Implications:  Don't get hung up on July's negative headline number for starts; this isn't the end of the recovery in the housing market.  Almost all of the weakness was in multi-unit construction (Apartments, Duplexes, etc.), which are extremely volatile from month to month, and the underlying trends show single-family activity is still in a rising trend.  Multi-unit starts fell 15.3% in July and are down 33.7% from a year ago.  Meanwhile, single-family starts slipped only 0.5% in July and are up 10.9% from a year ago.  Permits to build show the divergence between multi-family and single-family should continue.  In the past year, building permits are down 9.8% for multi-family but up 13% for single-family.  This shift is unwinding the pattern that held in the early stages of the housing recovery, when multi-family led the way (2011-15).  Back in 2015, 35.7% of all starts were in the multi-family sector, the largest share since the mid-1980s, when the last wave of Baby Boomers was growing up and moving to cities.  In July, the multi-family share of starts was 25.9%.  The shift toward single-family is a positive sign for the economy because, on average, each single-family home contributes to GDP about twice the amount of a multi-family unit. This transition will continue going forward. We expect housing starts to rebound next month and continue to generally increase for at least the next few years.  Based on population growth and "scrappage," housing starts should eventually rise to about 1.5 million units per year.  And the longer this process takes, the more room the housing market will have to eventually overshoot the 1.5 million mark.  In other recent housing news, the NAHB index, which measures sentiment among home builders rose to 68 in August from 64 in July.  Expect further strength in the housing sector in the year ahead as more jobs, faster wage growth, and, for at least the time being, optimism about more market-friendly policies from the Trump Administration, continue to encourage both prospective home buyers and builders.       

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Implications: So much for the theory that retail is dead.  Retail sales grew 0.6% in July, beating consensus expectations, and were revised up substantially for prior months.  Including those upward revisions, sales were up 1.1%.  The increase in July itself was broad-based with 10 of the 13 major categories showing gains.  Sales of autos led the way rising by 1.2% in July, growing the most for any month this year.  Store closures continue to popularize headlines implying a weak consumer.  More than 5,400 stores have closed so far in 2017, already more than all of last year, and on pace for more than in 2008 at the height of the Panic!  But don't take this as a sign of a weak economy. Consumers are just spending their money differently than in the past, buying more items via the internet.  In fact, non-store retail sales grew by 1.3% in July, the largest gain this year and now make up 11% of retail sales in July, the largest portion ever.  Just think about Amazon. Do you own an Amazon Prime membership? Chances are you do, and use it frequently.  As of the second quarter of 2017, it's estimated there are 85 million Amazon Prime memberships in the United States.  Assuming one membership per household that would mean 72% of households are Prime members.  What this means for the retail sector is a change in business models, not its demise.  "Core" sales, which exclude autos, building materials, and gas, rose 0.5% and were revised higher for previous months.  Overall sales are now up 4.2% from a year ago while "core" sales are up 3.6%.  Given Plow Horse economic growth, that's about what we'd expect given a 1.7% increase in the consumer price index in the past twelve months.  The fundamental trends that drive growth in consumer spending continue to look good.  These include healthy job growth, wage growth, and very low consumer financial obligations relative to historical norms.  In other news this morning, the Empire State index, a measure of manufacturing sentiment in New York, surged to 25.2 in August – the highest reading in nearly three years - from 9.8 in July.  In inflation news, import prices rose 0.1% in July and are up 1.5% from a year ago.  Export prices increased 0.4% in July, and have increased 0.8% in the past year.  Both figures are a stark contrast to the negative direction of prices in the twelve months ending in July 2016.

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It's hard to read the business pages or watch the business news without seeing a story about the death of the consumer.  In particular, the business press continues to be obsessed by relative weakness among traditional brick and mortar stores.

There's no denying that the business model for delivering goods and services to consumers is changing fast.  But that doesn't mean the consumer, or retail in particular, is dead.  Far from it.       

Yes, in June, retail sales were up a tepid 2.8% from a year ago, 2.4% excluding auto sales.  But the consensus view is that retail sales were up 0.4% in July.  If so, retail sales, both overall and excluding autos, will be up about 3.5% from a year ago.

That's right about what we'd expect given Plow Horse economic growth and an overall consumer price index that's up 1.7% in the past year.  Remember, goods prices have been rising more slowly than prices for services for the past several years in a row and retailers focus on selling goods.
 
Meanwhile, sales at non-store retailers, which include internet sales, have been growing at a 10% annual pace.  That's the key reason many brick and mortar stores have been taking it on the chin: not weak sales overall, but a shift toward those who can deliver the goods (literally) with the least fuss.  Need to finally throw out those old pairs of underwear?  Well, you can either get in a car and drive to the store to buy some new ones or take only a minute and go to a website that will deliver the same new ones to your door.

Also, many Americans are getting more value out of the items they buy.  When your child outgrows a toy, you can put it on the Web and sell it, while those who don't mind getting something used can buy it for less.   

This week, many analysts will focus on the retail sales figures that come out of the Census Bureau each month, but figures from deep in the GDP reports show the consumer is doing fine.         

For example, in the second quarter of 2017, total spending on motorcycles was up 9% from a year ago.  Spending on boats used for personal pleasure was up 22%.  Spending on pleasure aircraft was up 16%.

These are not the hallmarks of a consumer in the throes of death. 

Yes, we are well aware that airplane ownership is not widespread.  And, for most of the country, boat ownership isn't either.  So let's look at some other kinds of spending as well.  Spending on amusement parks and campgrounds was up 13% compared to a year ago.  Meanwhile, Americans spent 11% more for veterinary services than a year ago. 

Sorry, but Spot would not be getting better health care if Americans weren't feeling pretty good.

None of this is to say that things couldn't be much better.  Of course they could!  But the economy as a whole and the US consumer in particular keeps plowing forward despite tax rates, regulation, and government spending that are all too high.     

Meanwhile, beneath the top line growth we do have, there's a huge battle being fought between business models, old versus new.  That's not a sign of weakness, though.  It's a tribute to the entrepreneurial spirit that has made America great.   

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

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Source: St. Louis Federal Reserve FRED database

Implications:  Consumer prices rose 0.1% in July, continuing the tame inflation that started in February.  Consumer prices rose at a 3.6% annual rate in the six months ending in January, and are now down at a 0.1% annual rate over the past six months.  So what's changed?  Energy prices declined substantially from mid-2014 through the start of 2016 and then rose through much of last year.  That rise helped push overall consumer prices up at a 3.6% rate in the six months ending in January.  But with energy prices generally down since then, overall inflation has been quiet as well.  Still, we think inflation is in a general rising trend.  Prices rose 0.2% in the twelve months through July 2015, 0.8% in the twelve months through July 2016, and 1.7% in the last twelve months.  Moreover, that acceleration in inflation has arrived despite oil prices being lower today than in 2015.   "Core" prices, which strip out the volatile food and energy components, have shown steadily rising prices of late, increasing in eleven of the last twelve months.  Within core inflation, a small sub-set of categories have kept prices from reaching or exceeding the Fed's 2% inflation target.  Cellphone service prices have declined 13.3% in the past year, while major household appliances are down 5.2% and vehicle costs are falling.  For the consumer these falling prices - which are the result of technological improvements and competition – plus rising wages mean increased spending power on all other goods. But it tempers inflation readings.  Meanwhile, costs for medical care and rent continue to push overall consumer prices higher.  We expect rents to accelerate in the year ahead as supply constraints get tighter in the housing market.  We still expect inflation to trend towards 2% in the medium term, and don't think the gains to consumers from falling prices in select areas are reason for concern or a justification for the Fed to slow the pace of rate hikes.  The best news in today's report is that real average hourly earnings rose 0.2% in July.  These earnings are up 0.7% over the past year, up at a 2.6% annual rate over the past six months, and a 3.0% annual rate over the past three months.  Because the Fed believes in the Phillips Curve, the trend of accelerating price and wage gains should have Fed officials focusing more on the potential for inflation to rise faster than desired as the jobless rate continues to fall below their long-term target.  That's why we expect the Fed to stick to their plan of starting to unwind the balance sheet while also raising rates one more time in 2017. 

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For many years now a relatively large contingent of analysts, investors and journalists has been convinced the stock market was in a bubble because the "Shiller P-E" ratio was just too high.  Back on 8/12/2013, in our Monday Morning Outlook, we made our case that the Shiller model was too pessimistic.  Now that looks like a pretty good call.

In the past four years, the bull market in stocks has continued, with the S&P 500 generating a total return – including both share price increases and reinvested dividends – of almost 60%, or more than 12% per year.

The response from many in the market is to say "OK, maybe a Shiller P-E ratio of 23.4 (from 8/2013) wasn't too high.  But now it's 30.5, and the bull market really is doomed."

As we said four years ago, Yale University economics professor Robert Shiller has made some great calls.  In his 2000 book, "Irrational Exuberance," Shiller argued that a 10-year average of corporate earnings smooths out the ups and downs of the business cycle.  Then, using this "cyclically-adjusted" level of earnings and comparing it to stock prices he claimed to generate a better version of the P-E ratio.  It was an all-time high in 1999-2000, a clear signal of a "bubble" in stocks. 

Several years later, Shiller warned investors about a housing bubble: Another prescient call.  Although we don't see eye to eye with Shiller about how the economy works, no one should doubt his intelligence or sincerity.

But that doesn't make him infallible.  We still think the Shiller P-E is painting an overly pessimistic view of the stock market.  One basic flaw is that by using a ten-year time horizon for earnings, the Shiller P-E includes a massive drop in earnings from 2008-09 generated by awful political management of the economy and a mis-use of mark-to-market accounting.

But even if you take the Shiller P-E at face value, the situation isn't as bad as some claim. 

Let's go back to December 1999, when the Shiller P-E peaked at 44.20, the highest level on record.  That P-E corresponds to an earnings yield of 2.26% (100 divided by the Shiller P-E).  At the time, 10-year Treasury Notes were yielding 6.28%.  In that environment, investing in Treasury securities was clearly the better deal.  The following ten years proved that proposition, with the S&P generating an annualized total return of -0.9%.

Next look at May 2007, when the Shiller P-E peaked at 27.55 prior to the last recession.  That translates into an earnings yield of 3.63%.  At the time, the 10-year Treasury yield was 4.75%. 

At first glance it looks like bonds were more attractive.  But that doesn't factor-in the potential of corporate earnings growth.  And, in the end, despite the deepest recession since the Great Depression, earnings growth helped generate a higher return for stocks than for bonds.  In the ten years after May 2007, the S&P generated a total return of 6.9% per year, beating the 4.75% on a 10-year Treasury Note.

Where does this leave us today?  A Shiller P-E of 30.5 corresponds to an earnings yield of 3.28%, which is already more generous than the yield on any Treasury security.

The 10-year Note yield would have to be 7.3% today for the stock market to be as bad a deal relative to bonds as it was back in 1999.  (Take today's earnings yield and add the gap between the Treasury yield and earnings yield in 1999, or 3.28% + (6.28% - 2.26%) = 7.30%)  

For stocks to be as "bad" a deal as they were in May 2007, the 10-year Note yield would have to be about 4.4% today, which remember, even then didn't mean bonds beat stocks.

Moreover, all these comparisons will look even better once the 2008-09 atypical earnings swoon drops out of the ten-year earnings window.

This economic expansion is not over.  Earnings have, and will, continue to grow.  And, as we said four years ago, those who swear by the Shiller P-E are going to be underinvested in stocks.  This bull market has a long way to go.       

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

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Source: St. Louis Federal Reserve FRED Database

Implications: The trade deficit declined in June, coming in at $43.6 billion, a slightly smaller trade deficit than the consensus expected.  While exports increased $2.4 billion in June and imports declined by $0.4 billion, both imports and exports are up from a year ago: exports by 5.8%, imports by 4.6%.  We see expanded trade with the rest of the world as positive for the global economy, and total trade (imports plus exports) is up 5.1% in the past year.  Look for more of that in the year to come as economic growth accelerates in Europe.  In particular, it looks like France's new president Emmanuel Macron is intent on moving its economy toward a freer labor market, which should, in turn, make other European countries follow suit.  Better growth in Europe will increase global trade and US exports as well.  In June itself, increased petroleum exports and a decline in crude oil imports were key drivers in the trade balance, once again highlighting the impact that U.S. energy technology – led by fracking – is having on an international scale.  But the largest contributor to the smaller trade deficit in June came from our North American trade partners.  Exports of goods to Canada and Mexico rose $1.8 billion in June, while imports declined $0.3 billion.  Despite rhetoric out of Washington about NAFTA, total trade in goods to the region is up 9.7% since last November.  Trade is one of our four pillars to prosperity; freer trade leads to improved economic growth.  And while we have our qualms with some of the talk coming out of Washington related to paring back free trade, there has been significantly more hot air than substance.  We will watch trade policy as it develops, but don't see any reason at present to be sounding alarm bells.  A key trend that we will be keeping an eye on is the shift towards developing countries like China and India making up a steadily increasing share of U.S. trade.  While they receive just 9% of U.S. goods exports, that is up from just 2% in early 2000.  Given demographics and shifts towards more market based economies, we expect both countries to rise in importance as trade partners in the years ahead.

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