 | Personal Income Increased 0.2% in May, Personal Consumption Unchanged |
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| Posted Under: Data Watch • PIC |
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Implications: As expected, the American consumer took a breather in May. As a result, it appears that real GDP is growing at about a 1.5% annual rate in the second quarter. But “real” (inflation-adjusted) personal consumption is still up a respectable 1.9% from a year ago and at an all-time record high. We expect spending to continue to move higher over the rest of the year as incomes continue to rise. In other words, real GDP should pick up as well in the second half. Real incomes are up 1.4% versus a year ago and up at a 3% annual rate in the past three months. This growth is not due to artificial support from government spending. Real private sector wages and salaries are up 2.4% in the past year, while real government transfer payments are down 0.9%. In addition, spending will also get a boost from a drop in households’ financial obligations – recurring payments like mortgages, rent, car loans/leases, as well as other debt service – which are now the smallest share of income since 1993. Meanwhile, on the inflation front, the Fed’s favorite gauge of inflation – core PCE, which excludes food and energy – is up 1.8% from a year ago, just ever so slightly still below their target of 2%. Given healthy spending patterns and inflation already close to the target, the Federal Reserve still has no justification for another round of quantitative easing. In other news this morning, the Chicago PMI index, which measures manufacturing activity in that area, came in at a 52.9 for June, beating consensus expectations. As a result, we expect an above-consensus 53.0 for next Monday’s nationwide ISM manufacturing report.
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| | Step Two – Going Backward – Election More Important Than Ever |
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| Posted Under: Government • Research Reports • Taxes |
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In one of the least likely outcomes in Supreme Court history, Chief Justice Roberts, who was widely considered a conservative voice on the Court, proved to be the swing vote in one of the largest expansions of US government involvement in the economy ever.
Justice Kennedy, who many feared would be the swing vote in favor of the Affordable Care Act (ACA or Obamacare), joined Justices Scalia, Thomas and Alito in dissenting against the new law. In his oral statement today at the Supreme Court, Kennedy said, "In our view, the entire Act before us is invalid in its entirety." In other words, if Roberts would have joined these four, the entire law would probably have been struck down.
Instead, the Chief Justice “threaded the needle,” or “cut the baby in half” and said that while the Commerce Clause would not allow Obamacare, the power of Congress to tax and spend does allow it. In other words, you can be taxed if you don’t buy health insurance. As far as we know, this is the only tax in American history that can be levied for not doing something. In other words, you can live in the back of your brother’s property, grow your own food, build your own house out of lumber you cut down, but still be forced to pay a tax just because you’re a breathing citizen of the United States
The tax is 2.5% of income with a ceiling linked to the average cost of insurance and a floor of $695 no matter what your income. The ACA described this as a “penalty,” which Roberts said was not constitutional under the Commerce Clause. Nonetheless, he argued that “It is not our [the Supreme Court’s] job to protect the people from the consequences of their political choices.”
As a result, he found a way to make Obamacare constitutional, by using the argument that it is a “tax” not a “penalty.” And since Congress has the power to tax, the law will stand. We do not agree with this argument and find it interesting given that Justice Roberts said at his nomination hearing that “Judges are like umpires. Umpires don’t make the rules, they apply them. Nobody ever went to a game to see the umpire.” It certainly seems he found a way to be at the center of the game.
At the same time, the Supreme Court ruled that the new Medicaid mandates on states cannot be enforced by too heavily penalizing the states. In other words, states either opt in or opt out of the expansion in Medicaid envisioned under Obamacare, but cannot be penalized by taking away monies that have nothing to do with the new expansion of Medicaid.
Some conservative commentators are taking solace in the fact that Roberts’ decisions plus the four conservative dissents created a working majority for the most limited interpretation of the Commerce Clause since the 1930s. We agree. However, if the federal government is free to use its taxing authority as expansively as the Court now allows, we don’t see the gain for those who support limited government.
A Step Backward
What all of this means is that the US is facing the prospect of looking much more like Europe. Government’s size and scope is expanding, taxes are rising, and a single-payer healthcare system is not that far off as long as citizens can be “penalized” for not buying health insurance. Long-term growth prospects are now reduced and the Plow Horse Economy has lost some of its forward momentum.
We do not believe the ruling, in and of itself, will cause a recession. However, it will continue to hold down price-earnings ratios and push off a new high in the stock market until after the election in November, an election that has suddenly become “one of the most important in our lifetimes.”
The silver lining in Roberts’ decision is that if the “penalty” is now a “tax,” it can be repealed with just a simple majority in the US Senate via the budget reconciliation process, with no filibuster allowed. If it had been upheld and still considered a “penalty” it would have needed a 60-vote, filibuster proof majority to turn back. As a result, even more so than yesterday, the direction of the US economy hinges on the election in November. Will the US become more like Europe, with lackluster growth, high unemployment, higher tax rates, and eventually major debt problems, or not?
The bottom-line: we stand by our Plow Horse Economy, but one that will grow at a 2.5% to 3% growth rate for the rest of this year – we had been forecasting 3% to 3.5% growth in the second half – and an 8% or above unemployment rate by November – we had been forecasting a rate at 7.8% or slightly below.
Interest rates will remain at record low levels, while stocks will face a more difficult road. Downside policy risks have increased, but stocks remain seriously undervalued already and could get a lift as the economy improves going into the second half. All of this could change quickly following the elections in November, but the US has now taken a step backward. Taxing “inactivity” is a new chapter in American History. Justice Roberts has made his mark.
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| | Real GDP Growth in Q1 was Unrevised at a 1.9% Annual Rate |
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| Posted Under: Data Watch • GDP |
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Implications: Real GDP growth in the first quarter was not revised at all from the prior estimate of a 1.9% annual rate. However, the mix of growth was a bit more favorable, with lower inventories and more commercial construction. More business investment means more productive capacity for the future; lower inventories means more room on shelves to fill in future quarters. Profits were revised lower for Q1 but all of the downward revision was due to profits from the rest of the world; profits at domestic non-financial firms were revised up to a new all-time high. Gains in profits and worker income suggest the economy is growing faster than the GDP numbers show. What we produce adds up to GDP, which is the report most analysts focus on. But the government also calculates gross domestic income (GDI), which is supposed to equal GDP. When there is a discrepancy, the government tends to later revise GDP toward GDI. Real GDI grew at a 3.1% annual rate in Q1, suggesting growth was probably better than the GDP headline of 1.9%. Meanwhile, nominal GDP was up at a 3.9% rate in Q1 and up 4% in the past year, which means the Federal Reserve is already loose enough even without quantitative easing. In other news this morning, new claims for jobless benefits declined 6,000 last week to 386,000. Continuing claims for regular state benefits fell 15,000 to 3.30 million. These figures and other figures suggest June nonfarm payrolls will be up 55,000 and private payrolls up 65,000. (Data next week from Intuit and ADP may alter these forecasts.) Pending home sales, which are contracts on existing homes, increased 5.9% in May after dropping 5.5% in April. These figures suggest a slight rebound in existing home sales in June.
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| | New orders for durable goods increased 1.1% in May |
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| Posted Under: Data Watch • Durable Goods |
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Implications: New orders for durable goods rose more than the consensus expected in May, up 1.1%, and the underlying trend remains favorable, up a healthy 4.6% in the past year. The gain in May was mostly due to the transportation sector, which is very volatile from month to month, but orders were still up 0.4% even excluding transportation. We expect this number to pick up steam over the rest of the year. Unfilled orders (ex-transportation) are up 9.1% in the past year and are now at record highs. Also, we are in the early stages of a home building recovery. As housing continues to improve, orders for durables should pick up as well. Shipments of “core” capital goods (which exclude defense and aircraft) rebounded in May after dropping steeply in April. These shipments have dropped in the first month in nine of the past ten quarters, with a rebound in the following two months. So if the trend continues we should see this number higher in June. Business investment should continue to grow. Monetary policy is loose, interest rates are extremely low, and profits are at record highs while companies have record amounts of cash on their balance sheets. Moreover, capacity utilization at US factories is approaching its long-term norm, meaning companies have a growing incentive to update their equipment. In other recent manufacturing news, the Richmond Fed index, a measure of factory activity in the mid-Atlantic, declined to -3 in June from +4 in May. A negative reading, suggesting some contraction, is not good, but the index was -10 in August last year while the US economy was still growing. In other words, the decline does not signal a recession. Meanwhile, the housing market shows marked improvement. The Case-Shiller index, which measures home prices in the 20 largest metro areas, increased 0.7% in April (seasonally-adjusted), with 17 of the 20 metro areas showing price increases. Although prices are still down 1.9% from a year ago, they are up at a 6.2% annual rate in the past three months.
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| | New single-family home sales increased 7.6% in May |
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| Posted Under: Data Watch • Home Sales |
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Implications: The market for new homes should be the last piece of the housing puzzle to recover and even that is now on the mend. New home sales easily beat consensus expectations, coming in at a 369,000 annual rate in May and are now up 19.8% from a year ago. The median price of a new home sold is up 5.6% versus a year ago. Although the inventory of homes rose slightly, the increase was due to the inventory of homes not yet started as well as homes still under construction; the inventory of completed new homes fell again, to the lowest level on record (dating back to 1963). The months’ supply of new homes, is now 4.7. This is below the average of 5.7 over the past 20 years and not much above the 4.0 months that prevailed in 1998-2004, during the housing boom. The lack of availability of completed new homes is likely holding back sales, which will improve even more as builders finish some of the homes now under construction. We see the same phenomenon in the existing home market, where a lack of homes on the MLS is temporarily holding back sales (see the most recent Wesbury 101). The road ahead looks better than it has in years. Look for housing to continue to move higher, and to add to GDP for the fifth consecutive quarter.
For the entire report, click here.
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| | The Second Step: Supreme Court |
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| Posted Under: Bullish • Government • Markets • Monday Morning Outlook • Stocks |
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Step Two of our Four Steps to Recovery will happen sometime this week. The wait for the Supreme Court to issue its decision on whether President Obama’s health care reform law is constitutional is almost over.
“Obamacare” is the president’s signature legislative achievement. His legacy largely hinges on how the case is decided. If the law is fully upheld and if the president wins re-election, the odds of fully implementing the law go way up. In combination, these two events would codify the US’s move toward a cradle-to-grave social welfare state (emulating much of Europe). This would reduce the growth potential of the US economy and further diminish price-earnings ratios.
As of right now, before the Court issues its decision, we think this combination is highly unlikely. Much more likely is the Court striking down the mandate to buy health insurance as well as other parts of the law that go with the mandate, like the requirement that insurance companies cover all applicants, with no price difference based on health status.
It is entirely possible the Court strikes down the entire law. Oral arguments suggested that the Court understood striking down a major feature of the health care law and letting the rest stand would, in effect, re-write the law in a way Congress never intended. In other words, striking down all the law could be a more restrained decision than striking down just part of it.
If the Court lets most of the law stand, the voters would still get a chance to throw out the rest. Right now, 61% of Americans oppose the mandate, while at the same time supporting other parts of the bill. A new Senate and House, and possibly a new President could use the same special budget procedures that were used to enact Obamacare to repeal what was left. Even if the GOP does not sweep all races, the law is so unpopular that many parts of it could likely change.
In other words, right now the path to getting the law fully implemented is very narrow. Equity markets do not seem to realize this. Neither do businesses that seem to be holding back on investment and hiring decisions temporarily because the Supreme Court ruling is so close. If the Court starts the ball rolling by declaring the mandate unconstitutional, look for the economy and stock markets to take a sharp turn for the better.
Supporters of bigger government and higher taxes have lusted after a federally-dominated national health care system for multiple generations. Losing now, after they had a supportive president and a filibuster-proof majority in the Senate would be demoralizing.
By contrast, the advocates of smaller government and lower taxes would have the winds at their backs. It would be the second step of what we are calling the Four Step Process to Recovery. The first step was Governor Scott Walker’s recent victory in Wisconsin. Although many governors of both major parties have taken on government unions, the unions decided to make Walker the poster child and lost badly.
So, step two would highlight a shift in the direction of the American political environment.
In the late 1960s and 1970s, the Great Society programs of President Johnson moved the US to a bigger government. Equity markets went nowhere for 17 years. Then government shrank substantially under Reagan and Clinton, and equities soared once this process got underway.
The stage is being set for government to shrink once again. And, if so, equities are exactly the place to be.
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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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