am

Business Inventories – Aug

+0.5%

+0.5%

+0.5%

+0.7%

10-16 / 8:15 am

Industrial Production – Sep

+0.2%

+0.1%

+0.4%

8:15 am

Capacity Utilization – Sep

78.2%

78.1%

78.1%

10-17 / 7:30 am

Housing Starts – Sep

1.210 Mil

1.251 Mil

1.282 Mill

10-18 / 7:30 am

Initial Claims – Oct 13

210K

215K

214K

7:30 am

Philly Fed Survey – Oct

20.0

16.2

22.9

10-19 / 9:00 am

Existing Home Sales – Sep

5.290 Mil

5.270 Mil

5.340 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/2018/10/15/heartburn,-not-a-heart-attack

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Powell Moves Markets

Posted on Updated on

October 8, 2018

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

Federal Reserve Board Chairman, Jerome Powell, who has been remarkably quiet as he adjusts to his new role at the Fed, finally roiled markets last week. He made comments on Wednesday, during the Atlantic Festival at a session moderated by Judy Woodruff of the PBS News Hour.

Powell said, “The really extremely accommodative lowinterest rates that we needed when the economy was quite weak,we don’t need those anymore.”

He added, “(I)nterest rates are still accommodative, butwe’re gradually moving to a place where they will be neutral.We may go past neutral, but we’re a long way from neutral atthis point.” [Our emphasis added.]

The reaction of the markets was swift and dramatic. The 10-year Treasury note rose from 3.06% on Tuesday to 3.23% on Friday, its highest yield since 2011. From their intraday highs on Wednesday to Friday’s close, the Dow Jones IndustrialAverage fell 1.8%, the S&P 500 fell 1.8%, and the NASDAQ Composite fell 3.3%.

To begin with, we agree completely with Mr. Powell. There are a number of models that purport to measure a “neutral”interest rate – a federal funds rate which does not hurt growth, but also does not lift inflation. Rates above neutral hurt the economy, rates below neutral lift inflation.

One model is the “Taylor Rule,” which is based on setting separate targets for real GDP growth and inflation and then adjusting short-term interest rates when these data deviate from the targets. For example, if inflation and economic growth are above the target, then the “neutral” rate should move higher. If the economy or inflation fall, then so should the neutral rate. There are multiple versions of the Taylor Rule and right now these versions suggest a neutral federal funds rate somewhere between 3% and 5%.

While we very much like a rule-based monetary policy, and think the Taylor Rule is a fine rule, we try to simplify things even more. We think the growth rate of nominal GDP (real growth plus inflation) is the best target. Nominal GDP (or total spending

in the economy) is a measure of the average growth rate of all business plus government. When interest rates are below thisaverage growth rate there’s an incentive for business to borroweven for projects that return less than average. This can cause distortions in the market. When rates are above this average, it can shut down activity.

Our model uses a two-year moving average of nominal GDP growth to avoid the volatility of shorter time frames. In the past, when the Fed has lifted the federal funds rate above two- year nominal GDP growth, recessions have occurred. It happened in 1969, 1973-74, twice in the early 1980s, 1990-91, 2000-01, and 2007-08.

Right now, nominal GDP growth over the past two years has been 4.6%. Looking back, a federal funds rate of roughly 50 to 75 basis points below nominal GDP growth is roughly neutral. As a result, we currently estimate a neutral rate around 4%. Moreover, we believe real GDP will keep growing at least 3% annually, while inflation continues to rise by 2% or more. Inother words, the “neutral” rate is rising. And likely movingtoward 4.5%.

This is why we agree with Chairman Powell. At the same time, we think the stock market has over-reacted, while the bond market is finally bowing to the reality that longer-term rates are heading much higher.

We have never believed that long-term rates were being held down by recent slow growth or low foreign rates. We believe they have been held down by the Fed’s policy of low short term rates and the market belief that the Fed would hold them low. That has now changed.

And, yes, higher interest rates do reduce the fair value of equities. But even with current earnings, it would take a 3.7% 10-year yield to make current equity values “fair.” With earningslikely to grow 20%+ this year and 10%+ next year, the market can handle higher interest rates and continue to rise. Higher rates are coming, but that doesn’t mark the end of the recovery or the bull market.

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

10-10 / 7:30 am

PPI – Sep

+0.2%

+0.2%

-0.1%

7:30 am

“Core” PPI – Sep

+0.2%

+0.2%

-0.1%

10-11 / 7:30 am

Initial Claims – Oct 6

210K

206K

207K

7:30 am

CPI – Sep

+0.2%

+0.2%

+0.2%

7:30 am

“Core” CPI – Sep

+0.2%

+0.2%

+0.1%

10-12 / 7:30 am

Import Prices – Sep

+0.2%

0.0%

-0.6%

7:30 am

Export Prices – Sep

+0.2%

+0.2%

-0.1%

9:00 am

U. Mich Consumer Sentiment- Oct

100.6

100.6

100.1

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.

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2018/10/8/powell-moves-markets

No Looming Recession

Posted on Updated on

October 1, 2018

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

As far as Harvard economist Martin Feldstein is concerned, we’re all doomed. Feldstein says that the low interest rates of the last several years have created a stock market bubble rivaling the housing bubble that precipitated the last crisis. As interest rates keep rising, he says, the stock market bubble will eventually burst, sending the economy into another “long and deep downturn.”But, unlike in the prior recession, with interest rates still relatively low, the Federal Reserve will have less room to respond to a weaker economy.

We have to admit to feeling a little awkward disagreeingso strongly with Feldstein. He’s been a long-time advocate of lower tax rates and less government spending, policy positions near and dear to our hearts.

But, when it comes to forecasting what the economy will do in the next few years, we think he’s laid an egg.

Why? Let’s start by looking back. We like to assess fair value in residential housing by comparing the asset value of owner-occupied homes to the annualized rent these homes could earn. Using historical averages, our calculations suggest home prices were about 40% above fair value at the end of 2005. With US homes valued at about $21 trillion, that meant an overvaluation of about $6 trillion. (Note: When an asset is priced 40% too high, it takes a loss of 28.6% from theovervalued level to bring the price down to fair value.) For perspective, GDP was $13 trillion that year.

By contrast, the stock market is not even close to that kind of overvaluation. At present, the price-to earnings ratio on the S&P 500 is 22.3. The average in the past 40 years is 20.2. So even if you accept the P-E ratio as the gospel (and we don’t), equities only appear about 10% over-valued.

Except the current P-E ratio only reflects two quarters of the tax cut so far. The forward P-E ratio is 16.9, which leaves room for a 20% rally in equities just to get back to the 40-year average of 20.2 (assuming earnings estimates are accurate.) Moreover, the average P-E ratio of 20.2 over the past 40 years was established when the yield on the 10-year Treasury Note was averaging 6.26%, not the 3.06% it’s at today. In other words, bonds were a much more attractive alternative to equities in the past than they are today.

The basic problem with all this is that if you want to sound smart – and if you want media attention – it’s better to be a pessimist. Warn people about impending doom and they hang on every word. And let’s be honest, telling people the bull market has room to roam is not the best way to get published.

We’re sure the economy will eventually face another recession. It may even be a deep one, although our best bet is that the next recession will be mild compared to the last. When it happens, the pessimists will tell you how they got it right all along. But getting it right, briefly, at least a few years from now is not worth losing out on the gains to be made in the meantime. Those who stay long equities will be rewarded.

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/2018/10/1/no-looming-recession

Previewing the Fed

Posted on Updated on

September 24, 2018

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

The Federal Reserve meets on Wednesday and there’s one thing we know for sure: it’s going to raise rates by another 25 basis points, lifting the federal funds rate to a range from 2.00 to 2.25%.

Why are we so confident? Two reasons. First, the market in federal funds futures is putting the odds of a September rate hike at 99%. For the Fed to let those odds get so high without pushing back forcefully with speeches and leaks to friendly reporters means the Fed is fully on board.

Second, and much more important, it’s the right thing to do. Nominal GDP – real GDP growth plus inflation – is up 5.4% in the past year and up at a 4.6% annual rate in the past two years. An economy growing at that pace calls for higher short-term rates.

But the meeting is not only about changing the level of short-term rates; it’s also about signaling the path of future rate hikes as well as the continued reduction in the size of the Fed’s balance sheet, which became bloated during and after the financial crisis a decade ago.

Back in June, the last time the Fed issued economic projections, it forecast that real GDP would be up 2.8% this year and 2.4% next year. But, given the momentum in the economy, we think the Fed may lift these forecasts. It may also want to reconsider its projections for inflation now that its favorite measure of inflation – the PCE deflator – is already up 2.3% from a year ago

In turn, that should translate into a more aggressive “dot plot,” as well. In June, the consensus at the Fed – the “median dot” – showed a total of four rate hikes this year, with one more hike in September and a last one in December. But almost half of the voters at the Fed had the Fed stopping at the third rate hike this year or maybe even stopping at two in June. That’s going to change substantially on Wednesday and we expect a large majority at the Fed projecting a fourth rate hike in December. Our best guess is that the median dot will still show three rate hikes in 2019, but that may change in December, by which time the Commerce Department will have reported strong real GDP growth for the third quarter.

In the end, we expect four more rate hikes in 2019. That would take the federal funds rate to a range of 3.25 to 3.5%. Right now, that’s not what the market expects. The market is putting the odds of four rate hikes or more next year at 5%. As the economy continues to impress, look for those odds to soar over the next several months. In turn, that means long-term Treasury yields keep trending higher, as well.

 

The Fed may also consider using Wednesday’s meeting to change some wording that’s been in every Fed statement since December 2015, which was the first time the Fed raised rates after the financial crisis. The language is “The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.”

Some at the Fed may think Wednesday’s rate hike means monetary policy is no longer accommodative. That would be a mistake. But others may want to rightly change the wording because inflation already exceeds 2%. As a result, the Fed needs to start considering how tight it may eventually have to get to keep inflation from staying above 2%.

Just remember, though, that nothing the Fed does on Wednesday is worthy of obsession. Just because the financial media dwells on every word from the Fed, doesn’t mean investors should. Instead, focus on profits, which, continue to point to a robust bull market.

 

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

9-26 / 9:00 am

New Home Sales – Aug

0.630 Mil

0.624 Mil

0.627 Mil

9-27 / 7:30 am

Initial Claims – Sep 22

210K

220K

201K

7:30 am

Q2 GDP Final Report

4.2%

4.1%

4.2%

7:30 am

Q2 GDP Chain Price Index

3.0%

3.0%

3.0%

7:30 am

Durable Goods – Aug

+1.9%

+2.1%

-1.7%

7:30 am

Durable Goods (Ex-Trans) – Aug

+0.4%

+0.6%

+0.1%

9-28 / 7:30 am

Personal Income – Aug

+0.4%

+0.4%

+0.3%

7:30 am

Personal Spending – Aug

+0.3%

+0.3%

+0.4%

8:45 am

Chicago PMI

62.0

64.5

63.6

9:00 am

U. Mich Consumer Sentiment- Sep

100.5

100.8

100.8

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

The Growing Deficit

Posted on Updated on

September 19, 2018

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

The U.S. federal government reported last week that it ran a deficit of $214 billion in August, the fifth largest deficit for any single month in US history.

The Congressional Budget Office thinks these numbers are consistent with a budget deficit of about $800 billion for Fiscal Year 2018, which ends September 30. If so, that would be the largest annual deficit in raw dollar terms since FY 2012. This deficit is roughly 4.0% of GDP, which would be the highest since FY 2013.

For many, this growing deficit is a dagger to the heart of the tax cut enacted in late 2017. They say the tax cut was irresponsible. However, economic growth has picked up because of the tax cut, and growth is the key to higher fiscal receipts down the road – in fact tax receipts are still hitting record highs.

Between 2010 and 2017, the U.S. passed two large tax hikes, yet the deficit was still $665 billion in FY 2017, which was not exactly a model of fiscal purity. As a result, we call“politics” on all those now fretting about deficit spending only when a tax cut is involved.

It’s important to recognize that the tax cut has, so far, reduced revenue compared to how much the federal government would have collected in the absence of the tax cut. But, total federal receipts are likely to end the current Fiscal Year up slightly from last year and at a record high. Next year, according to the CBO, revenue should be up 4.6% and at another record high.

In other words, the tax cut didn’t lead to an outrightreduction in revenue, it just slowed the growth of revenue.

Spending is the problem. Total federal spending will rise about 4% this year and is scheduled to rise about 8% next year. In spite of an acceleration in economic growth, government spending is rising faster than GDP.

While this is a long-term problem, it will not turn the U.S. into Greece overnight. No fiscal crisis for the nation is at hand. Last year, net interest on the federal debt amounted to 1.4% of GDP. The Congressional Budget Office projects that net interest will hit 2.9% of GDP before some of the tax cuts theoretically expire in the middle of the next decade.

That is a large increase, but net interest relative to GDP hovered between 2.5% and 3.2% from 1982 through 1998. The U.S. paid this price and the economy still grew more rapidlythan it has in the past decade. The U.S. didn’t become Greece.

Compare two economies of equal size. One spends $500 billion, but with zero taxes, the other spends $2 trillion, but taxes $1.5 trillion. Both have $500 billion deficits, but the first economy would be more vibrant and could finance the debt more easily. It’s not that deficits don’t matter, but deficitsalone are not a reason for investors to run for the hills.

And when deficits are partly caused by more federal spending on interest payments you know who will hate it the most? The politicians.

Here’s why. Politicians like to deliver things their constituents are grateful for, things that make voters more likely to vote for them rather than someone else. Tax cuts help politicians get more votes, at least from those who actually pay taxes. Government programs can also help incumbents corral votes. Pass out government checks and you can get more votes, too. But bondholders have no gratitude for politicians when they receive the interest they’re owed on Treasury securities.

Higher net interest payments will eventually “crowd out”future tax cuts and government programs, making it tougher for incumbents to get re-elected. As net interest payments rise, more politicians will start obsessing about the deficit again, just like in the 1980s and 1990s.

The true threat to long-term fiscal health is spending. If left unreformed, entitlement programs like Social Security, Medicare, and Medicaid will take a ceaselessly higher share of GDP, leading to a larger and larger share of American production being allocated according to political gamesmanship rather than individual initiative, in turn eroding the character of the American people.

Unless we change the path of spending, last year’s tax cuts- and the boost to economic growth they’ve already provided – risk getting overwhelmed in the long run. But, for investors,this isn’t an immediate problem. After all, deficit fears have been around for decades and equities still rose. Stay bullish, for now.

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Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

9-17 / 7:30 am

Empire State Mfg Survey – Sep

23.0

23.8

19.0

25.6

9-19 / 7:30 am

Housing Starts – Aug

1.235 Mil

1.253 Mil

1.168 Mil

9-20 / 7:30 am

Initial Claims – Sep 15

210K

208K

204K

7:30 am

Philly Fed Survey – Sep

15.8

21.1

11.9

9:00 am

Existing Home Sales – Aug

5.380 Mil

5.380 Mil

5.340 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/2018/9/17/the-growing-deficit

Wage Growth Steps Up

Posted on Updated on

September 11, 2018

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

Friday’s jobs report finally included what appears to be evidence of the long-awaited acceleration in wage growth.

Average hourly earnings grew 0.4% in August, which meant they were up 2.9% from a year ago, the largest 12-month increase since the economic recovery started in mid-2009. By contrast, these wages were up 2.6% in the 12-months ending inAugust 2017. Moreover, this measure of wages doesn’t include extra earnings from irregular bonuses and commissions, like those paid out since the tax cut was passed late last year.

Total wages, which factors in both average hourly earnings as well as the total number of hours worked, are up 5.1% in the past year, meaning consumers have plenty of earnings to keep increasing spending.

Nonetheless, many still argue that the 2018 corporate taxcut didn’t help workers. Nothing could be further from the truth. In December 2017, figures on average weekly earnings as well as private payrolls suggested private-sector workers were earning wages at a $6.0 trillion annual rate. In August, those total wages had increased to a $6.2 trillion annual rate – a boost of $200 billion per year. By contrast, corporate profits – which have also grown rapidly – were up by just $100 billion annualized from the end of 2017 through the second quarter. Workers have taken home two times more than companies!

When hit with this data, the anti-tax cutters argue that this increase in wages has been concentrated at the top of the pay- scale. The rich are getting richer and the tax cuts haven’t helped lower to middle income workers. Guess what? This isn’t true, either.

Usual earnings for the median full-time wage & salary worker grew 2.0% in the year ending in the second quarter this year. But these earnings grew 3.9% for workers at the bottom 10th percentile, while workers at the top 10th percentile had their usual earnings grow only 1.2%. Usual earnings for people who never finished high school are up 7.6% in the past year, faster growth than for any other educational category.

Put it all together and we have a labor market that is already tight and set to get tighter. Back in June, the Federal Reserve projected an average unemployment rate of 3.6% in the fourth quarter of this year and 3.5% in the fourth quarter of 2019 and 2020. The projection for this year sounds about right, but we’re forecasting a jobless rate of 3.2% by the end of 2019 and 3.0% in 2020. Either way, wages are likely to keep growing at an accelerating pace in the next few years.

That means the Fed will likely remain more aggressive with their rate hikes than the market is now projecting, but don’t fret. Even with our more aggressive forecasted path of two more 25 bps rate hikes this year and four next year, the Fed will still not be “tight.”

Tax cuts and deregulation have turned the Plow Horse Economy into a Kevlar Economy for the foreseeable future. And if we get trade deals that reduce tariffs along with some real focus on limiting government spending, the strength of this economy could make Superman jealous.

 

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/2018/9/10/wage-growth-steps-up

The Week Ahead

Posted on Updated on

September 4, 2018

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

In spite of woeful prognostications to the contrary, the US economy seems to be wearing Kevlar. Rate hikes, tariffs, Turkey, you name the fear, the economy remains unscathed. Case in point, through all the supposed turmoil, the U.S. grew at a 4.2% annual rate in the second quarter and looks set for a similar pace in Q3.

We get a boatload of economic data this week, including the ISM indexes for both manufacturing and services, as well as data on construction, auto sales, and, of course, Friday’semployment report. While we expect the data to continue painting a picture of robust economic growth, data are, as we all know, volatile.

While today’s ISM Manufacturing report was white-hot –the highest so far this expansion – we also expect gains in the Services index later this week, and car and light truck sales to be so-so, clocking in at a 16.8 million annual pace in August versus a 17.3 million pace in the past year.

The one piece of data we think could disappoint is the headline employment number out Friday. In recent years, August employment data have been prone to disappointment, with the initial report leading to unnecessary fears of an economic slowdown.

Back in September 2011, for example, we got a payroll report that showed zero nonfarm payroll growth for August. That’s right: a big fat goose-egg. The S&P 500 fell 2.5%. Some even talked openly of entering the long-awaited “double-dip” recession. But just two months later, the report was upgraded to 104,000. Now, after multiple annual revisions, the government says 112,000 jobs.

And 2011 wasn’t an anomaly. August payroll growth has fallen short of consensus expectations for seven years in a row. And just about every time, the pouting pundits have taken it as a bearish economic signal.

The jobless rate shows some seasonal distortions, as well. The unemployment rate finished 2009 at 9.9%. Sincethen it’s dropped to 3.9%, down 6.0 points, or an average of 0.06 points per month. So take any calendar month over the past 81⁄2 years and the unemployment fell on average 0.5 points. But for August, the unemployment rate has dropped a grand total of only 0.1 point – we’re not sure why, but that’s the data.

As a result, our forecast is that payroll growth for August will be a little softer than the consensus expects (but will be revised higher in the months ahead) and the jobless rate is going to stay unchanged at 3.9%, versus consensus expectations of a drop to 3.8%.

The key thing to remember is that if we’re right – and, obviously, we hope the report is better than we expect! – youshouldn’t get caught up in any pessimistic story you hear fromthe doomsayers. For the time being, the US has strengthened from a Plow Horse Economy to the Kevlar Economy, and none of these reports are likely to change that one iota.

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/2018/9/4/the-week-ahead

US Stops Subsidizing Global Growth

Posted on Updated on

August 27, 2018

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

For decades the United States has, directly and indirectly, subsidized global growth. For example, after World War II, the U.S. provided direct economic aid to Western Europe with the Marshall Plan, while also helping to rebuild Japan. And since then, we have provided never-ending direct aid to foreign countries, which has been a constant political football.

But in the economic scheme of things, the biggest subsidies of all have been indirect. For decades the U.S. has held trade tariffs below those of most foreign countries. And until recently, the U.S. has maintained a corporate tax rate significantly above the world average. At the same time, the U.S. hindered, through regulation, its production of energy.

According to the World Trade Organization, before the Trump tariffs were put in place, the U.S. had an average tariff of 3.4%. Canada had an average tariff of 4.0%, the EU 5.1%, Mexico 6.9%, China 9.8%, and South Korea 13.7% – all higher than the U.S., which means the playing field was tilted in favor of foreign countries. The U.S. was subsidizing them.

In 1993, America lifted its federal corporate tax rate to 35%, from 34%. When combined with state and local corporate taxes, the average rate was 38.9% and held there until the Trump tax cut in 2017. In 1993, the average worldwide corporate tax rate was roughly 33% (about 6 percentage points below the U.S.) and by 2017, the average had fallen to 23% (about 16 points below the U.S.). In other words, at the margin, businesses looking to invest globally had an incentive to invest outside of America.

The slowing of energy production in America became a direct subsidy to those who produce energy. Russia, Saudi Arabia and the Middle East, Venezuela and Mexico all benefited as the U.S. bought most of its crude oil from overseas.

But things have changed – in a huge way. The geopolitical implications of this are coursing through the worldright now. In some places, like Venezuela, it’s an economiccrisis. In others, like China, it’s reflected in slowing economicgrowth. And if anyone doesn’t understand the relationship

between fracking and the fact that women in Saudi Arabia willbe allowed to drive, they aren’t thinking hard enough.

But, more to the point, cutting the U.S. corporate tax rate to 21% and boosting tariffs on select countries and products is removing a huge subsidy to growth for the rest of the world. The U.S. is the dominant economy in the world and when it stops subsidizing foreign countries, who have not followed free market principles, economic pain spreads.

The U.S. has become not only the largest producer of petroleum products in the world, but a net exporter to some regions. And output keeps going up. This is altering the balance of world power in a huge way.

The impact of all this is to put pressure on other countries to come back to the table and talk about more equal trade. It also forces countries that previously were able to have high income tax rates, huge government budgets, and lots of red tape to rethink their fiscal policies. The global establishment have never been under attack like they are today. The world order is changing for the better.

This means the U.S. economy and its stock markets are in better shape relative to others. However, if these pressures really do lead to more freedom and less political interference in economic activity, the world could end up seeing a boom like itdid in the 1980s, when Reagan’s tax cuts led other countries to follow suit.

While news shifts rapidly, the pressures we outlined above already seems to have pushed Europe, Mexico, Canada, and China to negotiate on trade. We think this will eventually lead to lower tariffs, not a full-blown trade war. After all, because the U.S. is removing a subsidy to these countries, their growth will suffer relatively more. They have an incentive to follow better policies.

No one knows exactly how this will turn out, or whether the establishment will fight back and find a way to resist change. But, for now, the U.S. is benefiting from an increase in investment and growth due to better policies.

 

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

8-29 / 7:30 am

Q2 GDP Preliminary Report

4.0%

4.1%

4.1%

7:30 am

Q2 GDP Chain Price Index

3.0%

3.0%

3.0%

8-30 / 7:30 am

Initial Claims – Aug 25

213K

213K

210K

7:30 am

Personal Income – Jul

+0.4%

+0.4%

+0.4%

7:30 am

Personal Spending – Jul

+0.4%

+0.4%

+0.4%

8-31 / 8:45 am

Chicago PMI

63.0

64.8

65.5

9:00 am

U. Mich Consumer Sentiment- Aug

95.5

95.3

95.3

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/2018/8/27/us-stops-subsidizing-global-growth

Capitalism Works, Don’t Change It

Posted on Updated on

August 21, 2018

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

“Wealth creation” versus “the redistribution of wealth” isan age-old political/economic battle. And once again, Senator Elizabeth Warren – among others – has capitalism in the crosshairs.

Adam Smith defended capitalism in 1776. Karl Marx attacked it in the 1800s. William Jennings Bryan attacked it; Grover Cleveland defended it. FDR attacked it; Ronald Reagan defended it. And, today, the battle goes on, with many Democrats openly promoting socialism.

Elizabeth Warren wants her own “new deal”, employee- elected board members and companies responsible to communities over shareholders. She complains about “short-termism” – quarterly reporting that makes companies only worry about the bottom line in three-month periods. Even President Trump has weighed in; after talking with the CEO of Pepsi, he has suggested six-month reporting cycles.

We don’t disagree that some companies make decisions to“hit” quarterly earnings targets. Many believe privately-held companies often make better long-term decisions because theyaren’t kowtowing to analysts. But, Warren Buffet downplayshis quarterly reports and the stock market hasn’t punishedBerkshire Hathaway. And don’t think private companies ignore their monthly, or even weekly, results. They don’t.

We’re not arguing that freedom shouldn’t be applied. If companies want to report every six months, let them. But, ourbet is that the market wouldn’t like that. Investors deserve timely information. Even today, companies are free to say “we aren’t managing to quarterly data.” Let the market decide what matters. Let companies experiment. But more information, not less, is almost always better.

Over the years, political attacks on companies for short- termism have come and gone. We find this disingenuous. Washington DC, and many state capitals, make a complete mockery of fiduciary responsibility. Budgets haven’t been balanced in decades, and after eight years of economic recovery (and even before the recent tax cut) the budget deficit in 2017 was still over $650 billion. Not even Keynes would stand for that.

And Congress isn’t on a quarterly reporting cycle.Politicians report to the people in 2-, 4- and 6-year cycles. Yet, Congress can’t balance its budget, or in many recent years, even produce a budget. We find it fascinating (to put it nicely) that politicians who have shown such incredible fiduciary irresponsibility would even attempt to reform a system – The Capitalist System – that has produced unfathomable wealth and higher standards of living for so many. Before the nation debates a takeover of corporations by political fiat, maybe Congress should get its own house in order.

Senator Warren has proposed The Accountable Capitalism Act. Her Act would allow “stakeholders,” which includeemployees, and unstated others, to sue companies if they think they are not sharing profits equally with other stakeholders.

This is a terrible idea. Corporations provide products to consumers, and profits are simply a sign they are doing it effectively. As long as there is freedom for capital to move, for people to change jobs, and for investors to choose what to invest in, then the system holds no one hostage. As long as contracts are fairly enforced, the system remains equitable.

Profit signals opportunity. Profit signals growth. Some are complaining that corporations are returning too much of their profits to shareholders, but without these investors there would be no company in the first place – and far fewer jobs. In fact, today there are more unfilled jobs in America than there are unemployed Americans. In other words, workers have choices and companies must work hard to attract labor.

Senator Warren, and others, complain that profits are up while wages are stagnant. In her Wall Street Journal Op-Ed,she said “In the early 1980s, large American companies sentless than half their earnings to shareholders, spending the rest on their employees and other priorities. But, between 2007 and 2016, [they] dedicated 93% of their earnings to shareholders.”

The data doesn’t support this. Real average hourly earnings fell 7.3% from January 1980 to January 1995, while they rose 7.3% from December 2006 to December 2017.

Profits are the lifeblood of capitalism. Reporting them, earning them, and returning those profits to shareholders creates more investment, more wage growth, and more wealth creation. Politicians can’t balance a budget. Why would a sane electorate give them even more control of private wealth?

 

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

8-22 / 9:00 am

Existing Home Sales – Jul

5.400 Mil

5.390 Mil

5.380 Mil

8-23 / 7:30 am

Initial Claims – Aug 18

215K

215K

212K

9:00 am

New Home Sales – Jul

0.647 Mil

0.639 Mil

0.631 Mil

8-24 / 7:30 am

Durable Goods – Jul

-0.7%

-1.2%

+0.8%

7:30 am

Durable Goods (Ex-Trans) – Jul

+0.5%

+0.7%

+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/2018/8/20/capitalism-works,-dont-change-it

The Kevlar Economy

Posted on Updated on

August 13, 2018

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

Since March of 2009, the predictions of economic, and stock market collapse have been non-stop. Doom-and- gloomers have been unrelenting. And it’s doubly frustrating since you can’t disprove a negative until it doesn’t happen.

We have written hundreds of pieces since the recovery – and bull market – began, arguing that the pessimism was unjustified. We’ve argued that Brexit, Grexit, resetting ARMs, student loans, government debt, Obamacare, no QE4, tapering,…etc., would not stop growth. The doomsayers have been wrong. Constantly. For our troubles we get labeled“perma-bulls”, despite our arguments proving true. Meanwhile,the “perma-bears” have never had to answer for their fallacious forecasts.

Now they’re talking Turkey, tariffs, a strengthening dollar, China selling US debt, Fed rate hikes. They never give up. But, we still aren’t worried.

The United States, for the time being, is a Kevlar economy. It’s practically bulletproof. By allowing other countries to maintain higher tariffs, America, the world’sbiggest consumer, has helped those countries grow. By holding corporate tax rates higher than most other countries, the US has subsidized non-US growth.

But under new management, the self-sabotage is being eliminated. Cutting corporate tax rates and reducing regulation have made the US more competitive. No, we are not ignoring the negative impact of tariffs on some US producers and consumers, but tariffs hurt foreign countries more than they hurt America.

Countries without the Constitutional rule of law, property rights and true free markets need foreign help to grow. The US is removing some of that help in making itself more competitive. As a result, the US will continue to grow, while other countries suffer a loss of investment and sales. Once again doomsayers will be proven wrong.

Yes, it’s true that a slowdown in the growth of other countries can impact corporate earnings, or even have some impact on US growth, but the damage will not be nearly as great as the pouting pundits proclaim. We still forecast 3%+ real GDP growth over the next few years, along with continued jobs growth and the lowest unemployment rate in decades.

Doomsayers, take note. There are five real threats to prosperity: 1) Excessively tight Fed policy. 2) Excessive government spending. 3) Excessive regulation. 4) Tax hikes and 5) Trade protectionism.

Right now, the Fed is not tight, far from it. Government spending is too high, that’s why growth isn’t even higher. The Regulatory environment is improving. Tax rates have been cut and are not likely to be hiked anytime soon. Finally, tariffs are going up, but by a much smaller amount than taxes were cut. We also do not expect a protracted trade war because that would harm other countries much more than the US. Ultimately, we expect deals to bring tariffs down.

In other words, of the five threats, two are negatives (with trade likely to turn) and three are positives – and don’t forget new and unbelievably positive technologies! Someday, a recession will happen again, but for now the Kevlar economy will only get stronger.

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: