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   Brian Wesbury
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  Another Plow Horse Quarter
Posted Under: Autos • GDP • Monday Morning Outlook • Retail Sales

Animal spirits are back!  

Confidence surveys have soared since the election.  The Conference Board's future expectations measure hit the highest level since 2003.  The NFIB small business confidence index rose at its fastest pace ever.  Other surveys are up, too.

But, it will take much more than animal spirits to lift economic growth from its sluggish pace of the past several years. Since mid-2009, real GDP has grown just 2.1% at an annual rate.  We've been calling it a Plow Horse Economy, and have yet to find a better metaphor.  But we didn't predict plow horse growth because of weak confidence numbers, we believed our thoroughbred high-tech economy has been weighed down by an overweight, overbearing jockey called Government.

To truly revive the economy on a lasting basis, we need better policies, not just more confidence.  The new White House promises comprehensive corporate tax reform, a rollback of Obamacare, and more freedom to build energy infrastructure. These policies would lift growth and generate real, lasting, gains in confidence, too.
 
For the time being, though, we're stuck with the Plow Horse.  Although we get some data later this week that may make us tweak our forecast – like the CPI and Industrial Production – it looks like real GDP grew at about a 2.2% annual rate in the last quarter of 2016, almost exactly the average 2.1% pace since mid-2009.  

Here's how we get to our 2.2% forecast.

Consumption:  Auto sales skyrocketed in Q4, growing at a 12.7% annual rate, while retail sales outside the auto sector rose at a 5.5% pace.  But services grew much more slowly, so it looks like "real" (inflation-adjusted) personal consumption of goods and services, combined, grew at a 2.5% annual rate in Q4, contributing 1.7 points to the real GDP growth rate (2.5 times the consumption share of GDP, which is 69%, equals 1.7).

Business Investment:  Business equipment investment grew at around a 4% annual rate in Q4 while commercial construction was flat.  R&D probably grew near its trend of 5%.  Combined, we estimate business investment grew at a 3.3% rate, which should add 0.1 points to the real GDP growth rate (3.3 times the 13% business investment share of GDP equals 0.4).

Home Building:  Looks like residential construction rebounded in Q4 after declining in both Q2 and Q3, growing at about a 5% annual rate.  Expect an acceleration in 2017 despite higher mortgage rates, as more jobs and higher incomes offset the effects of higher rates.  In the meantime, a 5% growth rate will add 0.2 points to the real GDP growth rate.  (5.0 times the home building share of GDP, which is 4%, equals 0.2).

Government:  Military spending grew in Q4, but slowly, while public construction projects appear to have grown faster than usual.  On net, we're estimating that real government purchases rose at a 1.1% rate in Q4, which would add 0.2 percentage points to real GDP growth (1.1 times the government purchase share of GDP, which is 18%, equals 0.2).

Trade:  The third quarter included a slowdown in imports at West Coast ports due to the bankruptcy of a major international shipper.  As a result, trade added substantially to real GDP in Q3.  The end of that import problem will have the opposite effect on GDP in Q4.  At this point, the government only has trade data through November, it looks like the "real" trade deficit in goods has grown rapidly in Q4.  As a result, we're forecasting that net exports subtract 1.1 points from the real GDP growth rate.

Inventories:  At present, we have even less information on inventories than we do on trade, but what we have suggests companies are restocking shelves and showrooms in Q4.  We're forecasting inventories add about 0.8 points to Q4 real GDP.

Put it all together, and we get a forecast of 2.2% for Q4, right in-line with the Plow Horse trend that we will hopefully leave behind in the next couple of years. 

Brian S. Wesbury - Chief Economist
Robert Stein, CFA – Deputy Chief Economist

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Posted on Tuesday, January 17, 2017 @ 10:37 AM • Post Link Share: 
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  M2 and C&I Loan Growth
Posted Under: Government • Fed Reserve

 

Source: St. Louis Federal Reserve FRED Database

Posted on Tuesday, January 17, 2017 @ 8:07 AM • Post Link Share: 
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  Retail Sales Rose 0.6% in December
Posted Under: Data Watch • Retail Sales

 

Implications:  The US consumer is doing fine, with the first estimate of December retail sales coming in very close to consensus expectations.  Nothing very surprising in today's report.  Auto sales were strong, which we already knew from automakers unit sales reports last week; gas station sales were strong, which we knew based on higher gas prices; and non-store sales were up briskly, which we saw with all those package deliveries throughout December.  General merchandise stores lost ground, which is consistent with recent headlines, like the Limited shutting its stores.  A decade ago, general merchandise stores made 51% of sales through non-store activities; now non-store retail equals a record 89% of sales at those same merchandisers.  Expect that trend to continue in the years ahead.  The one potential surprise is that restaurants & bars had a weak December, with sales down 0.8%.  We wouldn't be surprised to see that figure revised upward in the months ahead.  Overall sales are up 4.1% in the past year and we expect that trend to accelerate.  Sales are up at a 5.2% annual rate in the past six months and a 6.0% rate in the past three months.  Although "core" sales, which exclude autos, building materials, and gas, were unchanged in December, it's not unusual for even these sales to take a breather month a few times per year.  Consumers are in relatively good shape.  Job growth continues, wages gains are accelerating, and consumer debt service obligations are very low by historical standards.  In other recent news, new claims for jobless benefits increased 10,000 last week to a still-modest 247,000.  Continuing claims dropped 29,000 to 2.09 million.  In other news this morning, inventories surged 0.7% in November, the largest gain for any month since 2015.  Plugging all these data into our GDP models suggests real GDP grew around a 2% annual rate in the fourth quarter, consistent with the Plow Horse growth we've seen since the recovery started in mid-2009.  Watch for better policies and faster growth in 2017.    

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Posted on Friday, January 13, 2017 @ 10:44 AM • Post Link Share: 
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  The Producer Price Index Rose 0.3% in December
Posted Under: Data Watch • Inflation • PPI

 

Implications:  Prices rose in nearly every category in December, finishing 2016 with the largest calendar year increase in producer prices going back to 2012.  Goods prices led the index higher in December, rising 0.7% on the back of a 2.6% jump in energy prices.  Since bottoming in early 2016, energy prices have been a tailwind pushing goods prices steadily higher following more than eighteen months of near constant declines.  Meanwhile, service prices have shown consistent, if moderate, inflation.  We expect this trend to continue in 2017, pushing overall inflation towards, and eventually above, the Fed's 2% inflation target.  Stripping out the volatile food and energy categories, "core" producer prices rose 0.2% in December and increased 1.6% in 2016, a significant pickup from the 0.2% rise for 2015.  This data, paired with continued gains in employment, puts the Fed on track for three to four rate hikes in 2017.  In other recent inflation news, import prices rose 0.4% in December and are up 1.8% from a year ago.  Petroleum import prices jumped 7.9% in December following November's 3.0% decline.  While the long decline in energy prices that began in mid-2014 appears to be over, don't be surprised if we see fits and starts on the road higher.  Export prices also rose in December, up 0.3%, and have increased 1.1% in the past year.  The Fed has plenty of inflation indicators to watch as leadership changes in Washington and new policies are put in place.  But, as things currently stand, inflation appears to have greater potential for an upside surprise than a return to the near-zero pace of inflation seen as recently as late-2015.

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Posted on Friday, January 13, 2017 @ 10:19 AM • Post Link Share: 
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  Big Government Causes Slow Growth
Posted Under: GDP • Government • Monday Morning Outlook • Spending

In 1930, Pluto was declared the ninth planet.  In 2007, it was demoted to "dwarf planet" status by astronomers after considering new evidence.  There are now only eight planets.

Also in the 1930s, the ideas of John Maynard Keynes came of age.  In spite of a massive amount of evidence that these ideas don't work, unlike astronomers, economists won't demote Keynes's theories to the dustbin of history.

This isn't that surprising.  Whether Pluto is a planet, or not, doesn't impact politicians, or their constituents.  If it did, Pluto might still be categorized as a planet.

Keynes thought a free market economy should be managed: in fact, needed to be managed.   His ideas flourished in the 1930s when the US was in the Great Depression.  Keynes believed that a lack of consumer demand was the culprit to economic problems and government should spend to boost jobs and economic activity.

To this day, in the name of Keynes, economists and politicians support stimulus spending, unemployment benefits, minimum wages, and the redistribution of income.

Not only do politicians and bureaucrats get to increase the size of their budgets and take credit for benefiting constituents, but they get to do it in the name of helping the overall economy.  They do it in the name of Keynesian economic theory.

But there is no evidence it has worked.  Keynes's theories, as mentioned earlier, have been around for over 80 years.  Countries all over the world have tried them.  Government budgets have increased dramatically.

This spending encompasses food stamps, welfare, unemployment benefits, Social Security, Medicare, Medicaid, ethanol, solar, wind, and electric vehicle subsidies.  State and local governments have boosted the minimum wage and created special subsidies and income support for citizens.  Other countries have single-payer healthcare systems and even bigger budgets relative to GDP than the United States.

But there is no economic nirvana anywhere.  After 80 years of growth in government, and little economic growth to show for it, doesn't anyone think we ought to stop and question the underlying assumptions that support these Keynesian policies?

Since the current expansion started, U.S. real GDP has expanded at just a 2.1% annualized rate.  At the same time government spending, tax rates and regulation have increased.  These government burdens reduce entrepreneurial activity, jobs, income growth and push companies out of the U.S.

But many ignore this correlation between bigger government and slower growth.  Instead of blaming government there are endless non-government excuses for slow growth.  Some blame demographics and some blame weak investment by companies.  Other explanations include income inequality, foreign trade, the residual effects of the financial crisis, or government debt levels (which result from low tax receipts.)

All of these explanations shift the blame to the private sector for slow growth and support Keynesian, big-government policy.  Unfortunately, government is funded by taxing incomes and profits of business activity or borrowing the wealth generated by that activity.  It's true that government can help create a positive environment for business, by, for example, enforcing the rule of law and contracts.  But the U.S. long ago surpassed the pro-growth level of spending.

The point is government doesn't create wealth.  The private sector does.  No matter what Keynesian theories say, it's a truth politicians and bureaucrats don't find very appealing.

Brian S. Wesbury - Chief Economist
Robert Stein, CFA – Deputy Chief Economist

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Posted on Monday, January 09, 2017 @ 10:21 AM • Post Link Share: 
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  The Trade Deficit in Goods and Services Came in at $45.2 Billion in November
Posted Under: Data Watch • Trade

 

Implications: The trade deficit expanded to a nine-month high in November as imports grew and exports declined.  While trade added significantly to GDP growth in Q3, the strong growth in exports in Q3 looks to have been temporary.  Expect trade to be a substantial drag on GDP in Q4 as a stronger dollar and tepid global growth continue to be factors.  The good news is that, so far, there's been no large visible effect of Brexit on trade, and we don't expect there to be any.  Although exports and imports to the UK declined in November, both remain in line with the levels seen before the June referendum.  We didn't buy into the fear mongering surrounding the "Leave" vote and believe Brexit will prove to be a long-term positive, as the UK uses its increased flexibility to make better trade agreements with the U.S. and other countries boosting global trade.  Another ongoing factor affecting trade with the rest of the world is the trend decline in US petroleum product imports.  Although the dollar value of petroleum imports increased 7.6% in November, and are up 15% from a year ago, we don't expect this to last.  Since OPEC decided to cut oil production, prices have increased north of $50.  As a result, expect more oil production to come back online in the Unites States and the petroleum import trend to revert lower.  Back in 2005 US petroleum and petroleum product imports were eleven times exports.  In November, these imports were 1.7 times exports.  This is also why oil prices have not spiked back to old highs even though the Middle East is in turmoil.  The US has become an important global petroleum producer, bringing a stabilizing effect to the world.  Overall, we expect real GDP growth to accelerate in 2017 and expect some widening in the overall trade deficit as US consumers buy imports with their healthy gains in income.  This will happen despite efforts by the incoming president to reverse the trade gap, which is ultimately driven by capital flows into the US.  If we make the US a better place to invest global capital – and it's likely President Trump and Congress will do that – the overall trade deficit will grow, not shrink.  

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Posted on Friday, January 06, 2017 @ 11:11 AM • Post Link Share: 
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  Nonfarm Payrolls Increased 156,000 in December
Posted Under: Data Watch • Employment

 

Implications:  While job growth continues to look like a plow horse, wage growth is starting to look like a thoroughbred.  Payrolls grew a moderate 156,000 in December.  But, like we mentioned last month, payrolls were revised up for November, north of 200,000 versus an original report of 178,000.  Look for another upward revision, this time to December, one month from now.  Civilian employment, an alternative measure of jobs that includes small-business start-ups, rose a modest 63,000 in December.  In the past year, payrolls are up 180,000/month while civilian employment is up 182,000/month.  Look for similar gains in 2017.  The best news in today's report, though, was on wages, which increased 0.4% in December and are up 2.9% from a year ago, the fastest growth so far in the economic expansion.  Combined with data on the number of hours worked, total wages, which exclude fringe benefits and irregular bonuses/commissions, were up 0.6% in December and are up 4% versus a year ago, more than enough to outpace inflation.  This will help keep the Federal Reserve on track for raising rates three times this year, like its "dot plot" suggested in December.  Although the unemployment rate ticked up to 4.7% in December, that follows a large decline to 4.6% in November.  Overall, the jobless rate dropped 0.3 points in 2016 and we expect a similar gradual drop in 2017, as the labor force continues to grow.  The labor force grew 1.8 million in 2016, the largest gain for any calendar year in the past decade.  Some analysts may claim that most of the job gains in December were part time.  But the data on full-time/part-time work are very volatile from month to month.  In the past seven years (since December 2009), part-time jobs are up 416,000 while full-times jobs are up 13.7 million.  Other analysts will point out that the number of people not in the labor force (neither working nor looking for work) hit a new record high in December.  But this was true in the 1990s and 2000s expansions as well, due to population growth.  Now we have retiring Baby Boomers as well, who are also driving this trend.  The labor market is still a far cry from where it would be with a better set of policies, but it looks like some of these policies are on the way.

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Posted on Friday, January 06, 2017 @ 10:45 AM • Post Link Share: 
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  The ISM Non-Manufacturing Index was Unchanged at 57.2 in December
Posted Under: Data Watch • ISM Non-Manufacturing

 

Implications:  Service sector sentiment matched the highest reading of 2016 in December, showing expansion for an 83rd consecutive month.  While the headline index was unchanged from November's reading of 57.2, the underlying details of the report were an improvement.  New orders jumped to 61.6, the highest reading in more than a year and a sign that business activity (and employment) should follow suit higher in the coming months as companies fill the rise in orders.  Meanwhile, the largest decline in December came from the employment index, which continued to signal job growth, but at a slower pace than in November.  A modest slowdown in the pace of employment gains is to be expected as the labor market tightens, but we expect hiring will continue and push up the pace of wage gains.  On the inflation front, the prices paid index rose to 57.0 in December from 56.3 in November, representing the highest reading in more than two years.  Rising costs for copper and fuels more than offset declining prices for beef and dairy.  Overall, positive sentiment from the service sector in December was broad-based, with twelve of eighteen industries reporting expansion while only three reported contractions.  And taken as a whole, today's report follows the strong manufacturing sector report released by the ISM on Tuesday in showing a healthy economy heading into the new year as businesses and consumers prepare for new political leadership and new policies.  In other news this morning, initial claims for unemployment insurance plummeted 28,000 last week to 235,000.  Continuing claims rose 16,000 to 2.11 million.  Meanwhile, the ADP report showed private payrolls increased 153,000 in December.  Plugging these figures into our models suggests tomorrow's official report from the Labor Department will show a nonfarm gain of 152,000, which we think will be revised up in later months.  In other recent news, automakers reported cars and light trucks were sold at an 18.4 million annual rate in December, up 3.1% from November, up 5.2% from a year ago, and the fastest pace for any month since 2005.  Auto sales hit another new annual record high in 2016, showing plenty of confidence on the part of consumers.

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Posted on Thursday, January 05, 2017 @ 11:24 AM • Post Link Share: 
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  The ISM Manufacturing Index Rose to 54.7 in December
Posted Under: Data Watch • ISM

 

Implications: Manufacturing ended 2016 on a high note, with the ISM manufacturing survey hitting the highest reading in two years.  And December's increase represents the fourth consecutive month that the index has moved higher, signaling faster growth.  Both the new orders and production indices hit multi-year highs, suggesting that 2017 should hit the ground running as factories gear up to fill increased demand.  Some of this may be in part due to President-Elect Trump's focus on the manufacturing sector, but we think the likelihood of tax and regulatory reform are boosting confidence across industries and will benefit both the manufacturing and service sectors.  The employment index also hit a 2016 high in December after being the only major indicator to decline in November.  That said, manufacturing remains a small portion of total employment.  We tend to focus on other signals of labor force strength (initial claims, earnings growth, and consumer spending) which have shown constant strength even through some turbulent times for the manufacturing sector.  On the inflation front, the prices paid index skyrocketed to 65.5 in December from 54.5 in November, with eighteen commodities rising in price while just three declined.  So any claims that rising prices are just a reflection of the rebound in oil prices are missing the mark.  Yes, energy prices have been on the rise since bottoming in early-2016, but rising economic activity is starting to put pressure on a wide variety of inputs.  This, paired with rising energy, is likely to push inflation above the Fed's 2% target in 2017.  As a whole, today's report shows the Plow Horse manufacturing sector starting to hit its stride as the nation prepares to pass the reins to a new President.  In other news this morning, construction spending increased 0.9% in November (+0.8% including revisions to October).  New single-family home building led the way, while hotel construction and public schools also increased. 

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Posted on Tuesday, January 03, 2017 @ 11:35 AM • Post Link Share: 
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  Watch the Spending
Posted Under: GDP • Government • Monday Morning Outlook • Spending • Taxes

President-elect Trump wants a Race Horse Economy, not a continuation of the Plow Horse we've had for the past several years.      

Out of all of his proposals, the one that should help the economy the most is corporate tax reform, in particular a big cut in the tax rate on profits to 15% or 20% from 35% at present.  Typically, corporate profits are subject to two layers of tax: first, when the company earns the money; second, when that same money flows to shareholders in the form of dividends or capital gains. 

So, for example, a dollar of pre-tax profits is reduced to 65 cents at the corporate level and then 49.5 cents if the profits are distributed to high-earning taxpayers.  (The 65 cents are taxed at a 23.8% rate, including the Obamacare-surcharge.)  In effect, these earnings face an effective tax rate of just over 50% (not even considering state income taxes), likely on the wrong side of the Laffer Curve.

In addition, cutting the top tax rate on regular income should help spur economic growth, as many entrepreneurs and partnerships face very high tax rates as well.  Lower tax rates will support a game-changing build-out of domestic energy infrastructure.  

But tax policy isn't the only fiscal game in town.  Investors need to watch government spending as well.  Cutting taxes without getting control of government spending is not a recipe for long-term economic growth.  Instead, reducing spending will help entrench expectations that lower tax rates would remain in place.

Every dollar the government spends ultimately has to be paid for by taxpayers, either through taxes today or debt, which simply obligates future taxpayers to make payments to bondholders.  Either way, there's no free lunch.     

Spending hit a 30+ year low in 2000 at 17.6% of GDP.  Now federal spending is at 20.9% (and that doesn't include how Obamacare shifts public spending to private insurers, the true cost of student loans, but does include payments from Fannie Mae and Freddie Mac).  We see the heavier load of government as the overweight jockey weighing down the private sector, preventing it from moving faster.     

In the next year or so, we'll be looking for entitlement reforms that reduce long-term spending commitments in Obamacare and Medicaid as well as reductions in non-defense "discretionary" spending.

Back in the 1980s, President Reagan not only cut taxes but cut spending relative to GDP as well.  President Clinton also cut spending.  By contrast, spending went up during the presidencies of both Bushes and under President Obama as well. 

So far, President-elect Trump has talked a good game on taxes but has been sending mixed signals on spending.  Investors need to pay attention to both.       

Brian S. Wesbury - Chief Economist
Robert Stein, CFA – Deputy Chief Economist

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Posted on Tuesday, January 03, 2017 @ 10:04 AM • Post Link Share: 
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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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