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Brian Wesbury
Chief Economist
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Bob Stein
Deputy Chief Economist
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 | The first estimate for Q4 real GDP growth is 2.8% at an annual rate |
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| Posted Under: Data Watch • GDP |
Implications: Real GDP grew at a 2.8% annual rate in the fourth quarter, up from 1.7% in Q3 and its strongest growth since Q2 2010. The Q4 increase came in just slightly below the consensus estimate of 3%. Nonetheless, the market seems to be disappointed in the data. The reason? Because consumption and business investment were weaker than expected, while inventories jumped. We do not agree with this disappointment. The weakest part of today's report – by far – was government purchases, driven by a wind-down of operations in Iraq and continued state and local spending cuts. Excluding government, real GDP grew at a robust 4.5% annual rate in Q4 and was up 2.6% for 2011 as a whole. Home building was up at a 10.9% annual rate in Q4. Excluding a couple of quarters in 2009-10, which were artificially and temporarily inflated by the homebuyer tax credit, this is the fastest growth in residential construction since 2004. Real GDP has now accelerated for three quarters in a row, durable goods orders have jumped for the past two months and suggest that business investment will accelerate in 2012. With housing and investment improving, the Federal Reserve will have a difficult time justifying QE3. However, nominal GDP grew at a 3.2% annual rate in Q4, which is a slowdown from recent quarters. We think this was a false signal. Nominal GDP grew 3.7% in 2011 and is up at a 4.2% annual rate in the past two years. These are not that far from the Federal Reserve's long-run outlook of a 4.5% growth rate for nominal GDP. As a result, we think essentially zero percent interest rates are too low and that trying to boost the economy further with easier money would be a mistake. A third round of quantitative easing is not needed and we expect the Fed to raise rates well before its current forecast of late 2014 or beyond.
Click here for a printable version.
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| | New single-family home sales fell 2.2% in December to a 307,000 annual rate |
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| Posted Under: Data Watch • Home Sales • Housing |
Implications: New home sales came in below the consensus expected pace of 321,000 in December, but sales remain in the narrow range they have been in since May 2010. Sometime over the next several years, new home sales will rise to an annual pace of about 950,000. But, given tight credit conditions and the large inventory of bargain-priced existing homes – particularly those in foreclosure or being sold short – this will take time. The best news in today's report was the continuing decline in inventories. The number of unsold new homes under construction is at a new record low and the number of unsold completed new homes is close to a record low. This is exactly what needs to happen for there to be a sustained recovery in housing. One positive sign is that builders are wise to the rapid reductions in inventories. The inventory of new homes where construction has yet to start (permits are issued, but building has not begun) is gradually rising – up 12% in the past three months. On the pricing front, median new home prices are down 12.8% from a year ago while average prices are down 8.8% from a year ago. However, prices spiked temporarily late last year, so the comparison is skewed. Mixed news on the housing market yesterday. Pending home sales, which are contracts on existing homes, declined 3.5% in December. However, given the 7.3% gain in pending sales in November, we anticipate that existing home sales, which are counted at closing, probably rose in January. Meanwhile, the FHFA index, which tracks prices on homes financed by conforming mortgages, increased 1% in November and is down only 1.8% versus a year ago. We anticipate a slight rise in home prices in 2012.
Click here for a printable report.
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| | New orders for durable goods increased 3.0% in December |
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| Posted Under: Data Watch • Durable Goods |
Implications: Terrific news on durables this morning. New orders for durable goods were up 3% in December and up at an even stronger 3.6% including upward revisions to November. Just like the last few months, the extremely volatile transportation sector fueled the change. But, the underlying trend is better represented by activity outside the transportation sector and the news was good there, too. Orders ex-transportation were up 2.1% and appear to be accelerating, up 7% from a year ago, but up at an 11.9% annual rate in the past six months and an 18.2% annual rate in the past three months. Shipments of "core" capital goods, which exclude defense and aircraft, were up a sharp 2.9% in December. Unfilled orders for core capital goods hit another all-time record high in December and are up 13.4% versus a year ago. Business investment is poised to march higher over the next few years as corporate profits and cash on the balance sheets of non-financial companies are both at record highs. While some may believe that these stronger orders were due to an expiring tax provision about accelerated expensing (depreciation), this is not correct. Equipment must be in place and functioning (not just ordered) to qualify for the tax break. In other news this morning, initial claims for unemployment insurance rose 21,000 last week to 377,000. Continuing claims for regular state benefits increased 88,000 to 3.55 million. However, these gains are dwarfed by the huge drop we saw in claims two weeks ago and should continue to make their way lower over time. In other recent news, the Richmond Fed index, a measure of manufacturing activity in the mid-Atlantic, increased to +12 in January from +3 in December. The gain easily beat consensus expectations of +6 and was the highest since March 2011. Shipments and new orders were particularly strong, signaling more robust reports on durables in the months ahead.
Click here for a printable version.
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| | Fed Language Goes Dovish, But Policy Unchanged |
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| Posted Under: Government • Inflation • Research Reports • Fed Reserve • Interest Rates |
The most important thing to remember about today's Federal Reserve meeting is that monetary policy ended the day exactly as it started: no more loose, no less loose, but still too loose.
The big news was that the Fed changed its policy expectation to maintain exceptionally low rates to late 2014 from mid-2013. However, this change has no impact on the current stance of monetary policy, which we believe is best measured by the gap between the federal funds rate and the trend growth rate in nominal GDP (real GDP growth plus inflation).
The Fed also made some other edits to the language of the statement. The most important was removing a sentence that the Fed "will continue to pay close attention to the evolution of inflation and inflation expectations." The removal of this language is consistent with the Fed's willingness to prolong the period of essentially zero percent short-term rates, which is destined to generate more inflation down the road.
The Fed also added language saying it "expects to maintain a highly accommodative stance for monetary policy," but, at this point, that's just restating the obvious. Other more minor changes include acknowledging "further" improvement in the labor market and inserting more definite wording on recent slower growth in business investment (which we think is temporary). The last noteworthy change to the language was saying that growth over coming quarters will be "modest," rather than "moderate."
Otherwise, the Fed made no changes to interest rates, the size of its balance sheet, or its policy of paying interest on excess reserves. In other words, no third round of quantitative easing. Given the re-acceleration in the economy we continue to think QE3 is a ship that will never sail.
In terms of its balance sheet, the Fed reiterated what it originally said in September, that it would keep rolling over the principal payments it receives so that the sizes of its Treasury portfolio and mortgage security portfolio would remain unchanged.
Unlike in November when the only dissenter wanted more policy accommodation, the lone dissent this month came from Richmond Bank President Jeffrey Lacker, who would have preferred the Fed not publicly commit to a time period for exceptionally low interest rates.
The big innovation in today's meeting was that the Fed provided not only a new economic forecast but also a record of what Fed officials currently think the target federal funds rate will be at the end of each of the next few years as well as over the long-run target.
The Fed anticipates real GDP growth of 2.4% in 2012 (Q4/Q4), down from a November forecast of 2.7%. For 2013, its real GDP forecast dipped to 3% from 3.2%. Despite lower real GDP projections, its forecast for the unemployment rate in Q4 2012 dropped to 8.35% from 8.6% and for Q4 2013 dropped to 7.75% from 8%. The Fed's forecast of the "long-run" unemployment rate remained at 5.6%. Also of note, the Fed's long-run goal for inflation is now 2% even rather than a range between 1.7% and 2%.
The new information on officials' expectations of the appropriate fed funds target shows a median that would make no change in policy either this year or next year and lift the funds rate to only 0.75% by the end of 2014. Over the long run, the consensus favors a funds rate of about 4.25%.
However, investors should take note that at his press conference today Chairman Bernanke made it clear that if the Fed's economic forecast proves either too optimistic or too pessimistic, that it would change its forecast and alter its policy expectations for the funds rate as well. The importance of this statement cannot be underestimated. We anticipate faster economic growth, lower unemployment, and higher inflation than the Fed projects over the next few years. As result, we believe the Fed will start raising interest rates well before late 2014.
Click here for a printable version.
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| | The New Normal? Don't Tell That To Gartman |
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| Posted Under: Bullish • Double Dip • Gold • Inflation • Markets • Bonds |
From the Financial Advisor:
There's cautious, there's bullish and then there's super-bullish. Three panelists at this week's Inside ETFs conference in Hollywood, Fla. offered different forecasts for this year's financial markets.
"There are three ways people see the world," said Brian Wesbury, chief economist with First Trust. "The first is that it's about to end and we're going to fall off a cliff and never come back. The second is that we're in the new normal of a post-apocalyptic world of slow growth. The third view—and this is my view—is that it's not as bad as we think."
Wesbury noted the doom-and-gloom scenarios that naysayers believed could throw the country into recession—the demise of the bond market if the U.S. credit rating was downgraded; the failure of the congressional super committee to forge a deficit reduction deal; and even the impact from the Japanese earthquake and tsunami—came and went without knocking the economy on its keister. Instead, he said, the U.S. economy showed resiliency thanks to personal consumption rates that are at an all-time high.
Nor should people read too much into negative sentiment expressed in the much-touted monthly consumer confidence index readings, which he said has proved to be a poor forecasting tool in the past. For example, he noted, the index was brimming with confidence shortly before the markets went into the abyss during the Great Recession.
If anything, the recent negative sentiment has helped create conditions that bode well for stocks going forward. "One reason to be optimistic about the equity market is because it's cheap," Wesbury said. "I believe 2012 will be a lot better than people think, and I think the first two views [doomsday and the new normal] will be wrong for the third straight year."
But Wesbury's optimism doesn't extend across all asset classes. "I think the U.S. bond market and gold are in huge bubbles," he offered.
Tom McManus, managing director and chief market strategist at Lazard Wealth Management, said that the trends of slower—and lower—economic growth puts him in the new normal camp.
That sober assessment was followed by a blast of optimism from Dennis Gartman, the usually voluble and colorful editor and publisher of The Gartman Letter, a daily commentary on the global capital markets.
"Here in the States, I'm phenomenally bullish," he said, adding that one of the pillars of his optimism is the recent resurgence in the nation's energy production. "In the very near future, the United States is going to be fully self-sufficient in energy," he said, citing new technologies that have boosted oil and gas production in such places as North Dakota, Texas and in the Appalachian Mountains in the Northeast.
"I can't imagine myself being more fundamentally, technically and monetarily bullish about equities than I am at this point," Gartman gushed. That said, his optimism isn't on cruise control.
"My biggest concern about the U.S. is that we'll try to do something to balance the budget," he said. "I understand the need to balance the budget, but I fear they'll do something wrong such as raise taxes.
"Rarely in history has a rising-tax regime created a rising-tax revenue stream," he continued. "It just doesn't happen. When people raise taxes, you get less revenue."
That, of course, is another discussion for another industry conference panel.
Click here for the article at financialadvisormagazine.com.
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| | Rally Not Built on Complacency |
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| Posted Under: Monday Morning Outlook |
There are three types of people involved in the prognostication business these days. The "end of the world" types, the "it's a slower, post-apocalypse world" types, and the "everything is going to be OK" types.
For a long time now, we have been saying that the "end of the world" types are over-doing it. This is actually a dangerous stance for us to take because the "end of the world" types can be very nasty to people who disagree with them. The "it's a slower world" types are more cerebral and less nasty, but equally adamant. We, obviously, fall in the third camp.
No matter how we make our argument, and no matter how consistently the economy grows, the doubt and fear and disbelief just won't go away. We noticed this recently, when conventional wisdom started to say that investors were being "complacent" these days.
In other words, when the equity markets go down, investors are "living in reality" and "accepting" that the economy and financial markets just aren't in great shape. But when the equity markets go up, they are being schizophrenic, overly optimistic, and now some are saying "complacent."
We couldn't disagree more. Private sector payrolls have grown 160,000 per month in the past year. The unemployment rate is down almost a full percentage point from a year ago, while the size of the labor force is up (just like it was up in 2010, too). Over the past four weeks, unemployment claims have averaged 10% lower than the same period a year ago.
Retail sales are up 6.5% from a year ago; orders for long-lasting durable goods are up 12.1%, and auto sales are up 8.4%.
Perhaps most importantly, the long-awaited recovery in the housing sector has finally started. Housing starts in the fourth quarter hit the highest level since late 2008 and were up at a 32% annual rate compared to Q2. This was not all apartment buildings; single-family housing was up at a 13% annual rate in the second half of 2011.
Meanwhile, even after a recent rally, US equities remain incredibly cheap. Based on trailing after-tax earnings, the price-to-earnings ratio on stocks in the S&P 500 is roughly 13.5. On future earnings it's even cheaper.
Flipping this over, so earnings are on top and price is on bottom, the "earnings yield" on stocks is 7.4%, compared to a 10-year Treasury yield of only 2%. This suggests that stocks are cheap relative to bonds.
In other words, rather than being the result of complacency, craziness or stupidity, the recent rally has a much more straightforward explanation. The economy is growing, it's very likely to continue to grow, and if that is the case then stocks are grossly undervalued relative to bonds.
And the good news continues. With about 15% of the S&P 500 companies having reported earnings for the fourth quarter of 2011, 60+% have beaten street estimates.
Notice how none of this has anything to do with a third round of quantitative easing by the Federal Reserve. The last round of quantitative easing was essentially useless, with banks boosting their excess reserves from $1 trillion to $1.6 trillion.
Nonetheless, bank lending is picking up and accelerated after QE2 ended. This has helped boost the M2 measure of money (Milton Friedman's favorite gauge), which has also been growing faster since the end of QE2 than during it.
So far in 2012, the S&P 500 has had eleven up days versus only two down days. That ratio probably won't continue for the full year, but the idea that it is unwarranted, crazy or complacent is a point of view that is supported by a decidedly bearish set of assumptions.
Rather, it appears that the stock market is finally (or once again) beginning to realize that the world is not ending and that the recovery is not so fragile that it cannot last. We remain optimistic. We continue to believe that things are getting better and we don't feel complacent at all.
Click here for a printable version.
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These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are 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.
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The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. By providing this information, First Trust is not undertaking to give advice in any fiduciary capacity within the meaning of ERISA, the Internal Revenue Code or any other regulatory framework. Financial professionals are responsible for evaluating investment risks independently and for exercising independent judgment in determining whether investments are appropriate for their clients.
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