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   Brian Wesbury
Chief Economist
 
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   Bob Stein
Deputy Chief Economist
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  M2 and C&I Loan Growth
Posted Under: Government • Fed Reserve

 

Source: St. Louis Federal Reserve FRED Database

Posted on Monday, August 29, 2016 @ 11:29 AM • Post Link Share: 
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  Bull Market Has Further to Run
Posted Under: Bullish • Government • Markets • Monday Morning Outlook • Interest Rates • Stocks

Now, the pessimists can't stop talking about profits.  S&P 500 reported earnings are down 3.4% and the government's economy-wide measure of corporate earnings are down 4.9% from a year ago. 

In hindsight, corporate profits peaked in 2014, just like they did in 1978, 1988, 1997, and 2006.  So, they say, a recession and bear market are on the way, just like the ones that followed those peaks in profits as well.  It's time to sell, again!        

One problem with this theory is that it assumes the decline in profits is permanent.  But profits have been hurt by the downdraft of energy prices, which crushed profits in that sector, while also hurting other related businesses.  However, energy prices are rebounding while profits outside of energy are accelerating.        

In addition, the ingredients for a recession are not yet there.  Monetary policy is not tight, consumer and corporate balance sheets are healthy, and the recovery in home building has much further to go.

We use a Capitalized Profits Model (the government's measure of profits divided by interest rates) to measure fair value for stocks.  A traditional measure using a 10-year Treasury yield of 1.62% suggests the S&P 500 is massively undervalued.  Using a 10-year yield of 3.5% suggests fair value for the S&P 500 is 2667, which is 23% higher than Friday's close.  Even a 4% Treasury yield suggests fair value is 2333.  We'd have to use a 10-year yield of 4.3% to conclude that the S&P 500 was already at fair value and no one expects that! 

And that's assuming no rebound in profits at all.   

Alternative versions of the cap profits model using corporate bond yields suggest fair value for the S&P of around 3000; around 2900 if we use the Baa yield, 3200 if we use the Aaa.  

None of this means the stock market must go up today, or this week, or even in the year ahead.  But it does bolster our case for a continuation of the bull market.

We have been forecasting 2375 for the S&P at year end.  At the bottom of the correction early this year, we stuck to our bullish forecast.  As of Friday's close, we needed a 9.5% gain to get there.  We only have four months to go, but that's not wildly optimistic by historical standards.
  
We're looking for a strong finish to 2016 as many of the investors who are now pessimistic realize their fears aren't justified by reality.

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

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Posted on Monday, August 29, 2016 @ 11:12 AM • Post Link Share: 
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  Personal Income Increased 0.4% in July
Posted Under: Data Watch • PIC

 

Implications: No signs of a recession here, not even close. Consumer spending grew 0.3% in July on top of large gains over the past three months.  This is not what you'd expect to see if consumers felt nervous about the economy.  Over the past four months, spending is up at a 7% annual rate, the fastest pace since 2005.  "Real" (inflation-adjusted) consumer spending grew 0.3% in July and is up 3% in the past year.  Meanwhile personal income grew 0.4% in July, and, including revisions to prior months, was up a whopping 0.9%. The gain was led by a 0.6% increase in private-sector wages and salaries.  As the labor market keeps tightening, look for income growth to continue to accelerate.  The one consistent dark cloud in these reports has been the data on government redistribution.  While unemployment compensation is the lowest since 2007, overall government transfers to persons are up 3.5% in the past year.  Before the Panic of 2008, government transfers – Medicare, Medicaid, Social Security, disability, welfare, food stamps, and unemployment insurance – were roughly 14% of income.  In early 2010, they peaked at 18.5%.  Now they're around 17%, but not falling any further.  Redistribution hurts growth because it shifts resources away from productive ventures and, among those getting the transfers, weakens work incentives.  That's why we have a Plow Horse economy, not a Race Horse economy.  On the inflation front, the PCE deflator, the Fed's favorite measure, was unchanged in July.  Although it's only up 0.8% from a year ago, it was up only 0.4% in the year ending in July 2015, so inflation is accelerating.  Meanwhile, the "core" PCE deflator, which excludes food and energy, is up 1.6% from a year ago.  That's also below the Fed's 2% inflation target, but we expect continued acceleration in the year-to-year change in the months ahead.  Together with continued employment gains, these data support the case for the Fed to hike rates again in 2016, hopefully in September.

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Posted on Monday, August 29, 2016 @ 10:56 AM • Post Link Share: 
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  Yellen Will Lift Rates
Posted Under: Government • Video • Fed Reserve • Interest Rates • Wesbury 101
Posted on Friday, August 26, 2016 @ 1:29 PM • Post Link Share: 
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  Real GDP was Revised to a 1.1% Annual Growth Rate in Q2
Posted Under: Data Watch • GDP

 

Implications:  Real GDP was revised slightly lower for the second quarter but the "mix" of growth was better and implies faster economic growth ahead.  Today's second reading of GDP Q2 showed real economic growth at a 1.1% annual rate, matching consensus expectations, versus the 1.2% reading a month ago.  However, the downward revision was mainly due to net exports, government purchases, and inventories, none of which can be relied on for long-term economic growth.  Consumer spending and business investment in R&D were revised higher.  In fact, consumer spending grew at the fastest pace since late 2014, a sign consumers are growing more confident about the future.  As a result, "core" GDP, a measure we like to follow that strips out these transitory factors, was revised to a 3.0% annual rate in Q2 versus a prior report of 2.7%.  Core GDP is up at a 2.9% annual rate in the past two years.  Nominal GDP growth (real growth plus inflation) was revised to 3.4% annual rate in Q2 from a prior estimate of 3.5%.  Nominal GDP is up 2.4% in the past year and up at a 3.3% annual rate in the past two years.  All of these figures suggest the economy can sustain higher short-term interest rates and the Fed is already behind the curve.  Look for the Fed to raise rates at least once this year, with the odds of two rate hikes greater than the odds of none at all.  Also in today's GDP report was our first glimpse at economy-wide corporate profits in the second quarter.  Profits declined 1.2% in Q2 and are down 4.9% versus a year ago, putting them at essentially the same level as early 2012.  Although some investors will see this as a reason to sell equities, we do not.  Profits are artificially low right now given weakness in the energy sector.  But energy prices appear to have bottomed out already, so profits will soon rebound as well.  In addition, our capitalized profits models suggest that even at higher interest rates (such as a 10-year Treasury yield of 3.5% - 4%), stocks are relatively cheap.  The last several years have seen a non-stop battle between entrepreneurs and innovators trying to boost growth while a bigger government suppresses it.  That's why we have a Plow Horse economy instead of a Race Horse economy like in the mid-1980s and late-1990s.  Look for more Plow Horse growth ahead, and a continuation of the bull market in stocks.  

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Posted on Friday, August 26, 2016 @ 10:30 AM • Post Link Share: 
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  New Orders for Durable Goods Increased 4.4% in July
Posted Under: Data Watch • Durable Goods

 

Implications: After showing the largest single-month decline in nearly two years in June, new orders for durable goods made it all back in July.  That's not to say that orders are booming - new orders are down 3.3% in the past year – but the decline is largely the result of efficiency improvements and falling prices for technology (the device you are reading this on now costs a fraction of what equivalent technology would have cost just years ago), not signs of looming recession.  Aircraft led orders higher, as Boeing reported 73 new orders in July, compared to just twelve orders in June.  But even excluding transportation, durable goods orders rose 1.5% in July, led by orders for capital goods (think machinery and equipment for the farm, construction, and power generation industries), and computers and electronic products.  In particular, machinery orders rose 1.6%, which may be a sign of improvement in the energy sector.  (Next week's factory orders report will have more details.)  Orders have been relatively flat in 2016, in contrast to the continued gains in employment, rising wages, a pick-up in inflation, and positive readings from the ISM for both the manufacturing and service sectors.  What could be causing the divergence in readings?  First, companies are becoming more efficient, making better use out of existing equipment.  Second, companies may be cautious with spending due to the slowdown in global growth and uncertainty regarding international operations.  If that's the case, expect orders to pick up in the months ahead as the dust settles and companies feel more confidence building for the future.  The job market shows that companies are planning for growth.  Shipments of "core" capital goods - non-defense, excluding aircraft – declined 0.4% in July, and if unchanged in August and September, will be a drag on Q3 GDP growth.  But with the rise in core capital goods orders over the last two months, expect shipments to follow suit in moving higher.  In other words, business investment should pick up in the months ahead.  In addition, consumer purchasing power is growing with more jobs and higher incomes, while debt ratios remain very low, leaving room for an upswing in big-ticket spending.  On the employment front, initial unemployment claims declined 1,000 last week to 261,000, the 77th consecutive week below 300,000.  Meanwhile, continuing claims fell 30,000 to 2.145 million.  Plugging these figures into our models suggests payroll growth of about 150,000-160,000 in August.

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Posted on Thursday, August 25, 2016 @ 11:03 AM • Post Link Share: 
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  Existing Home Sales Declined 3.2% in July
Posted Under: Data Watch • Home Sales • Housing

 

Implications:  After four consecutive months of steady growth, existing home sales took a breather in July, as supply constraints and high prices continue to hamper buyers.  Sales of previously owned homes fell 3.2% in July to a 5.39 million annual rate and are now down 1.6% from a year ago.  Many pessimistic analysts are likely to point out that this is the first year-over-year drop since November 2015, but this is a reflection of the surge in existing home sales last June/July, not the beginning of the end for the housing market.  Housing is volatile from month to month, and we think the broader trend will continue to be upward, but there are still some headwinds.  Tight supply and rising prices continue to hold back sales.  Even though inventories rose 0.9% in July, they have now fallen for fourteen consecutive months on a year-over-year basis.  Further, the months' supply of existing homes – how long it would take to sell the current inventory at the most recent selling pace – is only 4.7 months.  According to the National Association of Realtors® (NAR), anything less than 5.0 months is considered tight supply.  The good news is that demand was so strong that 47% of properties in July sold in less than a month, pointing to further interest from buyers in the months ahead.  However, higher demand from the summer selling season also helped push the median price for an existing home up 5.3% versus a year ago, the 53rd month in a row of year-over-year gains.  While this may temporarily price some lower-end buyers out of the market, it should help alleviate some of the supply constraints as "on the fence" sellers take advantage of higher prices and trade-up to a new home, bringing more existing properties onto the market as well.   In other housing news this morning, the FHFA index, which measures prices for homes financed with conforming mortgages, increased 0.2% in June and is up 5.6% from a year ago.  Another sign that supply remains limited and home builders have room to keep ramping up construction.

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Posted on Wednesday, August 24, 2016 @ 11:02 AM • Post Link Share: 
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  New Single-Family Home Sales Increased 12.4% in July
Posted Under: Data Watch • Home Sales • Housing

 

Implications:  Look out above!  New home sales boomed in July, easily crushing the most optimistic forecast from any economics group.  Sales rose 12.4% for the month to the fastest pace since 2007 and are now up 31.3% versus a year ago.  If anything, builders are falling behind the demand for new homes.  The inventory of unsold homes fell 7,000 in July and remains very low by historical standards (see chart to right).  The months' supply of homes (how long it would take to sell the entire inventory of homes) fell to only 4.3 in July.  To put this in perspective, that's lower than the average for any calendar year since 2004.  This means homebuilders still have plenty of room to increase both construction and inventories.  It's important to remember that home sales data are very volatile from month to month, so let's not get too carried away, but we think there are a few reasons to expect housing to remain a positive factor for the economy.  First, employment gains continue and wage growth is accelerating.  Second, the mortgage market is starting to thaw.  Third, the homeownership rate remains depressed as a larger share of the population is renting, leaving plenty of potential buyers as conditions continue to improve.  Unlike single-family homes which are counted in the new home sales data, multi-family homes (think condos in cities) are not counted.  So a shift back toward single family units will also serve to push reported sales higher.  Even though the median sales price of a new home is now down 0.5% from last year, this is likely due to a shift in the "mix" of homes sold, as other measures of home prices show continued gains.  On the manufacturing front, the Richmond Fed index, a measure of mid-Atlantic factory sentiment fell to -11 in August from +10 in July, signaling that activity in the factory sector will continue to be volatile.  That's what we should expect in a Plow Horse Economy.

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Posted on Tuesday, August 23, 2016 @ 11:29 AM • Post Link Share: 
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  Shut Out the Pessimists
Posted Under: Bullish • Employment • Housing • Monday Morning Outlook

You know the economy is getting better when the pessimists' theories on economic doom have been so wrong for so long they have to start recycling the old ones.

Right after the crisis a wave of mortgage "re-sets" was supposed to cause a double dip recession.  The idea was that many of the mortgages taken out in the housing boom, particularly interest-only mortgages,  had to re-set at higher interest rates or require principal payments, which would eat up workers' meager earnings, in turn reducing consumer spending and putting us back in recession.      

Since that gloom never materialized, some analysts are at it again.  Now, home equity lines of credit (HELOCs) are going to cause the recession.  But, just like the first time this theory appeared, a little number-crunching shows just how small the problem is relative to the size of the economy.  

US consumers have a little less than $500 billion in outstanding HELOCs right now, according to the NY Fed.  So let's make the outrageously pessimistic assumption that ALL of them re-set overnight and annual payments on these loans have to double, from about $25 billion per year (5% of $500 billion) to $50 billion per year.  That extra $25 billion is only 0.2% of annual consumer spending.  In other words, there's nothing to this theory.        

The other recession theory grabbing attention is about a tiny portion of the federal budget that is supposedly signaling that all the other bullish reports on the job market are missing the boat.  Tax revenue from federal unemployment taxes (or FUTA, a levy on businesses that funds the unemployment insurance program) totaled only $47.2 billion in the past year, versus $66.6 billion back in Fiscal Year 2012. That decline shows that the quality of jobs is heading down and that we are either headed into a recession or there already.

Anyone who makes this argument ought to have his economic credentials revoked, because they clearly don't know how unemployment insurance works.  When the US enters a recession, some states end up borrowing money from the federal government, which they repay when the economy starts to heal.  Those repayments come in the form of states temporarily getting a smaller share of unemployment tax revenue and the federal government getting a larger share, which is exactly what happened in 2010-2012.  Once the repayments are done, states go back to taking more and the federal government takes less.

This pattern is nothing new.  Federal unemployment tax revenue surged after the 1981-82 recession, peaking in 1984-85.  Stagnation in FUTA receipts after 1985 had nothing to do with slow job growth.  The US added 12.4 million jobs from mid-1985 through mid-1990.  These receipts also surged after the 1990-91 recession, peaking in 1995.  We then added 14.5 million jobs in the next five years.  In other words, a peak in FUTA early in an expansion is completely normal.

But the worst part of the analysis is the assertion that federal payroll tax revenue is falling.  That's completely untrue.  Federal payroll taxes (like Social Security and Medicare) have been $1.1 trillion in the past twelve months, a record high on both an overall and inflation-adjusted basis.  And that's true whether you adjust by using the overall consumer price index or the "core" index, which has grown faster because it excludes food and energy.       

Even Brexit is having trouble causing the British recession so many feared.  British jobless claims fell in July, after Brexit, while British retail sales spiked higher.  So much for the end of the world.

Look, someday a recession is going to happen.  But with monetary policy loose, tax rates relatively low, and free trade still holding up, it's not happening anytime soon.  Smart investors need to focus on the truth and shut out the pessimists.

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

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Posted on Monday, August 22, 2016 @ 11:22 AM • Post Link Share: 
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  M2 and C&! Loan Growth
Posted Under: Government • Fed Reserve

 

Source: St. Louis Federal Reserve FRED Database

Posted on Monday, August 22, 2016 @ 7:47 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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