 | The Consumer Price Index (CPI) Increased 0.1% in May |
|
| Posted Under: CPI • Data Watch |
|
Implications: For now, all continues to be quiet on the inflation front. Consumer prices rose a tepid 0.1% in May and are only up 1.4% from a year ago. The slight rise in May was due to rent (both actual rent and owners’ equivalent rent) as well as energy costs. Food and medical care each declined 0.1%. “Core” prices, which exclude food and energy, were up 0.2% in May and are up 1.7% from a year ago. Neither overall nor core price gains in the past year set off alarm bells. Instead, they suggest the Federal Reserve’s preferred measure of inflation, the PCE deflator (which usually runs a ¼ point below the CPI) will remain below the Fed’s target of 2%. We don’t expect this to last. Inflation probably bottomed in April when it was up only 1.1% from the prior year, and will be noticeably higher a year from now. However, for the Fed, the key measure of inflation is its own forecast of future inflation, which we see released tomorrow with the FOMC statement. So, even if inflation goes to roughly 3% in 2014, as long as the Fed projects the rise to be temporary it will not react to that inflation alone by raising short-term interest rates. The Fed is more focused on the labor market and, we believe, is willing to let inflation exceed its long-term target of 2% for a prolonged period of time in order to get the unemployment rate down. The worst news in today’s report was that “real” (inflation-adjusted) average hourly earnings declined 0.2% in May, although they are still up 0.5% in the past year. Given today’s news it looks like “real” (inflation-adjusted) consumer spending is growing at a 2.5% annual rate in Q2, consistent with our forecast of 2.5% real GDP growth.
Click here for a PDF version
|
|
| | Housing Starts Rose 6.8% in May to a 0.914 Million Annual Rate |
|
| Posted Under: Data Watch • Home Starts |
|
Implications: Housing starts bounced back in May and continued the upward trend that began in 2011. Although the vast majority of the gain was due to the volatile multi-family sector and overall starts came in below consensus expectations, single-family starts are up 16.3% from a year ago and the total number of homes under construction has increased for 21 consecutive months. We expect this trend to continue. Although housing permits declined 3.1% in May, they are up 20.8% from a year ago. Single-family permits were up in May and up 24.6% in the past year. Based on population growth and “scrappage,” housing starts will eventually rise to about 1.5 million units per year (probably by 2015). The bottom line is that no one should get worked up over every zig and zag in the data. Sometimes one indicator ticks down, like building permits; other times an indicator, like housing starts, will surge up above the underlying growth trend. That’s what a recovery looks like. In other recent housing news, the NAHB index, which measures confidence among home builders, rose to 52 in June from 44 in May. This was the highest level since March 2006 and the eight point upward move was the largest monthly gain since September 2002. In other news yesterday, the Empire State index, a measure of manufacturing sentiment in New York, rose to a three month high of +7.8 in June from -1.4 in May. These data are consistent with our forecast that real GDP is growing at a 2.5% annual rate in the second quarter.
Click here for a PDF version
|
|
| | It's More Than Housing |
|
| Posted Under: GDP • Housing |
|
With the apparent acceleration in economic growth this year, the search for excuses has also gotten underway. One way the more dour observers have tried to come to grips with faster GDP growth is to claim that housing activity is adding significantly to growth. Above is a table showing the annualized rate of change in real GDP and the contribution of housing to that rate change – both are rounded to the nearest tenth of a percent.
In the fourth quarter of 2012, housing accounted for roughly 100% of the increase in real GDP, but in Q1-2013, real GDP expanded at a 2.4% annualized growth rate and just 0.3% of that change was attributable to housing. Over the past eight quarters, real GDP has averaged 2.1% annualized growth and housing has attributed an average 0.25% per quarter. Without the growth in housing, real GDP would have expanded at an average annual rate of 1.88%. In other words, housing has added to growth, but it is far from the only thing that has been growing. It’s the Plow Horse economy with, or without, housing.
|
|
| | Keynesian Model Blew It Again |
|
| Posted Under: Government • Markets • Monday Morning Outlook • Spending • Stocks |
|
|
If there’s one economic conclusion we can make from recent data, it’s that the Keynesian model has failed - again.
Remember that “fiscal cliff clock” on cable TV? Well, the year-end deal included an end to the payroll tax cut and then two months later, on March 1, the dreaded federal spending sequester went into effect. In other words, the Keynesian clock struck midnight, the economy was supposed to slow sharply, and a recession was possible.
The theory was – still is in some quarters – that higher payroll taxes and less federal spending would reduce spendable incomes (especially for government workers and contractors) and hit consumer spending. This drop in spending would set off a multiplier effect that would drag down economic growth.
One widely-followed Keynesian forecasting unit predicted an uptick in the unemployment rate in the second quarter and a decline in nonfarm payroll growth to 100,000 per month. And when March payrolls rose a tepid 88,000, Keynesians blamed it on the fiscal cliff and said “here we go, it’s started.”
But the unemployment rate is lower in Q2 than in Q1 and nonfarm payrolls have risen an average of 155,000 since the sequester went into effect. Payroll growth during the same three months in 2012 was 147,000. Even the tepid March number was revised from 88,000 to 142,000.
The Keynesians, expecting doom and gloom anytime the government cuts spending, have pounced on any signal of soft economic growth. They jumped on the initial report of weakness in retail sales in March and blamed it on the sequester, even though the last three times Easter had been in March, like this year, sales have been unusually weak compared to other indicators (2002, 2005 and 2008).
But we found out this past week that core retail sales – which take out the monthly volatility caused by autos, gas, and building materials – have been up eleven months in a row and didn’t miss a beat after the sequester went into effect. Assuming consumer prices rose 0.1% in May (see our forecast table, below), “real” (inflation-adjusted) retail sales are up about 3% from a year ago. Total consumption, adjusted for inflation, is up 2.1% during the year-ended April 2013 versus the 1.8% growth during the year-ended April 2012
Meanwhile, equity investments, held by US households, are up about $800 billion in value since March 1. Taken at face value, it seems like the effect of the sequester has been positive, not negative.
Keynesians haven’t even been right about the stock market. We’re not going to call anyone out by name, but we’re thinking of a famous Keynesian economist who is widely known for having made a prescient call about 2008-09, whose name starts with an “R” and sounds a lot like Houdini.
It’s true that he called the collapse in 2008-09, but he originally went bearish in 2005, especially after Hurricane Katrina. Reports say that he recently turned bullish. So what if you sold in mid-2005 and waited until now to buy back in? Since mid-2005, the annualized total return on the S&P 500, including reinvested dividends, has been 6.2%. That’s nothing compared to the late 1990s – but, hey, it ain’t shabby either. In other words, completely ignoring the dire Keynesian advice, even when it was right, would have been profitable.
In mid-2005, you could have bought a 10-year Treasury Note that yielded 4%. Less drama for sure, but no clear advantage. Gold, on the other hand, was trading at about $430/oz. back in mid-2005, so that would have been a great buy, but not an option normal Keynesians would have recommended.
The bottom line is that all this focus on government actions through the lens of a Keynesian model has been basically worthless. Investors are better served when they follow free-market economic theories that focus on production, not demand-side models that focus on spending and debt. And this appears true in both the long, and the short, run.
Click here for a PDF version
|
|
| | Industrial Production was Unchanged in May, Capacity Utilization Declined to 77.6% |
|
| Posted Under: Data Watch • Industrial Production - Cap Utilization |
|
Implications: Another lackluster report on overall industrial production, but the details are consistent with continued plow horse growth. Output at factories, mines, and utilities was unchanged in May as utilities held down the overall figure. Manufacturing production rose 0.1% (0.2% including revisions to prior months). Production is up only 1.6% over the past year and down at a 0.8% annual rate over the past three months. But we do not expect this to last as the housing recovery is still in its very early stages and demand for autos and other durables remains strong. The auto sector has led the manufacturing gains, up 6.7% in the past year, but even manufacturing outside the auto sector has done OK, up 1.4% in the past year. We expect the gap between those two growth rates to narrow considerably in the year ahead, with slower growth (but still growth!) in autos and faster growth elsewhere in manufacturing. Capacity utilization fell to 77.6% in May, not far off from the average of 79.0% in the past 20 years. Continued gains in production should push capacity use higher, which means companies will have an increasing incentive to build out plant and equipment. Meanwhile, corporate profits and cash on the balance sheet are at record highs, showing they have the ability to make these investments.
Click here for a PDF version
|
|
| | The Producer Price Index (PPI) Rose 0.5% in May |
|
| Posted Under: Data Watch • PPI |
|
Implications: Producer prices rebounded 0.5% in May, easily beating consensus expectations. Even with this rebound, prices are up only 1.7% from a year ago. Given the loose stance of monetary policy, higher inflation is eventually coming, but it isn't here yet. The main culprits behind the wholesale price rise were energy and food prices which rose 1.3% and 0.6% respectively after falling 2.5% and 0.8% in April. Still, energy prices are down 17.3% at an annualized rate over the past three months. “Core” prices, which exclude food and energy and which the Federal Reserve claims are more important than the overall number, were up 0.1% in May and are up 1.7% versus a year ago. Some analysts may suggest that with the overall and “core” PPI only up 1.7% from last year that the Federal Reserve has room to continue its latest round of bond buying. We think this is a mistake, and it seems like some more members of the FOMC are starting to think the same thing. Core inflation is likely to continue growing and, despite projections of bumper US crop yields, food inflation should continue moving upward given recent improvement in foreign economies. Monetary policy is loose enough already. The problems that ail the economy are fiscal and regulatory in nature. Adding even more excess reserves to the banking system is not going to boost economic growth.
Click here for a PDF version
|
|
| | Retail Sales Increased 0.6% in May, Above the Consensus Expected Gain of 0.4% |
|
| Posted Under: Data Watch • Retail Sales |
|
Implications: So much for the theory that the federal spending sequester or end of the payroll tax cut was going to kill the consumer. Sales were up 0.6% in May and are up at a 3.8% annual rate since the beginning of the year. With consumer prices up at an annual rate of only about 0.6% since the start of the year, “real” (inflation-adjusted) sales are up at more than a 3% annual rate. “Core” sales, which exclude autos, building materials, and gas, rose 0.3% in May and 0.6% including upward revisions to prior months. Other analysts, who had been forecasting roughly 1.5% real GDP growth in Q2 are reacting to this report by marking up their forecasts; we’re holding steady where we’ve been all along, at 2.5%. Nonetheless, this growth is nothing to write home about – it’s still Plow Horse growth – but much better than many analysts were projecting at the beginning of the year. For the rest of 2013, we still expect two major themes to play out for the consumer: first, an acceleration in consumer spending growth versus the past couple of years despite higher taxes and the sequester; second, a transition away from growth in auto sales and toward other areas, like furniture, appliances, and building materials. Consumer spending should accelerate because of continued growth in jobs, hours, and wages. In addition, households have the lowest financial obligations ratio (debt service plus other recurring monthly payments) since 1981. In other news this morning, new claims for unemployment insurance declined 12,000 last week to 334,000. Continuing claims ticked up 2,000 to 2.97 million. Plugging these figures into our employment models suggests a solid nonfarm payroll gain of 185,000 in June. On the inflation front, no sign that loose monetary policy is having an effect yet on trade prices. Import and export prices fell in May, both for overall and core measures and are also down from a year ago. An easy Fed will eventually generate higher inflation figures, but those numbers certainly aren’t here yet.
Click here for a PDF version
|
|
| | Where's The Inflation? |
|
| Posted Under: Government • Markets • Monday Morning Outlook • Fed Reserve • Interest Rates • Stocks |
|
|
So far this year, the Plow Horse US economy has accelerated a little bit from 2010-2012, the S&P 500 is up 16%, interest rates have risen, and gold is off 17%. As our readers know, this is exactly what we’ve been forecasting.
Despite this success, we have had one big miss: inflation. Consumer prices – including food and energy – are up a mere 1.1% from a year ago. We’ve never been in the hyperinflation camp – that’s why we’ve been bearish on gold these past few years – but, we never expected such benign inflation.
We think gold had priced in 10% to 12% inflation, and we expected 3 or 4 or 5%, that’s why we were bearish on the yellow metal. And, at the same time we thought the Federal Reserve’s forecast of 1.5 to 2% inflation was too low. So, even though we have been right on gold, our inflation estimates have been too high – just like the Fed’s.
The “hyper-inflationistas” have been overly focused on the size of the Fed’s balance sheet, failing to recognize that it’s mostly due to a surge in excess bank reserves. The M2 measure of money has continued to grow around 6% per year, well below the growth in the monetary base, Quantitative easing has not only been unnecessary but has also made monetary policy more opaque, leading some to falsely expect hyperinflation.
Despite this, our model of Fed policy, which compares the federal funds rate to nominal GDP growth, says the Fed is easy. A federal funds rate of essentially zero is well below the 3.5% nominal GDP growth rate (real GDP growth plus inflation). This should generate rising inflation and we think inflation is right now at a crucial inflection point.
We expect to look back in a few years and see that the present low readings were the lowest inflation would get. And we also believe it will become apparent that weak monetary velocity is the reason for current low inflation.
The expansion of government over the past several years, both in measurable terms like spending relative to GDP as well as hard to measure ways, such as the regulatory costs of Obamacare, are suppressing the economy’s potential growth in a way that slows the circulation of money. As a result, for any given amount of money, we get less nominal GDP, including less real growth and less inflation.
Another issue might be the Fed’s decision to pay banks interest on excess reserves. This new policy was implemented in late 2008. It could mean that a low federal funds rate is not as “stimulative” as the historical record suggests it should be.
Yet another issue may be simple “inflation inertia.” It sometimes takes many years for loose money to generate higher inflation, especially when the public trusts the Fed to keep inflation low. For example, back in the 1950s, the federal funds rate averaged about 2% even as nominal GDP growth averaged 6 - 7%. But with the Bretton-Woods monetary system’s gold peg firmly entrenched, inflation averaged 2.2% for the decade. It wasn’t until the late 1960s that inflation became a problem.
If a similar pattern holds, we can expect inflation to rise from the current low, but not accelerate rapidly anytime soon.
However, in the end a price will be paid. Once unacceptably high inflation arrives, the same inertia helping hold inflation down will keep it up, so the Fed will have to tighten even more than it wants to wrestle inflation back down.
If Chairman Bernanke soon retires, he will get high marks for keeping inflation low, but his successor will have some problems to clear up. In other words, even though inflation has remained low, we don’t expect it to stay that way for long.
Click here for a PDF version
|
|
|
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.
|
|
Archive
Tags
|