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   Brian Wesbury
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  The Consumer Price Index Increased 0.1% in September
Posted Under: CPI • Data Watch • Inflation

 
Implications: Consumer prices increased a modest 0.1% in September as the Fed looks to stay on track to finish quantitative easing at the end of next week. Consumer prices are up only 1.7% in the past year and one of the key reasons is America’s booming energy production and, as a result, lower world oil prices. Energy prices declined for a third consecutive month in September and are down 0.6% from a year ago. Given the sharp drop in oil prices in the first half of October, look for more of the same in next month’s report. However, there are sectors where inflation is higher. Food and beverage prices are up at a 3.7% annual rate in the past three months and up 2.9% in the past year. So if you only use the supermarket to gauge inflation, we can understand thinking the headline reports are too low, that “true” inflation is higher. In addition, housing costs are going up. Owners’ equivalent rent, which makes up about ¼ of the overall CPI, rose 0.2% in September, is up 2.7% in the past year, and will be a key source of any acceleration in inflation in the year ahead. The worst news in today’s report was that “real” (inflation-adjusted) average hourly earnings declined 0.2% in September. But these earnings are still up 0.3% from a year ago and workers are also adding to their purchasing power because of more jobs and more hours worked. Plugging today’s CPI data into our models suggests the Fed’s preferred measure of inflation, the PCE deflator, probably rose 0.1% in September. If so, it would be up 1.5% from a year ago, still below the Fed’s target of 2%. We expect this measure to eventually hit and cross the 2% target, but given the bonanza from fracking and horizontal drilling, not until next year.

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Posted on Wednesday, October 22, 2014 @ 10:13 AM • Post Link Share: 
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  Existing Home Sales Rose 2.4% in September
Posted Under: Data Watch • Home Sales • Housing

 
Implications: Existing home sales look like they’re getting some of their mojo back. Sales increased 2.4% in September, have risen in five of the last six months, and are now the highest in a year. Although overall sales are still down 1.7% from that year-ago level, this masks a huge change in the composition of existing home purchases that bodes well for the future. Distressed homes (foreclosures and short sales) now account for only 10% of sales, down from 14% a year ago. All-cash buyers are now 24% of sales versus 33% a year ago. As a result, non-cash sales (where the buyer uses a mortgage loan) are up 11.5% since last September. So, even though tight credit continues to suppress sales, we are seeing early signs of an easing in mortgage credit, which suggests overall sales will climb in the year ahead. Another reason for the tepid recovery so far in existing home sales is a lack of inventory. Inventories are up 6% from a year ago, but down the past two months. In the year ahead, we expect higher home prices to bring more homes on the market, which should help generate additional sales. Either way, whether existing home sales are up or down, it’s important to remember that these data, by themselves, should not change anyone’s impression about the overall economy. Existing home sales contribute almost zero to GDP. Look for better sales in the months ahead. But, unless lenders dramatically loosen standards, the increases in sales will remain tame by historical standards.

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Posted on Tuesday, October 21, 2014 @ 11:40 AM • Post Link Share: 
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  Q3 Real GDP Still Looks Solid
Posted Under: Autos • GDP • Government • Housing • Retail Sales • Trade • Spending
The current recovery started in mid-2009. Since then, real GDP has grown at a 2.2% annual rate (what we have called a Plow Horse Economy). Now, despite a negative first quarter (caused by weather and inventories), the economy is picking up some speed. It’s not a race horse, yet, but we expect 2.5% to 3% real GDP growth, on average, in the year ahead.

The main reason for faster growth is that government spending as a percent of GDP is falling, down to 20.3% of GDP in Fiscal Year 2014, the lowest since 2008, and down substantially from the peak of 24.4% in 2009. Don’t get us wrong, government is still a drag on the economy, just less of one. The Sequester (1/2 of which still stands), an end to extended unemployment benefits, and tapering by the Fed are all signals that the tide may have turned.

Smaller government means a bigger and more vibrant private sector. The unemployment rate fell to 5.9% last month and initial claims for jobless benefits plummeted to 264,000 last week, the lowest since 2000. The labor market is still far from its full potential, but layoffs are few and far between.

Some worry that Ebola is a Black Swan. We aren’t physicians or experts on pandemics. But, Thomas Duncan, the Liberian patient who passed away in Dallas, was admitted into a Dallas hospital on September 28th, twenty-two (22) days ago. Since then, the only domestically-contracted cases of Ebola were two nurses who had immediate medical contact with Mr. Duncan. Not his family, not those who rode on the plane with him, not anyone else who he met while in the US.

It’s the fundamentals that we think we are qualified to speak on and next week we get the initial government report on real GDP in the third quarter. After a 4.6% growth rate in Q2, we expect real GDP to rise at a 2.9% annual growth rate in Q3.

Below is our “add-em-up” forecast for Q3 real GDP.

Consumption: Auto sales increased at a 6% annual rate in Q3 and “real” (inflation-adjusted) retail sales outside the auto sector grew at a 2% rate. Services make up about 2/3 of personal consumption and those appear to be up at about a 1% rate. As a result, it looks like real personal consumption of goods and services combined, grew at a 1.9% annual rate in Q3, contributing 1.3 points to the real GDP growth rate (1.9 times the consumption share of GDP, which is 68%, equals 1.3).

Business Investment: Business equipment investment looks like it grew 12% at an annual rate in Q3. Commercial construction looks like it grew at a healthy 3.4% rate. Factoring in R&D suggests overall business investment grew at a 7% rate, which should add 0.9 points to the real GDP growth rate (7.2 times the 13% business investment share of GDP equals 0.9).

Home Building: A 6% annualized gain in home building in Q3 will add about 0.2 points to real GDP (6 times the home building share of GDP, which is 3%, equals 0.2).

Government: Public construction projects, which had been slowed by the weather in Q1 and rebounded sharply in Q2, continued to increase in Q3. In addition, military spending grew at its fastest pace since 2008 during the third quarter. As a result, it looks like real government purchases grew at a 1.6% annual rate in Q3, which should add 0.3 percentage points to real GDP growth (1.6 times the government purchase share of GDP, which is 18%, equals 0.3).

Trade: At this point, the government only has trade data through August, but what it does have looks very good for US GDP. The “real” trade deficit in goods has gotten smaller in Q3. As a result, we’re forecasting that net exports add 1.0 points to the real GDP growth rate.

Inventories: After a weather-related lull in Q1, companies built inventories at a very rapid pace in Q2, correctly anticipating faster economic growth ahead. Now companies are still building inventories, but not at quite the same rapid pace. As a result, it looks like inventories will subtract 0.8 points from the real GDP growth rate in Q3.

Earlier this year some analysts saw the drop in Q1 real GDP as a sign that the US recovery was done. Instead, we told you to get ready for a rebound in Q2. That’s exactly what we got. One day, the expansion will come to an end, but we don’t see this anytime soon. Even with tapering, monetary policy is still loose, and government is shrinking relative to GDP, giving the private sector more room to grow. Get ready for more respectable growth ahead.

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Posted on Monday, October 20, 2014 @ 10:10 AM • Post Link Share: 
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  Housing Starts Rose 6.3% in September
Posted Under: Data Watch • Home Starts • Housing

 
Implications: Home building has been very volatile over the past few months but the underlying trend remains upward and we expect that to continue. Housing starts jumped 20.8% in July, then dropped 12.8% in August, and now rebounded 6.3% in September. Some look at this volatility as weakness. We don’t. The 12-month moving average is now at the highest level since September 2008. The total number of homes under construction, (started, but not yet finished) increased 0.4% in September and are up 19.5% versus a year ago. No wonder residential construction jobs are up 129,000 in the past year. Multi-family construction is taking the clear lead in the housing recovery. Single-family starts have been in a tight range for the past two years, while the trend in multi-family units has been up steeply. In the past year, 36% of all housing starts have been for multi-unit buildings, the most since the mid-1980s, when the last wave of Baby Boomers was leaving college. From a direct GDP perspective, the construction of multi-family homes adds less, per unit, to the economy than single-family homes. However, home building is still a positive for real GDP growth and we expect that trend to continue. Based on population growth and “scrappage,” housing starts will rise to about 1.5 million units per year over the next couple of years.

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Posted on Friday, October 17, 2014 @ 10:49 AM • Post Link Share: 
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  Industrial Production Increased 1.0% in September
Posted Under: Data Watch • Industrial Production - Cap Utilization

 
Implications: Despite recent turmoil in the equity markets, lots of good news on the economy this morning. Hold off on industrial production for a moment. Initial claims for unemployment insurance dropped 23,000 last week to 264,000, the lowest level since 2000. Companies might not be hiring like they would be with a better set of government policies and faster economic growth, but it looks like they’ve carefully hired the workers they want and are not letting go. Continuing claims increased 7,000 to 2.39 million. Plugging these figures into our payroll models suggests an October gain of about 255,000, another solid month. Now back to the factory sector, where industrial production soared 1% in September, easily beating consensus expectations. About half of the gain was due to strength at utilities and mines, which are very volatile from month to month, but manufacturing output grew 0.5% despite a 1.4% drop in the auto sector. One measure of the underlying trend is the non-auto manufacturing sector, which climbed 0.6% in September, has not dropped in any month since January (remember the brutal winter weather?), and is up 3.5% from a year ago. We expect continued growth in the industrial sector. The housing recovery is still young and both businesses and consumers are in a financial position to ramp up investment and the consumption of big-ticket items, like appliances. Capacity utilization rose to 79.3% in September, which is higher than the average of 78.7% over the past twenty years. Further gains in production in the year ahead will push capacity use higher, which means companies will have an increasing incentive to build out plants and equipment. In other manufacturing news this morning, the Philly Fed Index, which measures factory sentiment in that region, stood at a still solid 20.7 in October versus 22.5 in September. The only blemish on today’s economic news was the NAHB index, which measures sentiment among home builders. The index fell to 54 in October, reversing last month’s surge to 59. However, the drop this month simply brought the index back down to where it was, on average in July and August.

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Posted on Thursday, October 16, 2014 @ 12:07 PM • Post Link Share: 
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  Retail Sales Declined 0.3% in September
Posted Under: Data Watch • Retail Sales

 
Implications: After a very solid report out of the retail sector in August, consumers took a breather. Retail sales fell 0.3% in September, led by a decline in the very volatile auto sector which was expected. But even outside of the auto sector, retail sales were down 0.2%. Gas station sales were a large culprit, falling 0.8% in September as oil prices continue to drop. Prices at the pump on a national average are now down 4.5% from a year ago. The widespread use of fracking and horizontal drilling is making this possible, which means consumers can take the money they save on filling their tanks and spend it on other things. It’s important to remember that even in the best years retail sales still fall in 3 months out of the year, so the decline in September, especially coming on top of the very strong August report, is not something to worry about. Overall retail sales still remain up a very healthy 4.3% from a year ago. “Core” sales, which exclude autos, building materials and gas, were unchanged in September and were up at a 4.3% annual rate in Q3 versus the Q2 average. These sales are a key input into GDP calculations and once we include other spending (on services and durables), our expectation is that “real” (inflation-adjusted) consumer spending, goods and services combined, grew at a 2% annual rate in Q3. We expect consumer spending to accelerate in the year ahead, as lower unemployment means an acceleration in income gains at the same time that consumer debt service is hovering near multiple-decade lows. In other news this morning, the Empire State index, a measure of manufacturing sentiment in New York, declined to +6.2 in October versus +27.5 in September.

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Posted on Wednesday, October 15, 2014 @ 12:23 PM • Post Link Share: 
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  The Producer Price Index Declined 0.1% in September
Posted Under: Data Watch • PPI

 
Implications: Producer prices declined 0.1% in September, the first decline for the index in over a year. Inflation is still in a long-term rising trend, but that process is going to be gradual, with many stops and starts along the way. As we noted in last week’s Monday Morning Outlook, booming energy production is a key reason why headline inflation hasn’t moved up more quickly. Producer energy prices fell 0.7% in September and are down 0.7% from a year ago, a testament to fracking and horizontal drilling. Largely as a result, producer prices declined in September and are up a modest 1.6% from a year ago. Still, through the first nine months of 2014, producer prices are up at a 1.8% annual rate, well above the 1.1% rate over the same period in 2013. Prices further back in the production pipeline (intermediate demand) do not yet confirm a continued acceleration in inflation. Prices for intermediate processed goods are down at a 0.2% annual rate in the past three months, well below the 1.2% pace over the past year. Prices for unprocessed goods are down at a 20.0% annual rate in the past three months. But intermediate demand prices are highly volatile and we expect prices to move higher over the coming months. Taken as a whole, the trend in producer price inflation continues to move towards 2%, suggesting the Fed should continue on the path of ending quantitative easing later this month. The problems that ail the economy are fiscal and regulatory in nature; continuing to add more excess reserves to the banking system is not going to boost economic growth. Loose monetary policy will eventually gain traction.

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Posted on Wednesday, October 15, 2014 @ 12:13 PM • Post Link Share: 
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  Check Out Brian Wesbury's Latest Piece in the Wall St. Journal
Posted Under: Europe • GDP • Government • Spending
Behind the Global Growth Slowdown

‘Austerity’ isn’t the problem. Eurozone governments are spending more now as a share of GDP than before the crisis.

Global stock markets are falling, and most of the blame is placed on Europe. German factory orders fell 5.7% in August, real GDP is stagnant or falling in many European countries, Standard & Poor’s has downgraded France to AA from AA+, and the International Monetary Fund and the Organization for Economic Co-operation and Development are reducing growth estimates.

All of this is setting off a cascade of fear and pundits are begging governments to “do something.” Yet this is not like the panic of 2008, and the slowdown in Europe is not new news; instead it is the “old normal.”

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Posted on Wednesday, October 15, 2014 @ 8:51 AM • Post Link Share: 
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  Timing The Market Doesn’t Work
Posted Under: Bullish • Europe • Markets • Monday Morning Outlook • Stocks
The stock market doesn’t owe anything to anyone. If you missed the bottom in 2009, no one owes you another chance to get in when stocks are that cheap. We may never see such historic lows again.

And even if markets did give us another chance, most investors would probably miss it all over again because they would be in such a panic – just like in 2009. Breathless, breaking-news would provide so much instantaneous, and conflicting, analysis of technical indicators, like “support levels,” “trading-volume,” “200-day moving averages,” and “new highs and lows” that investors wouldn’t be able to act with any confidence.

Fundamental analysts would talk of a “downward spiral in the wealth effect,” “a new normal,” “peak earnings,” “political gridlock,” or, “Fed inaction.” With this back-drop investors would expect even more declines.

But, even after the events of recent weeks, an investor that bought the S&P 500 on December 1, 2007, and held, would have made 6% per year (including dividends) through today. More recently, even after another 1.5% drop last Friday, the S&P 500 was 12.6% above its level of a year ago (14.9%, with dividends). How many people think of 2007, or last October, as a buying opportunity?
Believe it or not, we would argue that today is what a buying opportunity looks like. When stocks were rising just a few months ago, lots of investors were upset they hadn’t gone “long” in 2013. Now, with markets falling, and equity prices hovering near those same levels, they hesitate to buy.

Think about all the reasons for the market drop. One fear is a slowdown in Europe. But Europe has been a very sickly plow horse for several years, so much so that many serious economists were proposing a break-up of the Euro.

We’re not forecasting an economic boom in Europe, but with money easy, a collapse is not in the cards either. More like a slow motion continuation of very weak real growth as Euro-sclerosis continues.

Another fear is a slowdown in China. But goods exports to China are only 0.7% of US GDP, about half of what we export to Mexico, and if China gets in trouble our imports from China will cost less. When China is importing much more from the US, a slowdown there will be more significant. But for now, the concern is overdone.

Yet another fear is that “Abe-nomics” isn’t working in Japan. For the record, it won’t work. Free-markets, not government, save economies. Japan has been in decline for the past two decades, but the US has still grown. In other words, it’s nothing new.

The strangest fear is that a strong US dollar will hurt the market. But a strong dollar in the 1980s and 1990s coincided with a bull market, not a bust. King Dollar is good for investors.

We are not saying equities will go up today, or tomorrow, or even this week. Heck, for all we know the long-awaited correction may finally be upon us.

But, the Fed is not tight, trade protectionism is not in the wind, tax rates are not headed higher, and big government is checked by divided government. Profits are still rising, the US economy is accelerating, and our models show that equities are still cheap. It may not be the “mother of all buying opportunities,” but it ain’t the end of equities, either.

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Posted on Monday, October 13, 2014 @ 11:45 AM • Post Link Share: 
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  Inflation: What Inflation?
Posted Under: GDP • Gold • Government • Inflation • Monday Morning Outlook • Fed Reserve • Interest Rates
Who hasn’t heard forecasts of “Hyperinflation?” They’ve been all over the web and TV ever since the Federal Reserve started a huge expansion in its balance sheet, called Quantitative Easing, back in 2008. Among other things, these forecasts called for a dollar collapse, dire problems for the banking system and 1970s, or Weimar Republic-like, inflation.

We have consistently disagreed with these forecasts. Yes, the monetary base has expanded rapidly. But banks have held the vast majority of this QE as excess reserves. These reserves just sit at the Fed, earning 25 basis points, but other than that, gathering electronic dust. They haven’t boosted inflation as feared. And we don’t believe they are responsible for economic growth, or the rising stock market, either.

In economic terms, the velocity of money collapsed in the Panic of 2008 and, although there are some recent signs of a revival, it’s nowhere near bouncing back to where it was before the Panic. What QE has accomplished is reducing the money multiplier in a significant way.

To be clear, even though we never expected hyper-inflation, we did expect inflation to rise more than it actually has over the past few years. We thought inflation would be at least 3% by now, maybe even 4%. And yet, the Consumer Price Index is up only 1.7% in the past year while the Fed’s preferred measure, the PCE deflator, is up only 1.5%.

We still don’t expect inflation to stay this low, but for a number of reasons, we now expect any move higher over the next few years to be very gradual, maybe half a point per year. This isn’t enough, all by itself, to get the Fed to move rates much higher than it currently projects.

Here’s why we expect only a gradual rise in inflation.

First, the Fed is fully prepared to increase the interest rate it pays on excess reserves. And while this doesn’t guarantee the money supply won’t expand, the Fed is also ready to use higher capital standards and Chinese-like bank rules to hold back lending, which will contain money growth and loans.

Second, real economic growth should pick up over the next couple of years to close to 3% versus the average of roughly 2% growth per year since the recovery started in 2009. This extra growth could help soak up some of the loose monetary policy.

Third, and lately the most important reason for a very gradual slog higher in inflation, is the huge headwind coming from the energy sector, where the combination of horizontal drilling and fracking is transforming production. Supply is simply booming and prices are falling. Back in 2005, the US was importing ten times as much oil (petroleum and petroleum products) as it was exporting; now that ratio is down to 1.9 and headed lower. In the next few years, the US could easily become a net exporter of petroleum.

These forces are creating disarray in OPEC. Saudi Arabia is willing to accept lower prices for oil, undercutting other oil exporters in the Middle East as well as Russia. West Texas Intermediate, which was $104/barrel in late June is now below $90/barrel, and probably has further to fall.

Gold is below $1,200/oz., a clear sign that inflationary fears are receding. We still think it has further to fall.

As a result, even though the Fed will start to raise short-term rates next year, the rate hikes will be gradual. We don’t expect 50 basis point hikes at any single meeting anytime soon. More likely, the Fed will raise rates at one meeting and then pause at the next, in an attempt to damp volatility.

In turn, long-term rates will work their way higher, but not by leaps and bounds. We expect both equities and the 10-year Treasury yield to move higher later this year. While we look for 10-year yields to end this year below 3%, we look for something like 3.5% by the end of 2015 and 4% in 2016.

Most important for investors, is to understand that a 4% yield on the 10-year Treasury (the equivalent of a 25 price-earnings ratio) is not a headwind for the stock market. Based on next year’s forecasted earnings, the S&P 500 P-E is less than 15 today. That leaves plenty of room for equities to rally.

And even if the Treasury yield goes above 4%, that’s OK for equities as long as interest rates rise primarily because of improvement in real GDP growth rather than inflation.

The bottom line is that our outlook for inflation has shifted downward, but not dramatically. We still expect more inflation, just not enough to cause serious concern for at least the next couple of years. This is good news for the stock market and the economy.

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Posted on Monday, October 06, 2014 @ 10:33 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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