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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  This is a Correction, Not a Recession
Posted Under: Bullish • CPI • Employment • Inflation • Research Reports • Retail Sales

With the S&P 500 down 10.5% through February 11th,questions about the health of the economy seem to intensify daily. The concernstypically go something like this:  If thefinancial markets are a predictor of where the economy is headed, has the plowhorse finally lost traction?  Is arecession looming?  

Let's put this to the test.

An old joke says the stock market has predicted 19 of thelast five recessions.  Stocks don'talways lead the economy, and earnings clearly don't show that things areawful.  With 375 S&P 500 companieshaving reported Q4 earnings, 70.7% have beat estimates, although earnings aredown 5% from a year ago it's all due to just one sector, energy. Of the 375companies that have reported, only 23 of them have been energy. Excluding those23 energy companies, earnings for the other 352 companies are up 1.0% from a year ago.  So, for those claiming the market drop is dueto declining earnings, it seems more like an energy story than an economic one.It's plow horse earnings growth outside of energy, but it's earnings growth.

Corrections are designed to scare the snot out of people.This is one of those corrections, and if you read my email inbox or watch,read, or listen to the financial press, it's working.

But this is an emotional correction, not a fundamentalone.  The US is not entering arecession.  Let's look at a few morefacts:

Retail sales rose 0.2% in January, beating consensusexpectations and were up 0.4% including revisions to prior months.  This is the third consecutive month of gains,which is particularly impressive considering gas station sales plummeted 3.1%in January, due to lower prices at the pump. Again more of an energy story thanan economic one.  Excluding gas stations,retail sales have risen seven months in a row and are up 4.5% from a year ago.

In 2015, hourly earnings rose 2.7%, acceleration from thesub-2.0% trend seen over the previous two years. At the same time, initialclaims have been below 300,000 for 49 consecutive weeks. Private payrolls grewat a 216,000 monthly rate in 2015, and the unemployment rate is down to 4.9%.And no, this is not a "part-time" recovery. In the past twelve months,full-time employment has grown by 2.5 million jobs while part-time employmentis down 120 thousand! With 5.6 million unfilled jobs (the second highest onrecord), and quit rates at the highest levels of the recovery, there should belittle question why they Fed started to hike rates in December.

What about inflation? Oil has plummeted and we must be neardeflation if we aren't there already, Right?!? But, "core" inflation, which excludes the volatile food and energycomponents was up 2.1% year-to-year in December, very close to the Fed's 2%inflation target. Even with the huge drop in oil, the overall index is still up0.7% in the past twelve months. And the consumer price index is about to dropoff the huge declines from early last year when oil plummeted.  If the consensus is right and a 0.1% dropoccurred in December, year-to-year CPI will rise to 1.3% in January, from just0.7% in December.

In other words we don't have deflation in the US.

You can tell there is massively negative emotion in themarket because everything is bad.  Lowoil prices are bad.  Strong car sales arebad - by the way, autos sold at a record pace in 2015 and continued to rise inJanuary.  When the Fed dot plot forecastfour rate hikes in 2016, that was "bad."  And now it's "bad" that the Fed mayhold off on another rate hike for a while.

Whether the Fed continues to raise rates or folds to marketconcerns and holds off, the Fed won't be tight any time soon. Commercial andindustrial loans grew 13.6% at an annual rate in past 13 weeks, that doesn'tsound like evidence of tight monetary policy to us.

What we focus on are the Four Pillars of Prosperity:Monetary Policy, Tax Policy, Trade Policy, and Spending & Regulation. Solet's see where those stand:

  1. Monetary Policy – As we mentioned above, the Fedis still easy and will be for the foreseeable future


  2. Tax Policy – If anything, tax policy is likelyto get better before it gets worse, but don't expect much until after theelections


  3. Trade Policy - The US is not going to becomeprotectionist


  4. Spending & Regulation – This is the onlyreal area of concern. Spending and regulation are too high, but spending isstill a smaller share of GDP than it was five years ago and the Supreme Courtjust blocked harmful EPA regulations.

To say it succinctly, the fundamentals of the economy showno evidence of recession.  And, out ofthe four potential threats, only one is moderately negative.

This is a correction, not a turning point for the stockmarket.  Our models, with stocks drivenby interest rates and corporate profits, not sentiment, suggest the market isstill significantly undervalued.

It's not often you get recession level prices when there isno recession.

Put money to work, don't run away.

BrianS. Wesbury - Chief Economist

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Posted on Friday, February 12, 2016 @ 11:42 AM • Post Link Share: 
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  Retail Sales Increased 0.2% in January
Posted Under: Data Watch • Retail Sales


Implications:  Despite all of the market negativity and fear of recession, actual hard data on the economy keep telling a different story. Retail sales rose 0.2% in January, beating consensus expectations andwere up 0.4% including revisions to prior months.  This is the third consecutive month of gains,which is particularly impressive considering gas station sales plummeted 3.1%in January, due to lower prices at the pump. Excluding gas stations, retail sales have risen seven months in a rowand are up 4.5% from a year ago. Weakness at gas stations isn't a bad thing. Lower gas prices giveconsumers more money in their pockets, which, in spite of a narrative to the contrary, they are spending.  Overallretail sales are up a 3.4% from a year ago. "Core" sales, which exclude autos, building materials, and gas stations(the most volatile sectors) rose 0.4% in January, were revised up for previousmonths, and are up 3.6% from a year ago. Plugging these data into our GDP models suggests real (inflation adjusted) consumer spending will be up at a 2.0 - 2.5% annual rate in Q1.  We still expect roughly 2.5 million more jobsin 2016 and wage gains are starting to accelerate, which will translate into further spending growth in the year ahead. In other words, the economy remains a Plow Horse, not a horse destined for the glue factory, like the fear mongers claim.  In other positive news, yesterday it was reported that new claims for unemployment insurance declined 16,000 last week to 269,000, the 49th consecutive week under 300,000.  Continuing claims declined 21,000 to 2.239 million.  It's early, but plugging these figures into our models suggests February payroll gains north of 200,000.  In other news today, import prices declined 1.1% in January and are down 6.2% from a year ago.  The drop is mostly from petroleum, but not all of it; import prices are down 3.1% from a year ago even excluding petroleum.  Export prices declined 0.8% in January and are down 5.7% from a year ago. In other words, trade prices are not showing any sign of inflation.  The last piece of economic news today was a 0.1% gain in business inventories in December. We're now tracking an annualized real GDP growth rate of 0.4% in Q4, as light downward revision from the original report of 0.7%, but we expect growth to accelerate in the 1st quarter.

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Posted on Friday, February 12, 2016 @ 9:58 AM • Post Link Share: 
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  Want Faster Growth? Put the Jockey on a Diet!
Posted Under: GDP • Government • Monday Morning Outlook • Spending
The number one reason the US has a Plow Horse economy rather than a Race Horse economy is the growth in the size and scope of the federal government, which sits like a grossly overweight jockey atop an otherwise healthy thoroughbred.

After being limited in the 1980s under President Reagan and then in the 1990s in President Clinton's first six years in office, it started creeping upward again.

At first, it didn't seem like a big deal. The economy was booming in the late 1990s, and so the increase in spending was hard to notice. From 1992 to 1998, discretionary spending – federal outlays that have to be approved every year – were up only 0.5% per year.

Yes, much of the spending restraint was due to the Peace Dividend after the demise of the Soviet Union. But social (or non-military) discretionary spending grew at only a 4% annual rate, which was slower than the 5.6% annual growth rate of nominal GDP (real GDP growth plus inflation). In other words, social spending was shrinking relative to the economy.

Then, the limits on the size of government gave way. Maybe it was an inevitable political reaction to prosperity. Voters don't mind politicians loosening the purse-strings when times are good. Or maybe President Clinton was just spending more to reward supporters for standing by him during impeachment.

Either way, discretionary spending started moving up faster, growing 3.6% in 1999, 7.5% in 2000, and 5.5% in 2001 (the last budget President Clinton had a hand in) with increases in social spending leading the way.

Then came President Bush, who ushered in No Child Left Behind, a new prescription drug entitlement for seniors, and, eventually, TARP and "temporary" stimulus in 2008. In eight years, discretionary social spending rose 6.8% per year, and that doesn't even include prescription drugs or TARP. Total spending soared 8.3% per year. In Fiscal Year 2009, the federal government was spending 24.4% of GDP, up from 17.6% eight years prior.

Then came an avalanche of new spending initiatives in President Obama's first 15 months that substantially increased the future path of government outlays. Not all of it was designed to show up right away, just like FDR and Social Security or LBJ and Medicare and Medicaid. But data from the CBO show that between taking office and mid-2010, his policies added about 9% to future government spending.

And that's not even counting some of the new spending, which is hidden. When Obamacare regulates health insurance markets to raise insurance rates for some people and cut them for others, it's no different than the government taxing healthy people and spending money on the sick. But now, instead of collecting and spending the money directly, the government gets insurance companies to do the dirty work for it.

In 2010, voters reacted by handing control of the House of Representatives back to the GOP and, in 2011, some progress was made against higher spending. In particular, they passed a Sequester. But then the discipline faded and, with budget deal after budget deal, spending started creeping up again.

And so here we find ourselves, with huge entitlement programs ready to ramp up further as the Baby Boomers keep retiring and much of the economy regulated more than ever before.

Underneath all this are entrepreneurs generating new ideas, keeping the economy going, but only able to push growth to a Plow Horse pace, not the Race Horse pace we'd have if the jockey slimmed back down to where it was in, say, 1998.

Increasingly, it looks like the only way to end the upward spending ratchet is for voters to elect a president dedicated to a smaller government at the same time they elect a Congress with the same commitment. Less spending, less regulation, particularly in energy and health care, as well as lower tax rates are the only policies that can stir the economy out of its doldrums.

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

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Posted on Monday, February 08, 2016 @ 12:01 PM • 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 Monday, February 08, 2016 @ 7:49 AM • Post Link Share: 
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  The Trade Deficit in Goods and Services Came in at $43.4 Billion in December
Posted Under: Data Watch • Trade

Implications: The trade deficit widened in December as exports fell to the lowest level in four years. Slower growth abroad, along with a stronger dollar have slowed exports. For example goods exports to Canada and China are down 13.4% and 16.8% respectively from a year ago. Exports of goods to Africa are down 33.2% while exports to South & Central America are down 20.9%. This will not last forever, but may continue to be a factor for the coming year. Meanwhile, while increasing $0.6 billion in December, imports are also below year-ago levels. The largest contributor to the decline in the past year has been petroleum, which is now down 48.7% from a year ago. Yes, crude prices are down in the past year, impacting the value of crude imports, but the quantity of crude imports also fell in 2015, down 1.4% after dropping 4.0% in 2014. Back in 2005 US petroleum and petroleum product imports were eleven times exports. In December, these imports were only 1.8 times exports. Ever wondered why, with all the turmoil out of the Middle East, oil prices have continued to decline, not spike higher, like we had usually seen in the past? It's because the US is becoming more and more important in the energy space as a producer, bringing a stabilizing effect to the world. You can thank fracking and horizontal drilling for that. In fact, after years of running a trade deficit, the US ran a trade surplus in goods with OPEC in 2015! Plugging today's figures into our GDP models suggests trade will be a non-factor, either up or down, in the first quarter of the 2016 while the overall economy grows at a about a 1% annual rate. Although tepid, we think the government is still having problems seasonally-adjusting its data and so we then expect much faster growth in the middle two quarters of the year.

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Posted on Friday, February 05, 2016 @ 11:08 AM • Post Link Share: 
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  Nonfarm Payrolls Increased 151,000 in January
Posted Under: Data Watch • Employment

Implications: Today's report on the labor market suggests that a rate hike in the first half of 2016 is still likely and could even come as early as March. Payrolls increased 151,000 in January, below consensus expectations. But, other than that, today's report on the labor market was red hot, with a big spike in the other key measure of jobs, higher wages, and more hours. Civilian employment, an alternative measure of jobs that includes small-business start-ups, increased 615,000 in January. That's the reason the unemployment rate went down to 4.9% despite a 502,000 increase in the labor force. Remember, the consensus at the Fed is that a jobless rate of 4.9% is the long-term norm, and now we're already there with further declines in the pipeline for at least the next year due to the loose stance of monetary policy. Notably, the participation rate, while still very low by historical standards, hit 62.7% in January, the highest in eight months. It looks like faster wage growth is finally getting more people interested in working again. Average hourly earnings, which don't even include fringe benefits like health care or irregular bonuses/commissions, spiked 0.5% in January and are up 2.5% from a year ago. In the past six months, these wages are up at a 2.9% annual rate, the fastest pace for any six-month period since the recession. Meanwhile, the number of hours worked is up 2.1% versus last year. Combined with the gain in wages, workers' total earnings are up 4.7% in the past year, which is why consumer spending should continue to grow. If you're one of the traditional Keynesians at the Fed, who think lower unemployment leads to faster wage growth and then, eventually, broader inflation, today's report suggests your model accurately describes current conditions. Unemployment came down and now wages are growing faster. That's why investors who have steeply discounted the possibility of more rate hikes this year need to change their outlook. A modest series of rate hikes will not kill economic growth; it will help prevent mal-investment (like in the housing bubble in the prior decade) and future inflation. Although the labor market could be doing even better with a better set of policies, like less government spending, lower marginal tax rates, and less regulation, it continues to improve and is likely to keep getting better in 2016.

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Posted on Friday, February 05, 2016 @ 10:40 AM • Post Link Share: 
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  Nonfarm Productivity Declined at a 3.0% Annual Rate in the Fourth Quarter
Posted Under: Data Watch • Employment • Productivity

Implications: Taken at face value, today's productivity numbers were not good, with output per hour falling at a 3% annual rate in the fourth quarter and up only 0.3% from a year ago. The meager gain of 0.3% in 2015 was no different than the average for the past five years, which is the weakest 5-year period since the late-1970s and early 1980s. However, we think it's important to take the government's productivity numbers with a huge grain of salt. We don't think the official productivity figures are capturing the dynamism of the US economy. We strongly suspect the government is underestimating output in the increasingly important service sector, which means growth and productivity are higher than the official data show. As the economy becomes more and more friction-free due to new apps and technologies, productivity rises, but it does not get fully picked up in statistics because many of these benefits are free for consumers. The figures from the government miss much of the value of these improvements, which means our standard of living is improving faster than the official reports show. Note that on the manufacturing side, where it's easier to measure output per hour, productivity is up 1.5% in the past year and up at a 1.4% annual rate in the past five years. In spite of the problems with measurement, we anticipate faster productivity growth over the next few years as new technology increases output in all areas of the economy. The declining unemployment rate, decline in labor force participation, and faster growth in wages should generate more pressure for efficiency gains, while the technological revolution continues to provide the inventions that make those gains possible. In other news this morning, new claims for unemployment insurance increased 8,000 last week to 285,000. Continuing claims for regular state benefits declined 18,000 to 2.26 million. Plugging these figures into our models makes our final forecast for tomorrow a nonfarm payroll gain of 190,000 with the unemployment rate remaining at 5.0%. More Plow Horse growth.

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Posted on Thursday, February 04, 2016 @ 1:29 PM • Post Link Share: 
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  The ISM Non-Manufacturing Index Declined to 53.5 in January
Posted Under: Data Watch • ISM Non-Manufacturing

Implications: Activity in the service sector grew for a 72nd consecutive month in January. Let that sink in for a second. The largest sector of the U.S. economy has been reporting steady growth every month for the past six years. This marks a stark contrast from the manufacturing sector, where recent readings have indicated contraction. The ISM Services number came in 53.5 for January, short of consensus expectations, and represents a slight slowdown in the pace of growth (remember, levels above 50 signal expansion, so January's reading represents continued growth, but at a slower rate than in recent months). However, every year from 2010 through 2014, in all of which the economy kept growing, included months with at least one lower reading than 53.5. In other words, today's report doesn't indicate that the US economy is headed for a recession. The underlying details of the report show activity remains resilient. The new orders index, a signal of how business activity and employment are likely to move in coming months to fill demand, came in at 56.5 in January. In other words, it looks like service sector growth should continue in the months ahead. And while business activity and employment showed a slower pace of growth to start 2016, the majority of comments from survey respondents were positive about the business outlook. On the inflation front, the prices paid index dipped back below 50, with respondents citing continued declines in energy prices and a strong dollar pushing down meat prices. In sum, steady growth from the service sector, paired with positive trends in employment, earnings, and home building, keep the plow horse economy plodding forward. In other news this morning, ADP says private-sector increased payrolls 205,000 in January. Plugging this into our models suggests Friday's official report will show a nonfarm gain of 192,000, although our forecast may change based on tomorrow's data on unemployment claims. Yesterday, automakers reported they sold cars and light trucks at a 17.6 million annual rate in January, an increase of 1.4% versus December and up 5.2% from a year ago. What's remarkable is that sales rose despite a massive late-month snowstorm on the East Coast, which suggests auto sales will be even stronger in February. Look for auto sales to hit a new record high in 2016.

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Posted on Wednesday, February 03, 2016 @ 1:16 PM • Post Link Share: 
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  The ISM Manufacturing Index Rose to 48.2 in January
Posted Under: Data Watch • ISM

Implications: It was a real mixed bag report today from the ISM, with the headline index remaining in contraction territory (remember, levels above 50 signal expansion while levels below 50 signal contraction, so a move higher to 48.2 means continued contraction, but at a slower pace than last month), while the major sub-indexes were mostly positive. However, the two most forward looking measures, new orders and production, both returned to levels above 50, signaling growth. Employment was the major drag in January, as the petroleum and coal industry led ten of eighteen manufacturing industries to report declining employment. This comes in contrast to the continued strength in other employment indicators (such as initial claims, which have remained below 300K since February of last year). It's also important to remember that manufacturing represents a relatively small piece of overall employment. In 2015, manufacturing added an average of 2,500 jobs a month, while the private sector as a whole grew by more than 210,000 jobs monthly. In other words, today's report does little to change our outlook on Friday's employment report, where we expect to see significant gains. The modest readings from the ISM manufacturing report since peaking at 58.1 in August 2014, have given some pessimists reason to cheer, but we see no broad-based evidence of a significant slowdown. And remember, the ISM is a survey which can reflect sentiment as much as actual economic activity. As a whole, today's data continues to highlight a stark contrast in two broad sectors of the economy: services, where the economy is expanding briskly and prices are rising, versus goods, where both growth and inflation are soft to non-existent. Overall activity isn't booming, but it does continue to plow forward at a modest pace. In other news this morning, construction increased 0.1% in December (-0.5% including downward revisions for October/November). The slight gain in December itself was the by-product of a surge in government projects (paving roads and building bridges) and new home construction, and a large drop in commercial construction, particularly chemical manufacturing facilities, probably related to a drop in oil output.

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Posted on Monday, February 01, 2016 @ 11:20 AM • Post Link Share: 
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  Personal income increased 0.3% in December
Posted Under: Data Watch • PIC

Implications: These are not recessionary numbers. Household spending cooled in December, but incomes continued to grow, meaning consumers are in a position to increase spending over the next few months. Personal income rose 0.3% in December, beating consensus expectations, and is up 4.2% in the past year. The increase in income was led by wages and salaries in private service-providing industries. Meanwhile, wages and salaries declined in private goods-producing companies as pay went back to normal in December after a large one-time bonus to unionized auto workers in November due to recent contract ratification. Although consumer spending was unchanged in December, it's up 3.2% in the past year. That increase is not due to an unsustainable credit binge. Instead, it reflects higher purchasing power by American workers. The main driver of the income gains in the past year has been overall private-sector wages and salaries, which are up 4.8% from a year ago. The only bad news in this report was the continued failure to make progress against government redistribution. Although unemployment compensation is hovering around the lowest levels since 2007, overall government transfers to persons were up 0.7% in December and are up 5.4% in the past year, largely driven by the Obamacare-related expansion of Medicaid. Before the Panic of 2008, government transfers – Medicare, Medicaid, Social Security, disability, welfare, food stamps, and unemployment comp – 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 the incentive to produce. This is 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 down 0.1% in December. Although it's only up 0.6% from a year ago, it continues to be held down by falling energy prices. The "core" PCE deflator, which excludes food and energy, is up 1.4% from a year ago. That's also below the Fed's 2% inflation target, but we expect some acceleration in the coming year. As soon as energy prices stop falling, inflation is going to pick up. Together with continued employment gains, these data support the case for slow and steady rate hikes (think 0.25% at every other Fed meeting) in 2016.

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Posted on Monday, February 01, 2016 @ 10:24 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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