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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  The Trade Deficit in Goods and Services Came in at $48.3 Billion in August
Posted Under: Data Watch • Trade

Implications: The trade deficit in goods and services grew 15.6% in August, as exports declined while imports increased. In recent months, exports have been running below year-ago levels, as other areas of the world continue to struggle. Slower growth abroad, along with a stronger dollar have slowed exports. For instance, exports to the Euro Area are down 10.7% from a year ago. Exports to Africa are down 36.7% while exports to South & Central America are down 20.0%. This will not last forever, but may continue to be a factor over the coming year. Meanwhile, although imports are slightly below the year-ago level, they rose in August, led by the cell phones & other household goods. This jump was probably due to the launch of the iPhone 6S and 6S+. Meanwhile, today's data underscore why OPEC continues to become less relevant. Back in 2005 US petroleum and petroleum product imports were eleven times exports. In August, these imports were only two times exports. The US trade deficit with OPEC over the past year is now the smallest it's been since at least 1986, and through August the US is running a surplus with OPEC in 2015! This has a destabilizing impact on the Middle East, which compounds the problems of a vacuum in leadership. The US is headed toward energy independence thanks to fracking and horizontal drilling. In fact, despite lower oil prices over the past year and some recent dips in drilling activity, US domestic oil production is still expected to average 9.3 million barrels per day in 2015, a 600,000 barrel per day increase from 2014. Entrepreneurs and engineers, through the use of new technologies, have changed the way the world works and there's more to come. Trade now looks like it will very likely be a drag on real GDP in Q3, but we still expect overall real GDP growth of around 2% in the third quarter as some of the increase in imports leads to better inventories than we previously expected.

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Posted on Tuesday, October 06, 2015 @ 9:52 AM • Post Link Share: 
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  The ISM Non-Manufacturing Index Declined to 56.9 in September
Posted Under: Data Watch • ISM Non-Manufacturing

Implications: It's a tale of two economies when it comes to the ISM reports. While the manufacturing index suggests the factory sector is barely growing, the service sector, which represents a far larger portion of the total economy, continues to show strength. At 58.7, the third quarter average for the index represents the strongest quarter from the service sector going back to 2005. And you also have to go back to 2005 to find a stronger performance through the first nine months of the year. Keep this in mind when the pouting pundits focus on the slowdown in the index since July. What they may not mention is that September's decline comes off the two highest readings from the index in more than six years. Looking at the details of today's report doesn't show anything to worry about. In September, thirteen of eighteen industries reported growth. The business activity and new orders indexes slowed in September, but both stand well above 50, signaling continued growth, although at a slightly slower pace than in recent months. Expect activity to remain strong over the coming months as companies move to fill the steady flow of new orders coming in. Both the business activity and new orders indexes showed acceleration from the first quarter to the second (coming off the bitter winter and West Coast port strikes), and the growth trend continued through Q3. The biggest positive in today's report is the employment index rising to 58.3 in September from 56.0 in August. This is in line with the trend in initial claims (30 consecutive weeks under 300K) that suggests employment is healthier than the last two payroll reports have shown. It's very early, but our forecast for October payrolls is a return to gains of 200K+. In the past five years, payroll growth has been below trend in each third quarter and then above trend in each fourth quarter. We wouldn't be surprised to see more of the same this year. On the inflation front, the prices paid index dipped in September to 48.4, led lower by (who else?) mining. As a whole, today's report suggests continued growth in the months ahead and underlying strength in the economy.

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Posted on Monday, October 05, 2015 @ 11:07 AM • Post Link Share: 
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  The Bull Market Still Lives
Posted Under: Bullish • Markets • Monday Morning Outlook • Stocks
Stock market corrections (usually defined as 10% pullbacks) are hard to understand. Often they happen in the midst of long-term bull markets. But why? Is it like getting the flu? Is it just emotion? Or, are corrections a necessary cleansing out of excess optimism? Our answer: we don't really know.

One thing we do know is that almost every time they happen, pessimists come out of the woodwork saying that a Bear Market has begun. In the past seven years, this has happened a number of times, but each time, the market has bounced back to new highs. Think about 2011, when the S&P 500 fell by 19.4% from April 29th to October 3rd. Even with the recent decline, the market is up 77.5% since then. We think the 2015 correction is no different and expect stocks to move to new highs.

There's no real definition of a bear market, or a bull market, for that matter. Most pundits use the rule-of-thumb that a bear market is a 20% drop from a prior peak. However, in 1962 this happened in the midst of a long running rise in stock prices that went on until 1966. So, we don't really know what to call that!

That still leaves several other 20% market declines in 1957, 1970, 1973-74, 1980, 1981-82, 1990, 2000-02, and 2007-09. But each of these was correlated with recession and a recession anytime soon is extremely unlikely.

Monetary policy is loose and will remain that way even when the Federal Reserve starts raising interest rates (still later this year, in our view). We wish marginal tax rates were lower, but they're not high by historical standards. Trade policy continues to move, at least gradually, in a direction of lower barriers to international trade. The federal government could certainly find ways to spend less and reform entitlements, but government is not growing as quickly as it did in the prior decade.

Moreover, financial firms are better capitalized than they've been for years, corporate balance sheets are loaded with cash, and households' financial obligations are hovering near the smallest share of after-tax income since the early 1980s. Meanwhile, as much as home building has revived the past few years, it still has further to go. This is just not a recipe for recession.

There were two other "bear" markets that didn't accompany a recession. One was in 1966, during the long economic expansion of the 1960s. The other was in 1987, with the famous and short-lived Crash in October that year.

But the 1966 decline in stocks followed the "Great Society" legislation, and inflation was ramping up. And 1987 was a fluke. In addition, our capitalized profits models – what we use to estimate fair value for equities – would have said both times that equities were overvalued before those bear markets started. By contrast, the same model is now saying equities are still undervalued.

The model uses after-tax corporate profits discounted by the 10-year Treasury yield. Partly because profits have risen so much but mostly because the 10-year Treasury yield is artificially low, this model still suggests that the S&P 500 is massively undervalued. Using a 10-year Treasury yield of 2%, the model says the "fair value" of the S&P 500 is 4,850.

But this number is artificially high because the discount rate is being held down by the Fed. Using a 4% 10-year discount rate gives us a "fair value" 2,425, leaving plenty of room for equities to rebound from the recent correction and move much higher. Assuming zero growth in profits, the 10-year yield would have to rise to about 5% to signal that equities are fairly priced right now.

None of this means equities have to hit new highs this week, or even this month. It does suggest that fears about a bear market are way overblown. We see no reason for a recession on the horizon, and equities still look cheap.

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

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Posted on Monday, October 05, 2015 @ 10:33 AM • Post Link Share: 
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  Nonfarm Payrolls Increased 142,000 in September
Posted Under: Data Watch • Employment

Implications: No two ways about it, today's employment report was weak by the standard of the past few years. Job growth was slow, wages were flat, hours fell, and the labor force dropped. As a result, a rate hike in October is extremely unlikely. Payrolls expanded by a tepid 142,000 in September, falling short of even the most pessimistic forecasts. Moreover, instead of being revised upward, which usually happens this time of year, recent months were instead revised down by 59,000. Meanwhile, civilian employment, an alternative measure of jobs that includes small business start-ups, dropped 236,000. Although the jobless rate remained at 5.1%, it's nothing to celebrate as the labor force participation rate fell to 62.4%, the lowest since 1977. Worker earnings took a hit as well, due to a combination of flat earnings per hour and a slightly shorter workweek for those with jobs. As a result, total earnings slipped 0.2%. However, not all the news was soft. Despite the decline in September, workers' total earnings are up 4.5% versus a year ago and the expansive U-6 unemployment rate fell to 10.0% from 10.3%, as those working part-time for economic reasons fell to the lowest level since 2008. The bottom line is that today's report does not spell doom for the US economy; we are not facing an impending recession. The third quarter of each of the past five years (2010-2014) has had slower job growth than each of those years as a whole, and it looks like 2015 will be no different. The job market never moves in a straight line, either up or down. There are always months that are slower or faster than the underlying trend and we just got two in a row that are slower. This has happened before and will happen again, just like we'll get months like November/December 2014 when job growth averaged 376,000 per month. Remember not to get too excited when that happens again, just like you shouldn't get depressed today; the underlying trend is still about 200,000 per month. Other recent news supports this theme. Yesterday, automakers reported that cars and light trucks sold at an 18.2 million annual rate in September, up 9.9% from a year ago and the fastest pace since 2005. However, like a mirror image of job growth, don't look for auto sales to stay at that level. Sales should stay strong, but not stay as hot as the past two months.

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Posted on Friday, October 02, 2015 @ 11:32 AM • Post Link Share: 
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  No Recession in Sight
Posted Under: Bullish • GDP • ISM • Retail Sales • Video • Wesbury 101
Posted on Thursday, October 01, 2015 @ 11:44 AM • Post Link Share: 
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  The ISM Manufacturing Index Declined to 50.2 in September
Posted Under: Data Watch • ISM

Implications: We said it last month, but it bears repeating. Yes, today's report from the ISM showed the lowest reading for the headline index going back to 2012, but it is important to remember that the index measures the pace of expansion and contraction. Levels above 50 represent expansion, so while September's reading of 50.2 is lower than August's reading of 51.1, that does not mean that activity has declined. Instead, it continues to expand at a slightly slower pace than in recent months. It should also be noted that the September reading represents a 33rd consecutive month above 50. On the inflation front, the prices paid index declined to 38.0 in September from 39.0 in August, as falling prices for crude oil and gasoline helped push prices lower for fourteen of the eighteen industries reporting. The prices paid index has now shown contraction in prices for eleven consecutive months. Taken as a whole, today's report is about as plow horse as they come. Each of the major measures of activity moved lower in September, but all remained above 50, signaling continued expansion. The modest readings from the ISM manufacturing report in 2015 may have some worried that a slowdown could be the early signs of a downturn in the economy, but we disagree. While the overall index remains below the peak of 58.1 seen in August 2014, we don't believe this is anything to worry about. Data on employment, housing, and consumer spending continue to show strength, while the weaknesses in economic data have almost all come from surveys, which can reflect sentiment as much as actual economic activity. When looking at the fundamentals of the broader economy, there remains no recession in sight. In other news this morning, new claims for unemployment insurance increased 10,000 last week to a still low 277,000. Claims have been below 300,000 for seven consecutive months. Continuing claims dropped 51,000 to 2.19 million, the lowest since November 2000. Also on the labor market, yesterday's ADP report showed a gain of 200,000 in private-sector payrolls in September. Plugging these figures into our models suggests tomorrow's official employment report will show nonfarm payrolls up 192,000 in September. We expect that to be accompanied by upward revisions for August and that September will be revised up in future reports as well. Meanwhile, construction rose 0.7% in August, led by home building. In other recent housing news, the national Case-Shiller home price index increased 0.4% in July and is up 4.7% in the past year. Price increases in the past twelve months have been led by San Francisco, Denver, Dallas, and Portland.

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Posted on Thursday, October 01, 2015 @ 11:39 AM • Post Link Share: 
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  Chinese Auto Stimulus
Posted Under: Autos • Government
A tax cut? In China? We couldn't believe our ears! In the wake of a myriad of other measures to shore up its slowing economy, China announced Tuesday that the auto industry would be the focus of its latest stimulus measures. Starting Oct 1st, and continuing through the end of 2016, China will cut the sales tax on cars with engines of 1.6 liters or less from 10% to 5%.

Now don't get us wrong, we aren't usually on team China when it comes to economic and monetary policy making, but it's refreshing to see the Chinese forego QE (at least for now) in favor of tax cuts for consumers. If we had our way, the tax cuts would be across the board, not just for the auto sector, and permanent. But we will give credit where credit is due. A tax cut is a tax cut, and, even if it is limited to one area of the economy, it boosts the real spending power of consumers. And, according to Bloomberg, the market for these incentive eligible vehicles makes up 68% of total Chinese vehicle sales, meaning the benefits of this stimulus will be felt by a broad swath of its citizens.

So why is China acting now? Bloomberg reports vehicle sales have fallen for five consecutive months, and SAIC Motor Corp, China's largest auto manufacturer, recently cut its industry growth forecast for the year to 0%. With these worrying trends afoot (and a government looking to boost consumption driven growth), the state-backed China Association of Automobile Manufacturers took the opportunity to lobby the government for the tax cut.

It isn't every day that we agree with Chinese policy makers, and we certainly haven't agreed with many of their economic management efforts to date, but when compared with continuing zero interest rate policies in the U.S. and the ongoing European QE, this latest move by Beijing is a net positive. Tax breaks like these improve living standards by making goods more affordable, and we hope to see more policies like these in the future. China is undertaking a difficult transition to an economy that relies more broadly on domestic consumers rather than one based on overdone infrastructure investment and exporting to the rest of the world.

Before you think we have lost our minds by supporting China in this, we have some quibbles. Targeted tax cuts distort resource allocation. Cutting sales taxes across the board would have been better and would have respected the autonomy of the consumer. Nonetheless, we never argue with tax cuts. As a result, we view this as a positive move.

Posted on Thursday, October 01, 2015 @ 9:07 AM • Post Link Share: 
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  Bond Spreads Won't Sink the Economy
Posted Under: Government • Markets • Interest Rates • Bonds

A story in today's Wall Street Journal suggests yet another bogeyman for investors to fear: the widening spread in yields between corporate bonds and to the 10-year Treasury.

After bottoming at about 220 basis points last year, the yield spread between the typical Baa-rated corporate bond and the 10-year treasury has since widened to 320 bp. Supposedly, this widening is a harbinger of economic problems because it signals "that investors are less confident about companies' business prospects and financial health."

As usual a look at some history helps clarify matters. As the chart above shows, although the yield spread has widened, it has merely returned to where it was in 2010-12. In other words, the US has been through these "risk off" periods before without any real economic problems. This is nothing out of the ordinary for the Plow Horse recovery. We would need to see a much higher yield spread before we would consider this a truly worrisome condition.
Posted on Monday, September 28, 2015 @ 3:18 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, September 28, 2015 @ 12:34 PM • Post Link Share: 
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  Personal Income Increased 0.3% in August
Posted Under: Data Watch • PIC

Implications: Incomes and spending continued to move higher in August, led again by strong growth in wages & salaries. Payrolls are up almost three million from a year ago, helping push private-sector wages & salaries up a robust 4.1% in the past year. Total income – which also includes rents, small business income, dividends, interest, and government transfer payments – increased 0.3% in August and is up 4.2% in the past year, faster than the 3.5% gain in consumer spending. In other words, recent gains in consumer spending have been driven by higher incomes, not consumers getting into potential financial trouble with too much debt. The only real negative news in today's report was the failure to make any progress against government redistribution. Although unemployment compensation is hovering around the lowest levels since 2007, overall government transfers to persons are up 4.5% in the past year, largely driven by Obamacare. 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. This is why we have a Plow Horse economy instead of a Race Horse economy. The PCE deflator, the Fed's favorite measure of inflation, was unchanged in August. Although it's only up 0.3% 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 1.3% from a year ago. That's still below the Fed's 2% inflation target, but it's up a faster 1.6% annualized rate in the past six months. As soon as energy prices stop falling, inflation is going to pick up, supporting the case for starting rate hikes before year-end. In other news today, pending home sales, which are contracts on existing homes, declined 1.4% in August after rising in July. Our models project that existing home sales, which are counted at closing, should rise slightly in September.

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Posted on Monday, September 28, 2015 @ 12:24 PM • 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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