Lifting Our Target for Stock Prices

Posted on Updated on

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

July 8th, 2019

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

7-8 / 2:00 pm

Consumer Credit– May

$16.5 Bil

$19.0 Bil

$17.5 Bil

7-11 / 7:30 am

Initial Claims – July 6

220K

221K

221K

7:30 am

CPI – Jun

0.0%

+0.1%

+0.1%

7:30 am

“Core” CPI – Jun

+0.2%

+0.2%

+0.1%

7-12 / 7:30 am

PPI – Jun

+0.1%

0.0%

+0.1%

7:30 am

“Core” PPI – Jun

+0.2%

+0.1%

+0.2%

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

 

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

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The Longest Expansion

Posted on Updated on

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

July 1st, 2019

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

This Crazy Rate Cut

Posted on Updated on

June 24th, 2019

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

The narrative that the U.S. economy is in trouble – some say teetering on the edge of recession – has become so powerful and persuasive that few investors give it a second thought. So of course, they believe, the Fed should cut interest rates. Wehaven’t seen anything like it since the Fed was hiking rates in the deflationary late- ‘90s. Those rate hikes, which were totally unwarranted, ended up causing a recession.

The rate cuts that the Fed now seems to be planning are equally unwarranted. The dovish tones arose back in the fourth quarter of 2018, when the U.S. stock market experienced a correction while the Fed was lifting rates. Many believe this correction ended when the Fed signaled an end to rate hikes. But simply put, no one really knows if this was correlation or causation. We believe it was the former…pure happenstance.

The Fed is not tight. No way, no how. The federal funds rate is currently 2.375% and no one can look at us with a straight face and say that this interest rate is keeping anyone, anywhere from making an investment.

Of more important note, every prior Fed-induced recession happened because the Fed withdrew reserves from the system, pushing up interest rates. It was the lack of money – the squeeze on reserves – that pushed interest rates higher and caused the recession. Rates themselves don’t cause recessions, it’s the reason rates move that really matters.

Today, the Fed still has $1.4 trillion in excess reserves in the system, so it can hardly be called tight by any stretch of the imagination. It is when the Fed withdraws too many reserves, pushing the federal funds rate above the pace of nominal GDP growth, that the economic tides turn toward recession. So how close are we now? Over the past two years, nominal GDP is up at a 4.8% annualized rate, twice the current federal funds rate.

Some argue a slowdown in foreign growth should have the Fed concerned. But we know of no U.S. recession ever caused by weakness overseas. Japan collapsed in the 1990s, the U.S. boomed.

It is true there have been some weak economic data points of late. The bears have been pointing, for example, to the Markit Services and Manufacturing indices. But, these are surveys and have never, to our knowledge, been successfully used to predict a recession.

Others are fretting over the tepid 75,000 new jobs added in May. But since this recovery began, the initial payroll reports have come in weak on multiple occasions without signaling recession, just look at May 2012, or December 2013, or May 2016, or September 2017, or February 2019. All months at first came in weaker than the May report and not one signaled recession.

What investors should be focused on is initial unemployment claims as a share of total employment at the lowest reading ever. Job openings, meanwhile, are 1.6 million greater than the total unemployed. Retail sales are booming, up 10.9% in the past three months at an annual rate. After revisions, real GDP likely grew 3.3% at an annual rate in Q1 and is likely to rise 2.0% in Q2 (held down by a 1.0 point slowdown in inventories). There is absolutely no evidence of recession.

The worst part of the proposed rate cut is that all those who think they see a recession will become convinced that the Fed avoided it, even though it was never coming.

It’s true that inverted yield curves, as we now see betweenthe 3-month and 10-year Treasury yields, often proceed recessions. But typically, those inversions have happened when the Fed took out too many reserves from the system, which is not the case today. Instead, today’s inversion is based, completely, on the market pricing in rate cuts. This is not your father’s yieldcurve inversion.

We think a rate cut is crazy. However, it makes our bullish case for stocks even easier to defend, in spite of the fact that we think the Fed would be sowing the seeds of future economic problems.

 

page1image887240240

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

6-25 / 9:00 am

New Home Sales – May

0.684 Mil

0.657 Mil

0.673 Mil

6-26 / 7:30 am

Durable Goods – May

-0.2%

-0.6%

-2.1%

7:30 am

Durable Goods (Ex-Trans) – May

+0.1%

+0.1%

0.0%

6-27 / 7:30 am

Initial Claims – Jun 22

218K

218K

216K

7:30 am

Q1 GDP Final Report

3.2%

3.3%

3.1%

7:30 am

Q1 GDP Chain Price Index

0.8%

0.8%

0.8%

6-28 / 7:30 am

Personal Income – May

+0.3%

+0.3%

+0.5%

7:30 am

Personal Spending – May

+0.5%

+0.5%

+0.3%

8:45 am

Chicago PMI – Jun

53.5

53.1

54.2

9:00 am U. Mich Consumer Sentiment- Jun

98.0 98.0 97.9 Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/6/24/this-crazy-rate-cut

Better Signs

Posted on Updated on

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

A few key economic reports have taken a turn for the better, boosting expected real GDP growth in the second quarter and pointing to an upward revision to first quarter growth.

Retail sales grew 0.5% in May, very close to consensus expectations, and were revised up substantially for prior months. Pairing this data with other recent reports, it now looks like real GDP in Q1 will be revised up to a 3.3% annualized growth rate from the prior estimate of 3.1%.

More important than the Q1 revisions, it now looks like real GDP is growing at a 2.0% annual rate in the second quarter. Thatmay not sound great, but it’s a big improvement from the 0.9%estimate the Atlanta Fed’s “GDP Now” model was signaling in early May. Moreover, this comes despite Q2 growth likely being held down by inventories. Both our estimate and the AtlantaFed’s estimate of real GDP growth excluding inventories (also known as Final Sales growth) is running 3.0%+ in Q2. Fed, take note. With Final Sales this strong, the underlying economy is doing well.

Moreover, with inventories likely to rebound in months ahead, we expect total real GDP growth will come in near 3.0%in 2019 (Q4/Q4), well above the Fed’s consensus projection in March of 2.1%. In other words, Fed forecasts have been overly pessimistic and will likely affect rate cut thinking.

Despite what the data show, some analysts continue to price in recession, and the bond market seemingly agrees. The tepid May 75,000 increase in US payrolls bolstered pessimism, but other employment data don’t support this fear. The highest frequency data on jobs are unemployment claims, and thosedon’t signal a problem at all. Initials claims came in at 222,000 last week, while the four-week moving average was 217,000, both very low levels. Moreover, the US currently has 1.6 million more job openings than unemployed people.

It’s true that consumer and producer prices increased only0.1% in May, but in the past three months consumer prices are up at a 3.3% annual rate while producer prices are up at a 3.5% pace.

At the close on Friday, the futures market in federal funds showed a 21% chance the Fed will cut rates this Wednesday, and an 86% chance of a rate cut by the meeting in late July. All told, the futures market is pricing in two or three rate cuts for 2019. We think these expectations are way out of line with the fundamental strength of the economy. The Fed is not tight. Theydon’t need to cut rates, and we don’t think they will cut rates this week, or even this year.

As the summer goes on, we expect evidence will continue to show that the economy isn’t slipping into recession. Why? We think the Trump Administration is either (a) going to forge a trade deal with China or, (b) in the absence of a deal with China, move toward freer trade with other countries and regions (Japan,South Korea, the EU,…etc.) to help organize an effort to getChina to conform to normal trade rules.

Our best guess is that the “dot plot” from the Fed, which shows the projected path of short-term interest rates, will look much different than it did in March. Back then, it showed about one-third of policymakers thought rates would be higher by year end, while none thought rates would be lower. Look Wednesday for a dot plot showing some policymakers forecasting higher rates by year end, some lower, but most showing no change at all. That’s what we think will actually happen in 2019, too.

For all the issues the US economy faces, it has some pretty strong winds at is back. Corporate tax rates have been cut, boosting incentives for investment. The federal funds rate is still well below nominal GDP growth, and the Fed still has $1.4 trillion in excess reserves in the banking system. In other words, monetary policy is not an impediment to entrepreneurs or businesses. Finally, the federal government is reducing regulation, not increasing it.

Meanwhile, home building has plenty of room for further growth, and households have both low debts relative to assets and low debt service relative to incomes. Banks are in strong financial shape, while the rest of Corporate America has debts that are below normal relative to assets.

None of this means the US economy will grow forever. It won’t. But too many analysts and investors are needlessly fearful of a recession starting soon. We don’t see one this year or in 2020. Beyond that, forecasts are merely guessing. Appetite for risk should improve from here. Smart investors should get in front of it.

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

6-17 / 7:30 am

Empire State Mfg Survey – Jun

11.0

9.3

-8.6

17.8

6-18 / 7:30 am

Housing Starts – May

1.240 Mil

1.240 Mil

1.235 Mil

6-20 / 7:30 am

Initial Claims – Jun 15

220K

218K

222K

9:00 am

Philly Fed Survey – Jun

10.7

15.1

16.6

6-21 / 9:00 am

Existing Home Sales – May

5.260 Mil

5.470 Mil

5.190 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/Retail/Commentary/CommentaryArchiveList.aspx?CommentaryTypeCode=MMO&CommentaryCategoryCode=ECONOMIC_RESEARCH

No Need for Rate Cuts

Posted on Updated on

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

June 10th, 2019

At the Friday close the market consensus was that the Federal Reserve would cut short-term interest rates by 50 – 75 basis points in 2019, with another 25 basis point cut in 2020. We think this is nuts.

The US economy doesn’t need rate cuts. At present, we are projecting that real GDP is growing at about a 1.5% pace in the second quarter. That’s slower than the recent trend but largelyheld down by a return to a more normal pace of inventory accumulation, which is a temporary phenomenon. Excluding inventories, real GDP is growing at a 2.5 – 3.0% annual rate.

Some analysts and investors are worried about the relatively slow pace of payroll growth in May, which came in at 75,000. But there’s nothing awful about this pace of jobcreation. The bond market is convinced this means rate cuts are necessary to avert a recession; but the stock market has surged,suggesting it’s not worried about growth.

Since the business-cycle peak in 2001, the labor force has grown 0.7% per year. At that trend, we need about 90,000 jobs per month to keep the unemployment rate steady, not far from where we were in May. So rather than seeing the May payroll gain as a reason to cry, we should instead have seen the prior trend as a reason to celebrate. In fact, while low unemploymentrates may lead to smaller monthly gains in jobs, we’re notconvinced it will anytime soon.

Nor does potentially slower job growth mean the economy has to grow more slowly, as well. Productivity growth has picked up in the past couple of years due to deregulation and lower taxes on corporate profits and investment. As a result, theeconomy’s growth potential has improved, and a smaller share

of growth can come from increasing the number of hours worked.

This weekend brought good news: that the Trump Administration and Mexico reached a deal to avert higher tariffs. As we explained in last week’s MMO, a potential tradewar with Mexico on immigration was a legitimate concern and we are very relieved the threat has passed. We also hope the G20 meeting later this month leads to a trade deal with China. If so, this news along with better economic data, should propel longer- term Treasury yields significantly higher. Risk appetites in the financial sector should recover.

As a result, we expect the Fed to “punt” at the June meeting, leaving rates unchanged, although the new “dot plot” will likelyshow some policymakers projecting rate cuts later this year. Our view is that better news will cut the rate reductions off at the pass, and the Fed will end up leaving rates unchanged this year.

Does anyone seriously believe short-term rates at 2.375% are an obstacle to economic growth, that it is preventing some entrepreneur from embarking on some venture or a firm from putting some equipment into place?

Instead, we think policymakers who are interested in promoting economic growth would be better served by turning the focus toward government spending. In the background of all the recent news, the long-term fiscal problems embedded into Social Security, Medicare, and Medicaid keep getting worse.

The federal government spent 20.3% of GDP in the four quarters ending in March, far higher than the 17.7% it spent in 2000. Finding ways to reduce spending now and in the future would boost our growth potential even higher.

630-517-7756 • http://www.ftportfolios.com June 10, 2019

 

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

6-11 / 7:30 am PPI – May +0.1% +0.1% +0.2%

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

6-12 / 7:30 am CPI – May +0.1% +0.1% +0.3%

7:30 am “Core” CPI – May +0.2% +0.2% +0.1%

6-13 / 7:30 am Initial Claims – June 8 215K 215K 218K

7:30 am Import Prices – May -0.2% +0.2% +0.2%

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

6-14 / 7:30 am Retail Sales – May +0.6% +0.7% -0.2%

7:30 am Retail Sales Ex-Auto – May +0.4% +0.4% +0.1%

8:15 am Industrial Production – May +0.2% +0.2% -0.5%

8:15 am Capacity Utilization – May 78.0% 78.0% 77.9%

9:00 am U. Mich Consumer Sentiment- Jun 98.0 100.0 100.0

9:00 am Business Inventories – Apr +0.5% +0.5% 0.0%

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/2019/6/10/no-need-for-rate-cuts

The Plow Horse Returns?

Posted on Updated on

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

We haven’t been worried about a trade conflict with China, which has a long track record of pirating intellectual property and is a potential military rival in the (not too distant) future. The US has enormous leverage with China, given our trade deficit with the country and the ability of firms to shift supply chains toward alternatives, like Vietnam, Mexico, and India.

However, we are more concerned about President Trump’s recent tariff threat toward Mexico if they don’t cooperate to stemthe flow of migrants from Central America. Using tariffs to achieve policy goals outside of foreign trade makes it much more difficult for international companies to plan ahead.

If the President imposes these tariffs, who knows what’snext? Could he use tariffs to persuade NATO allies to spend more on their militaries? Could a future president use tariffs to try to get other countries to comply with stricter CO2 emissions standards? The range of outcomes quickly widens, which means businesses will have to allocate capital according to political calculations, which means less efficiently.

Before the most recent threat, we thought the odds a recession in the next year were about 10%. Now, we thinkthey’re more like 15 – 20%; still low, but higher enough to warrant some extra concern. As a result, we will be watching the data flow over the next couple of months even more closely than usual for signs of broad economic weakness. The economy grew 2.5% in 2017 and 3.0% in 2018 because of a combination of deregulation and tax cuts. Protectionism and added uncertainty could offset those positives.

So far, we don’t see signs of weakness; the economy keep shumming along. No deal with China and higher tariffs onMexico (and perhaps others), doesn’t mean recession, but instead a return to roughly 2.0% Plow Horse growth. We estimate that the impact of the tariffs net of the benefits of tax cuts and deregulation roughly equal the negative effects of PresidentObama’s tax hikes and regulation.

Some are calling for the Federal Reserve to cut interest rates to offset this damage, but we don’t think rates need to be lower to boost growth. Does anyone seriously think there are firms that are not investing because the Fed has lifted short-term rates to 2.375%? In addition, there are still $1.4 trillion in excess bank reserves.

We understand the fear of a wider trade war but don’t think it will happen. We continue to believe markets will push policymakers in the right direction. However, a return to the Plow Horse economy is still possible. Remember, though, even then stocks rose substantially. Investors who stay calm while others panic will continue to 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/2019/6/3/the-plow-horse-returns

Don’t Count on a Rate Cut

Posted on Updated on

May 20, 2019

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

5-21 / 9:00 am

Existing Home Sales – Apr

5.350 Mil

5.310 Mil

5.210 Mil

5-23 / 7:30 am

Initial Claims May 18

215K

217K

212K

9:00 am

New Home Sales – Apr

0.675 Mil

0.647 Mil

0.692 Mil

5-24 / 7:30 am

Durable Goods – Apr

-2.0%

-2.9%

+2.6%

7:30 am

Durable Goods (Ex-Trans) – Apr

+0.1%

-0.1%

+0.3%

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

First Trust Monday Morning Outlook:

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

Trade War Hysterics

Posted on Updated on

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

May 13, 2019

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/5/13/trade-war-hysterics

The Big Picture and the Fed

Posted on Updated on

May 6, 2019

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

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

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

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

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

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

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

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

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

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

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

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

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

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

5-7 / 2:00 pm

Consumer Credit – Mar

$16.0 Bil

$15.3 Bil

$15.2 Bil

5-9 / 7:30 am

Initial Claims – May 4

220K

215K

230K

7:30 am

Int’l Trade Balance – Mar

-$50.2 Bil

-$48.8 Bil

-$49.4 Bil

7:30 am

PPI – Apr

+0.3%

+0.2%

+0.6%

7:30 am

“Core” PPI – Apr

+0.2%

+0.1%

+0.3%

5-10 / 7:30 am

CPI – Apr

+0.4%

+0.4%

+0.4%

7:30 am

“Core” CPI – Apr

+0.2%

+0.2%

+0.1%

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

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/5/6/the-big-picture-and-the-fed

Resilient Economy

Posted on Updated on

April 22, 2019

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

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

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

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

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

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

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

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

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

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

Home Building: If there’s one area of the US that remains a conundrum it’s housing, where it looks like we had the fifth straight quarter of slowed activity. We expect that to change moving forward, but for the time being we see a decline at a – 2.6% annual rate, which translates into a 0.1 point drag on real GDP growth. (-2.6 times the 4% residential construction share of GDP equals -0.1).

Government: Looks like a relatively large 2.3% increase in real public-sector purchases in Q1, which would add 0.4 points to the real GDP growth rate. (2.3 times the government purchase share of GDP, which is 17%, equals 0.4).

Trade: Net exports’ effect on GDP has been very volatile in the past year, possibly because of companies front-running, and then living with, some tariffs and (hopefully) temporary trade barriers. First quarter data suggest net exports should add an unusually large 1.1 points to real GDP.

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

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

 

Date/Time (CST)

U.S. Economic Data

Consensus

First Trust

Actual

Previous

4-22 / 9:00 am

Existing Home Sales – Mar

5.300 Mil

5.410 Mil

5.210 Mil

5.510 Mil

4-23 / 9:00 am

New Home Sales – Mar

0.650 Mil

0.634 Mil

0.667 Mil

4-25 / 7:30 am

Initial Claims – Apr 20

200K

200K

192K

7:30 am

Durable Goods – Mar

+0.7%

+0.7%

-1.6%

7:30 am

Durable Goods (Ex-Trans) – Mar

+0.2%

+0.3%

-0.1%

4-26 / 7:30 am

Q1 GDP Advance Report

2.2%

2.6%

2.2%

7:30 am

Q1 GDP Chain Price Index

1.2%

1.6%

1.7%

9:00 am

U. Mich Consumer Sentiment- Apr

97.0

97.0

96.9

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

First Trust Monday Morning Outlook:

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/4/22/resilient-economy