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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  Existing Home Sales Rose 2.4% in December
Posted Under: Data Watch • Home Sales • Housing

Implications: Sales of existing homes are trending up, but nowhere close to booming. Sales rose 2.4% in December and are up only a modest 3.5% from a year ago. However, the underlying fundamentals are improving. Distressed homes (foreclosures and short sales) now account for only 11% of sales, down from over 30% in the recent past, while all-cash buyers are down to 26% of sales from a high of 35% in February 2014. As a result, non-cash sales (where the buyer uses a mortgage loan) have jumped to 74% of the total and have been rising. In other words, even though credit (but, not liquidity) remains relatively tight, we see evidence of a thaw, which suggests overall sales will climb at a faster pace in the year ahead. What’s interesting is that the percentage of buyers using credit has increased as the Fed tapered. Those predicting a housing crash from tapering were completely wrong. Probably the biggest reason for the tepid recovery in existing home sales so far is a lack of inventory. Inventories are down 0.5% from a year ago and at the lowest level in almost two years. In the year ahead, we expect the higher level of home prices to bring more sellers into the market, which should help generate additional sales. Either way, whether existing home sales are up or down, it’s important to remember these data, by themselves, should not change anyone’s impression about the overall economy. Existing home sales contribute almost zero to GDP, which counts “new” production, not re-sales of old property. Also, on the housing front, the FHFA index, which measures prices for homes financed with conforming mortgages, was up 0.8% in November, the largest increase in 18 months. In the past year, the FHFA index is up 5.3% versus a gain of 7.4% in the year ending in November 2013. We expect further gains in home prices in 2015, although at a slower pace than in recent years. In other recent news, new claims for unemployment benefits declined 10,000 last week to 307,000. Continuing claims increased 19,000 to 2.44 million. Plugging these figures into our models suggests nonfarm payrolls will be up 231,000 in January. That would bring the total gain for the past twelve months to more than 3 million, the first time that’s happened for any 12-month period since 1999.

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Posted on Friday, January 23, 2015 @ 11:10 AM • Post Link Share: 
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  Housing Starts Rose 4.4% in December
Posted Under: Data Watch • Home Starts

Implications: Home building continues to pick up steam and the recovery still has much further to go. Housing starts rose 4.4% in December, easily beating what the consensus expected, and has shown annualized growth exceeding one million units for a fourth straight month. Overall, more homes were started in 2014 than any year since 2007. The best news in the report was that the gain in December was all due to single-family units, which generate more real GDP per unit than multi-family homes, like apartments. Even the negative news in the report had a silver lining. Building permits fell 1.9% in December, but all of the drop was due to multi-family units, which are very volatile from month to month; permits to build single-family homes hit the highest level since 2008. Until recently, the recovery in home building had been dominated by multi-family units. As a result, the number of multi-family units still under construction is now the highest since 1987, when the last wave of baby Boomers had recently graduated college and filled up apartment buildings. But today’s data adds to the evidence that the recovery in single-family housing is starting to catch up. Over the past two years, multi-family starts have been roughly unchanged while single-family starts are up 18.4%. Multi-family permits are down 9.9% from a year ago, while single-family permits are up 8.1%. The underlying trend in housing clearly remains upward and we expect that to continue. No wonder residential construction jobs are up 132,100 in the past year. Based on population growth and “scrappage,” housing starts should rise to about 1.5 million units per year over the next couple of years. In other recent housing news, yesterday, the NAHB index, which measures confidence among home builders, declined to 57 in January from 58 in December. Readings greater than 50 mean more respondents said conditions were good rather than poor. Given the pick-up in construction, look for sales numbers to pick up as well in the year ahead.

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Posted on Wednesday, January 21, 2015 @ 10:02 AM • Post Link Share: 
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  Davos - And the Euro
Posted Under: Europe • Government • Monday Morning Outlook • Trade
Perfect! Last week, the Swiss National Bank in reaction to market pressure, ended its crawling peg against the euro. The Swiss Franc surged 40% versus the euro, before settling around 20% higher, and roughly 17% against the already strong dollar. So, guess what? Attendees at The World Economic Forum – an annual gaggle of the global financial elite held in Davos, Switzerland, which starts today – just saw their trip get a lot more expensive.

Most people who attend (or who aspire to attend) just call the meeting “Davos.” It’s been described as a meeting of the 1% - wealthy business CEO’s, high-ranking government officials, heads of international organizations, and, occasionally a famous economist, artist, professor, or author. And, don’t forget the press – they are everywhere.

For the most part, the meeting is made up of people who believe the “elite,” in business and government – the ones often called the “smartest people in the room” – can “fix” just about any problem that exists in the economy or society.

Last year’s theme was “Resilient Dynamism.” No joking; to the people at Davos that actually means something, or at least they all pretend that it does. This year, it’s “The Reshaping of the World: Consequences for Society, Politics and Business.” Some attendees actually think a central authority can Reshape the World and still have Resilient Dynamism.

Reading the agenda items, it sounds like an interesting conference. The panels will fret about financial market risk, inequality, global warming and talk about designing the perfect regulatory environment for fixing all these things.

While they may not say it exactly like this, they believe a “partnership between government, business and academia will produce a ‘better’ world.” And why shouldn’t they; many of them would be the central planners in that supposedly better world. But what these government, business, and academic officials just found out is that markets ultimately control prices, not central planners.

The Swiss National Bank, the central bank of Switzerland, had previously tied the local Swiss Franc to the

value of the euro. It did this to prevent the Swiss Franc from rising too much against the euro, which would, in theory, have made Swiss exports less competitive.

But, Switzerland has an excellent long-term monetary track record. The Swiss Franc has generally gained strength versus other currencies (even the US dollar) in the past 45 years. As a result, investors from around the world still prized investing in Switzerland. Moreover, with the European Central Bank threatening more quantitative easing, these two forces (one long-term and one short-term) put upward pressure on the Swiss Franc. To offset that upward pressure the central bank had been intervening in the foreign exchange market by buying Euros, issuing more Swiss Francs and racking up losses.

Continuing the peg would have swelled its balance sheet even further. In the end the “smartest Swiss in the room” were forced to cave to market forces. The world was aghast. Journalists, politicians, central bankers, and all forms of central planners were stymied. Their best laid plans of more QE to solve Eurozone problems took a massive hit. This is a lesson we doubt will be learned.

In the end, markets always win. You can only fight them for so long. The foreign exchange markets wanted the Swiss Franc higher because it represented the collective wisdom of people protecting their own assets, not just the Mandarins at the central bank who had temporarily decided it’d be better if the Swiss Franc didn’t move higher.

Keep that in mind when you hear breathless interviews and reporting from Davos in the week ahead, on what the smart set, the elite, thinks about world problems and how to solve them. Because in the end, what they often say is that they know better than markets. But, the Invisible Hand, which most of them refuse to believe in, and many try to control, is simply more powerful.

If they really want to “Reshape the World,” Davos attendees will agree that getting out of the way and trusting that Invisible Hand is a much better solution than the ones they will likely dream up.

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Posted on Tuesday, January 20, 2015 @ 9:29 AM • Post Link Share: 
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  M2 and C&I Loan Growth
Posted Under: Government • Fed Reserve

Posted on Tuesday, January 20, 2015 @ 7:54 AM • Post Link Share: 
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  Key Upcoming Events - Jan
Posted Under: Europe • Government • Markets • Fed Reserve
January has set 2015 off with a bang. With that in mind, we wanted to make sure that our readers know what we will be watching closely in the weeks to come. The current slowdown in Europe guarantees that the Fed won't be the only central bank in the spotlight later this month, and with Greece continuing to lag behind the rest of its EU counterparts the Greek elections are going to be more crucial than ever. The following events are on our radar and we think they should be on yours as well.

1/22 – Next ECB meeting

1/25 – Greek elections

1/27-1/28 – Fed Meeting (Fed Statement on the 28th)

Posted on Friday, January 16, 2015 @ 1:03 PM • Post Link Share: 
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  The Consumer Price Index Declined 0.4% in December
Posted Under: CPI • Data Watch • Inflation

Implications: The sharpest decline in energy prices in more than six years pushed overall consumer prices lower in December at the fastest pace since the Panic of 2008. But it wasn’t just energy prices keeping a lid on inflation in December. Even excluding energy, consumer prices were unchanged for the month, with declines in clothing, airfares, and auto prices offsetting increases in rent, medical care, and food. Consumer prices rose only 0.8% in 2014, largely due to plummeting energy prices, which have now declined for six straight months. Gas is below $2.60 per gallon in all of the lower 48 states (including high-tax Illinois, New York and even California). Given the continued drop in oil prices in the first half of January, look for another tame reading on inflation in next month’s report. However, the underlying trend in inflation is higher than the overall number. Although unchanged in December, “core” consumer prices, which exclude food and energy, were up 1.6% in 2014. Also, there are sectors where prices are rising faster. Food prices rose 3.4% in 2014, the largest gain since 2011. So if you only use the supermarket to gauge inflation, we understand thinking the headline reports are too low and that “true” inflation is higher. Meanwhile, housing costs are going up. Owners’ equivalent rent, which makes up about ¼ of the overall CPI, rose 0.2% in December, was up 2.6% in 2014, and will be a key source of higher in inflation in the year ahead. In other words, even though overall prices remain subdued, there is no broad, tight-money, induced deflation out there. One of the best pieces of news in today’s report was that “real” (inflation-adjusted) average hourly earnings rose 0.1% in December after a 0.6% jump in November. These earnings are up 1% from a year ago, signaling that living standards are increasing, but still at a slow pace.

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Posted on Friday, January 16, 2015 @ 10:46 AM • Post Link Share: 
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  Industrial Production Declined 0.1% in December
Posted Under: Data Watch • Industrial Production - Cap Utilization

Implications: Don’t judge a book by its cover. Although industrial production dropped 0.1%, the underlying details of the report were very good. Industrial production is divided into three major parts: manufacturing (which includes autos), utilities, and mining (which includes oil and gas production activities). Today’s data was fascinating. Utility output fell 7.4% as an unusually mild December in much of the country reduced demand for heating. Mining was up 2.3%, with strength in oil and gas extraction offsetting declines in drilling and well-servicing activity – plummeting oil prices are roiling this market. And, while overall manufacturing rose 0.3%, auto production fell 0.9%. If there were a “core” industrial production statistic it would be “manufacturing, excluding autos,” which rose a strong 0.4% in December and is up 4.7% versus a year ago. In the past 17 months, this key measure has only declined once, and that was last January during the worst of an unusually brutal winter. We expect continued growth in the industrial sector in the year ahead. The housing recovery has further to go and both businesses and consumers are in a financial position to ramp up investment and the consumption of big-ticket items, like machines and appliances. Capacity utilization declined to 79.7% in December from 80.0% in November, but still remains higher than the average of 78.7% in the past twenty years. In the past year, capacity utilization is up 1.2 percentage points and further gains in production in the year ahead will push capacity use even higher, which means companies will have an increasing incentive to build out plant and equipment.

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Posted on Friday, January 16, 2015 @ 10:31 AM • Post Link Share: 
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  The Producer Price Index Declined 0.3% in December
Posted Under: Data Watch • PPI

Implications: Still no sign of inflation as producer prices fell for the fourth time in five months. The decline in overall producer prices can all be attributed to energy, which fell 6.6% in December and is down 12.9% versus a year ago, a testament to fracking and horizontal drilling. Although energy prices have dropped further in January, that trend won’t last forever. As a result, our forecast is still that the US suffers neither hyperinflation nor deflation. Instead, it’s going to be a slow slog upward for inflation. “Core” prices, which exclude food and energy, show deflation is not setting in. Core prices rose 0.3% in December and are up 2.1% in the past year. However, prices further up the production pipeline remain quiet. Prices for intermediate processed goods are down 2.3% in the past year while prices for unprocessed goods are down 8.6%. Regardless, with the labor market improving, the Fed is still on track to start raising rates around the middle of the year. These rate hikes will not hurt the economy; monetary policy will still be loose and will likely remain that way for the first couple of years of higher short-term rates. Counterintuitively, higher short term rates may boost lending as potential borrowers hurry up their plans to avoid even higher interest rates further down the road. In other words, the Plow Horse economy won’t stop when the Fed shifts gears. In other news this morning, new claims for unemployment benefits increased 19,000 last week to 316,000. We wouldn’t make too much of this as claims are often very volatile in January. Continuing claims fell 51,000 to 2.42 million. Plugging these numbers into our models suggests January will be another solid month with payroll growth again exceeding 200,000. On the manufacturing front, two separate measures of factory sentiment went in different directions in January, but both signal continued growth. The Empire State index increased to +10.0 in January versus -1.2 in December, while the Philadelphia Fed index fell to +6.3 from +18.7.

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Posted on Thursday, January 15, 2015 @ 1:49 PM • Post Link Share: 
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  Retail Sales Declined 0.9% in December
Posted Under: Data Watch • Retail Sales

Implications: Retail sales missed big in December, down 0.9%, but we don’t think this is the end for the consumer. The drop in December is likely due to three factors, all of which are temporary. First, gas prices plunged, so sales at gas stations fell 6.5%, the largest drop for any month since the Panic of 2008. Second, aggressive sales in November pulled some retail spending into the earlier part of the Christmas-shopping period. And third, “core” sales, which exclude autos, building materials and gas, slipped 0.2%. That’s only the second decline in all of 2014, which we chalk up to normal monthly volatility. Regardless of how it affects top-line retail sales, the drop in gas prices is good news. Every one cent decline in the price of gas saves consumers about $3.7 million a day (so, today, consumers are saving more than $575 million a day versus 6 months ago). Shoppers are now able to take that money and shift their purchases elsewhere, although they might not spend all of it immediately. In the meantime, “core” sales, which are a key input into GDP calculations, were up at a solid 5.2% annual rate in Q4 versus Q3 and it now looks like real GDP grew at a 3 – 3.5% annual rate in Q4. However, with December sales down, first quarter spending is starting off on a weaker footing, meaning a Plow Horse start to GDP in 2015. Nonetheless, we expect roughly 3 million more jobs in 2015 and wage gains to go along with them. In other news this morning, on the inflation front, still no sign of a problem in the trade sector, especially given the strength in the US dollar. Import prices fell 2.5% in December, but were up 0.1% excluding petroleum. Export prices fell 1.2% in December, both including and excluding agriculture. In the past year, import prices are down 5.5% while export prices are down 3.2%. This environment of expanding consumption, low inflation and new innovation is still a great one for equities. Don't let the bearish forecasters scare you.

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Posted on Wednesday, January 14, 2015 @ 11:15 AM • Post Link Share: 
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  Bullish, For the Right Reasons
Posted Under: Markets • Monday Morning Outlook • Stocks
Last week, we forecast the S&P 500 will hit 2,375 at the end of this year (link), so we’re obviously bullish on stocks. Our case is based on fundamentals, specifically, the long-term link between stocks, earnings, interest rates, and the economy as a whole. However, just because we’re bullish, doesn’t mean we agree with every bullish argument that’s out there.

One theory making the rounds is that stocks do well in the third year of a president’s term. Superficially, the idea seems appealing. Since 1947 the average annual gain on the S&P 500 has been 7.5% (all returns quoted exclude dividends). But, the S&P is up an average of 16.1% in the 17 years that have been the third in the presidential cycle. Sounds good so far, right?

But in 13 of those 17 times, the president was eligible to run again in the next election, and all but one of them pursued re-election. (The exception was Kennedy. Yes, both Truman and Johnson initially pursued re-nomination in 1952 and 1968, respectively.)

So, given that Obama can’t run again, a better comparison would be the four times a sitting president couldn’t run again: 1959, 1987, 1999, and 2007. And, guess what? The average annual return in those years was 8.4%, the median was 6.0%, so no significant difference with the long-term 7.5% average.

Another theory making the rounds is that years that end in a “5” are very good for equities. Dating back to at least 1925, there isn’t a loser in the bunch and seven of those nine years generated gains of at least 20%.

We’d love to believe this has some larger meaning, but it’s little more than numerology; we’d put more weight on a horoscope. Every year ends in one of ten different numbers, so when looking back, just through random chance, there are bound to be some that do well for a while and others that do poorly. Coincidence, that’s all it is.

Equities have done well in years ending with a “5” for fundamental reasons, not magic. Massive tax rate cuts and lower government spending led to a long bull market that included 1925. After massive declines in 1929-32, the mid-depression rebound included 1935. In 1945, we won a little thing called World War II. Long bull markets were underway in 1955, 1985 and 1995. And then, a tight Fed caused the 1973-74 crash, while an easy Fed caused a 1975 rebound.

Remember the Super Bowl indicator? When old NFL teams win, “buy” and when old AFL teams win, “sell.” It worked until the late 1990s, when Denver (AFL) was winning Super Bowls, yet stocks soared. Or the Hindenburg Omen – a technical indicator signaling stock market crashes – which has been triggered multiple times in the past several years.

Correlation isn’t causation, but in a world full of data, people will find lots of meaningless statistical relationships that they become convinced have meaning. Don’t forget the statistician who drowned crossing a river with an average depth of just 2 feet. So let’s focus on fundamentals, instead, and right now they look good, whether the year ends in five, or not.

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Posted on Monday, January 12, 2015 @ 9:29 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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