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  Let the Private Sector Take the Reins on Infrastructure
Posted Under: GDP • Government • Research Reports • Spending

The Trump administration took its first steps to address infrastructure Tuesday, with the president signing an executive order aiming to expedite environmental review and permitting processes.  Some will decry the fact that these actions weren't accompanied by a multi trillion-dollar spending bill.  With treasury yields so low, the narrative goes, we can borrow massively to finance new bridges and airports, repair crumbling highways, create jobs, and boost economic growth, all while locking in rates that make doing so very affordable. Further, this idea seems to enjoy bi-partisan support.  However, government infrastructure spending is far from the panacea it is being made out to be, all too often resulting in money flowing to political allies and massive cost overruns.  

First, it is important to note that the largest barrier to infrastructure development is not an unwillingness to invest from the private sector. Instead, the biggest roadblock is a combination of environmental regulations, NIMBY-ism, and local permitting that can drag projects out for years and significantly increase building costs.  The president's executive order is a concrete step toward solving this.

These exact issues have been a major impediment to much needed upgrades to commercial rail, seaport, bridge, and water infrastructure nationwide. With the opening of the recently widened Panama Canal, seaports and their private sector partners estimate they will need to spend $155 Billion on upgrades to accommodate larger ships and cargo volumes. However, the opposition from local communities, competing industries, and air regulators has been fierce. In the LA area, BNSF looks ready to abandon its major project following 10 years and $50 million in costs. Similarly, Union Pacific claims it has been in "environmental review purgatory" for nearly a decade in LA and Long Beach, while CSX has stated publicly that the permitting process alone can take double the time of actual construction for its port projects.

And these challenges aren't just confined to the private sector. Gone are the days of the New Deal when much of the country was still undeveloped and the federal government could undertake major projects with minimal opposition. Last year, it was announced that the California high speed rail project that was partly financed by President Obama's 2009 stimulus bill would be delayed another four years. In fact, the Associated Press reported that, as of March, no track had yet been laid. Many of these delays have been attributed to lawsuits, opposition by local farmers, and bureaucratic red tape. As a result, the new estimated cost for the project has now risen to $64 Billion, nearly double the original $33 billion estimate.

But how about state and local government infrastructure projects? Surely they can undertake these projects more efficiently than Washington.

As of June, Census Bureau numbers show that roughly 92% of all public construction was undertaken by states and local municipalities. The problem is that the American infrastructure system is set up in a way that funnels a large portion of federal funding to states on an "equality" basis that isn't adjusted for population or density.  This led to Alaska receiving about 8 times more money per head than New York for highways in 2015. Further, state DOTs have remarkably bad track records at utilizing this money effectively. All too often the result is politically motivated highway mega-projects like the infamous Boston "Big Dig", or more recently, Milwaukee's Marquette Interchange taking priority over routine maintenance. In their most recent annual report, Smart Growth America calculated that from 2009-2011, the most recent data available, state DOTs spent 55% of their funds annually to construct or expand only 1% of all roads.

On top of this, cost overruns are commonplace when it comes to public works megaprojects. One driver of these inflated costs is federal "prevailing-wage" requirements that force government projects to pay union style wages despite an abundance of labor at lower market rates. It's no surprise then that one comprehensive study from the Journal of the American Planning Association found that nine out of ten of these projects come in over budget, illustrating the dangers of simply throwing money at the problem.

When it was passed in 2009, President Obama called his stimulus bill "the largest new investment in our nation's infrastructure since Eisenhower built an interstate highway system in the 1950s." Despite this, only $48 Billion of the original $787 Billion total was earmarked for transportation infrastructure. Oftentimes, money earmarked for "stimulus" becomes another way to grow budgets for the general bureaucracy.

For the record, we aren't saying that upgrading infrastructure can't be beneficial, the construction of Denver's airport comes to mind as a crucial driver of the city's recent prosperity. And as we wrote last year, we also agree that the US would benefit from sensible debt financing. However, we think the country would be better served by locking in low rates to help service our debt not only today but in the future. This would give us time to catch our breath and fix our long-term fiscal problems, like Medicare, Medicaid, and Social Security.

As for infrastructure, if we really want to unlock investment potential in the US, the best way to do that is to reduce the regulatory and financial burdens that continue to dissuade private companies from pulling the trigger on big budget infrastructure projects. On this, the Trump administration's actions were right on the money. Not only is this cheaper for the tax payer, but it will also increase the odds that resources are allocated where they are most needed. When money is doled out politically it means resources are being shifted away from more productive uses, which hurts economic growth. We already know Government is bad at picking winners and losers, so why not give the private sector – and free markets - the incentive to lead the charge?

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

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Posted on Friday, August 18, 2017 @ 9:05 AM • Post Link Share: 
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  Industrial Production Rose 0.2% in July

 

Implications:  Industrial production rose in July as the most volatile sectors offset each other while "core" production, which is manufacturing excluding autos, rose 0.2%.   As a result, the headline measure for industrial activity rose 0.2% in July and is now up 2.2% from a year ago.  The weakest sector was autos, which fell 3.6% in July.  The decline in auto manufacturing has begun to accelerate recently, down 23.9% at an annual rate in the past three months versus a drop of 4.9% in the past year.  This has been driven by prior overproduction in the auto sector that left both new and used car dealers saddled with a glut of inventory.  Over the past couple of years, pent up demand for new vehicles after the financial crisis pushed sales temporarily above the long-term trend.  Production rose to meet that demand, but then overshot.  Now carmakers are paring back production to more normal levels which has been the cause of recent weakness.  A big source of strength in today's report was utilities, which jumped 1.6%, as hotter than average July weather pushed up demand for air conditioning.  Another positive contribution to today's headline number came from mining which rose 0.5% in July, and is now up at a 15% annual rate in the past three months versus 10.2% in the past year. Even though oil and gas-well drilling posted its first drop in 14 months in July, falling 1%, it is still up a massive 100% in the past year.  Based on other commodity prices, we think oil prices are below "fair value" range, but with oil companies profitable at current prices, mining should stay in recovery after the problems of the past two years. In other news this morning, the Philly Fed index, a measure of sentiment among East Coast manufacturers, came in at +18.9 for August. That's a decline from +19.5 in July, but still very high. Finally, on the employment front this morning, initial jobless claims fell 12,000 to 232,000, while continuing claims declined 3,000 to 1.95 million. These numbers point to continued strength in the labor market in August.

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Posted on Thursday, August 17, 2017 @ 11:07 AM • Post Link Share: 
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  Housing Starts Declined 4.8% in July
Posted Under: Data Watch • Home Starts • Housing

 

Implications:  Don't get hung up on July's negative headline number for starts; this isn't the end of the recovery in the housing market.  Almost all of the weakness was in multi-unit construction (Apartments, Duplexes, etc.), which are extremely volatile from month to month, and the underlying trends show single-family activity is still in a rising trend.  Multi-unit starts fell 15.3% in July and are down 33.7% from a year ago.  Meanwhile, single-family starts slipped only 0.5% in July and are up 10.9% from a year ago.  Permits to build show the divergence between multi-family and single-family should continue.  In the past year, building permits are down 9.8% for multi-family but up 13% for single-family.  This shift is unwinding the pattern that held in the early stages of the housing recovery, when multi-family led the way (2011-15).  Back in 2015, 35.7% of all starts were in the multi-family sector, the largest share since the mid-1980s, when the last wave of Baby Boomers was growing up and moving to cities.  In July, the multi-family share of starts was 25.9%.  The shift toward single-family is a positive sign for the economy because, on average, each single-family home contributes to GDP about twice the amount of a multi-family unit. This transition will continue going forward. We expect housing starts to rebound next month and continue to generally increase for at least the next few years.  Based on population growth and "scrappage," housing starts should eventually rise to about 1.5 million units per year.  And the longer this process takes, the more room the housing market will have to eventually overshoot the 1.5 million mark.  In other recent housing news, the NAHB index, which measures sentiment among home builders rose to 68 in August from 64 in July.  Expect further strength in the housing sector in the year ahead as more jobs, faster wage growth, and, for at least the time being, optimism about more market-friendly policies from the Trump Administration, continue to encourage both prospective home buyers and builders.       

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Posted on Wednesday, August 16, 2017 @ 10:25 AM • Post Link Share: 
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  Retail Sales Increased 0.6% in July
Posted Under: Data Watch • Retail Sales

 

Implications: So much for the theory that retail is dead.  Retail sales grew 0.6% in July, beating consensus expectations, and were revised up substantially for prior months.  Including those upward revisions, sales were up 1.1%.  The increase in July itself was broad-based with 10 of the 13 major categories showing gains.  Sales of autos led the way rising by 1.2% in July, growing the most for any month this year.  Store closures continue to popularize headlines implying a weak consumer.  More than 5,400 stores have closed so far in 2017, already more than all of last year, and on pace for more than in 2008 at the height of the Panic!  But don't take this as a sign of a weak economy. Consumers are just spending their money differently than in the past, buying more items via the internet.  In fact, non-store retail sales grew by 1.3% in July, the largest gain this year and now make up 11% of retail sales in July, the largest portion ever.  Just think about Amazon. Do you own an Amazon Prime membership? Chances are you do, and use it frequently.  As of the second quarter of 2017, it's estimated there are 85 million Amazon Prime memberships in the United States.  Assuming one membership per household that would mean 72% of households are Prime members.  What this means for the retail sector is a change in business models, not its demise.  "Core" sales, which exclude autos, building materials, and gas, rose 0.5% and were revised higher for previous months.  Overall sales are now up 4.2% from a year ago while "core" sales are up 3.6%.  Given Plow Horse economic growth, that's about what we'd expect given a 1.7% increase in the consumer price index in the past twelve months.  The fundamental trends that drive growth in consumer spending continue to look good.  These include healthy job growth, wage growth, and very low consumer financial obligations relative to historical norms.  In other news this morning, the Empire State index, a measure of manufacturing sentiment in New York, surged to 25.2 in August – the highest reading in nearly three years - from 9.8 in July.  In inflation news, import prices rose 0.1% in July and are up 1.5% from a year ago.  Export prices increased 0.4% in July, and have increased 0.8% in the past year.  Both figures are a stark contrast to the negative direction of prices in the twelve months ending in July 2016.

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Posted on Tuesday, August 15, 2017 @ 10:32 AM • Post Link Share: 
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  Consumers Are Doing Fine
Posted Under: Bullish • Monday Morning Outlook • Retail Sales

It's hard to read the business pages or watch the business news without seeing a story about the death of the consumer.  In particular, the business press continues to be obsessed by relative weakness among traditional brick and mortar stores.

There's no denying that the business model for delivering goods and services to consumers is changing fast.  But that doesn't mean the consumer, or retail in particular, is dead.  Far from it.       

Yes, in June, retail sales were up a tepid 2.8% from a year ago, 2.4% excluding auto sales.  But the consensus view is that retail sales were up 0.4% in July.  If so, retail sales, both overall and excluding autos, will be up about 3.5% from a year ago.

That's right about what we'd expect given Plow Horse economic growth and an overall consumer price index that's up 1.7% in the past year.  Remember, goods prices have been rising more slowly than prices for services for the past several years in a row and retailers focus on selling goods.
 
Meanwhile, sales at non-store retailers, which include internet sales, have been growing at a 10% annual pace.  That's the key reason many brick and mortar stores have been taking it on the chin: not weak sales overall, but a shift toward those who can deliver the goods (literally) with the least fuss.  Need to finally throw out those old pairs of underwear?  Well, you can either get in a car and drive to the store to buy some new ones or take only a minute and go to a website that will deliver the same new ones to your door.

Also, many Americans are getting more value out of the items they buy.  When your child outgrows a toy, you can put it on the Web and sell it, while those who don't mind getting something used can buy it for less.   

This week, many analysts will focus on the retail sales figures that come out of the Census Bureau each month, but figures from deep in the GDP reports show the consumer is doing fine.         

For example, in the second quarter of 2017, total spending on motorcycles was up 9% from a year ago.  Spending on boats used for personal pleasure was up 22%.  Spending on pleasure aircraft was up 16%.

These are not the hallmarks of a consumer in the throes of death. 

Yes, we are well aware that airplane ownership is not widespread.  And, for most of the country, boat ownership isn't either.  So let's look at some other kinds of spending as well.  Spending on amusement parks and campgrounds was up 13% compared to a year ago.  Meanwhile, Americans spent 11% more for veterinary services than a year ago. 

Sorry, but Spot would not be getting better health care if Americans weren't feeling pretty good.

None of this is to say that things couldn't be much better.  Of course they could!  But the economy as a whole and the US consumer in particular keeps plowing forward despite tax rates, regulation, and government spending that are all too high.     

Meanwhile, beneath the top line growth we do have, there's a huge battle being fought between business models, old versus new.  That's not a sign of weakness, though.  It's a tribute to the entrepreneurial spirit that has made America great.   

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

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Posted on Monday, August 14, 2017 @ 10:27 AM • 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, August 14, 2017 @ 7:52 AM • Post Link Share: 
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  North Korea and Stocks
Posted Under: Markets • Video • Stocks • Wesbury 101
Posted on Friday, August 11, 2017 @ 3:43 PM • Post Link Share: 
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  The Consumer Price Index Rose 0.1% in July
Posted Under: CPI • Data Watch • Inflation

 

Implications:  Consumer prices rose 0.1% in July, continuing the tame inflation that started in February.  Consumer prices rose at a 3.6% annual rate in the six months ending in January, and are now down at a 0.1% annual rate over the past six months.  So what's changed?  Energy prices declined substantially from mid-2014 through the start of 2016 and then rose through much of last year.  That rise helped push overall consumer prices up at a 3.6% rate in the six months ending in January.  But with energy prices generally down since then, overall inflation has been quiet as well.  Still, we think inflation is in a general rising trend.  Prices rose 0.2% in the twelve months through July 2015, 0.8% in the twelve months through July 2016, and 1.7% in the last twelve months.  Moreover, that acceleration in inflation has arrived despite oil prices being lower today than in 2015.   "Core" prices, which strip out the volatile food and energy components, have shown steadily rising prices of late, increasing in eleven of the last twelve months.  Within core inflation, a small sub-set of categories have kept prices from reaching or exceeding the Fed's 2% inflation target.  Cellphone service prices have declined 13.3% in the past year, while major household appliances are down 5.2% and vehicle costs are falling.  For the consumer these falling prices - which are the result of technological improvements and competition – plus rising wages mean increased spending power on all other goods. But it tempers inflation readings.  Meanwhile, costs for medical care and rent continue to push overall consumer prices higher.  We expect rents to accelerate in the year ahead as supply constraints get tighter in the housing market.  We still expect inflation to trend towards 2% in the medium term, and don't think the gains to consumers from falling prices in select areas are reason for concern or a justification for the Fed to slow the pace of rate hikes.  The best news in today's report is that real average hourly earnings rose 0.2% in July.  These earnings are up 0.7% over the past year, up at a 2.6% annual rate over the past six months, and a 3.0% annual rate over the past three months.  Because the Fed believes in the Phillips Curve, the trend of accelerating price and wage gains should have Fed officials focusing more on the potential for inflation to rise faster than desired as the jobless rate continues to fall below their long-term target.  That's why we expect the Fed to stick to their plan of starting to unwind the balance sheet while also raising rates one more time in 2017. 

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Posted on Friday, August 11, 2017 @ 10:42 AM • Post Link Share: 
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  The Producer Price Index (PPI) Declined 0.1% in July
Posted Under: Data Watch • Government • Inflation • PPI • Fed Reserve • Interest Rates

 
Implications:  Producer prices declined 0.1% in July, led lower by a 0.2% dip in services.  Within the service sector, margins for retailers and wholesalers led the index lower, down 0.5% in July.  Declining margins were broad-based, but were led by fuel retailers, chemical wholesalers, and auto retailers.  Goods prices also ticked lower in July, with energy prices falling 0.3%.  Taking out the typically volatile food and energy sectors, and you are left with "core" prices, which also declined 0.1% in July, but have risen 1.8% in the past twelve months, very close to the 1.9% gain in overall producer prices.  So in spite of the dip in prices in July, the trend is very close to the Fed's 2% inflation target.  As a result, today's data are unlikely to alter the Fed's view that further rate hikes are warranted, with one coming later this year, and it should soon announce the start of reductions in the size of its balance sheet.  We see a similar pattern with prices further up the production pipeline, with a drop in prices in July for both intermediate processed and unprocessed goods, but with these prices up 3.5% and 5.2% over the past year, respectively.  The Fed will keep all this in mind as it plans the path of monetary policy.  News out this morning on the Fed's other key area of focus, employment, showed that initial jobless claims rose 3,000 last week to 244,000.  Meanwhile continuing claims declined 16,000 to 1.95 million.  It's early, but taking these together and considering the Amazon hiring surge, suggests payrolls will be up in the neighborhood of 190,000 in August, a little faster than the 180,000 monthly average in the past year.

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Posted on Thursday, August 10, 2017 @ 11:29 AM • Post Link Share: 
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  “Shiller P-E” Still Wrong Signal

For many years now a relatively large contingent of analysts, investors and journalists has been convinced the stock market was in a bubble because the "Shiller P-E" ratio was just too high.  Back on 8/12/2013, in our Monday Morning Outlook, we made our case that the Shiller model was too pessimistic.  Now that looks like a pretty good call.

In the past four years, the bull market in stocks has continued, with the S&P 500 generating a total return – including both share price increases and reinvested dividends – of almost 60%, or more than 12% per year.

The response from many in the market is to say "OK, maybe a Shiller P-E ratio of 23.4 (from 8/2013) wasn't too high.  But now it's 30.5, and the bull market really is doomed."

As we said four years ago, Yale University economics professor Robert Shiller has made some great calls.  In his 2000 book, "Irrational Exuberance," Shiller argued that a 10-year average of corporate earnings smooths out the ups and downs of the business cycle.  Then, using this "cyclically-adjusted" level of earnings and comparing it to stock prices he claimed to generate a better version of the P-E ratio.  It was an all-time high in 1999-2000, a clear signal of a "bubble" in stocks. 

Several years later, Shiller warned investors about a housing bubble: Another prescient call.  Although we don't see eye to eye with Shiller about how the economy works, no one should doubt his intelligence or sincerity.

But that doesn't make him infallible.  We still think the Shiller P-E is painting an overly pessimistic view of the stock market.  One basic flaw is that by using a ten-year time horizon for earnings, the Shiller P-E includes a massive drop in earnings from 2008-09 generated by awful political management of the economy and a mis-use of mark-to-market accounting.

But even if you take the Shiller P-E at face value, the situation isn't as bad as some claim. 

Let's go back to December 1999, when the Shiller P-E peaked at 44.20, the highest level on record.  That P-E corresponds to an earnings yield of 2.26% (100 divided by the Shiller P-E).  At the time, 10-year Treasury Notes were yielding 6.28%.  In that environment, investing in Treasury securities was clearly the better deal.  The following ten years proved that proposition, with the S&P generating an annualized total return of -0.9%.

Next look at May 2007, when the Shiller P-E peaked at 27.55 prior to the last recession.  That translates into an earnings yield of 3.63%.  At the time, the 10-year Treasury yield was 4.75%. 

At first glance it looks like bonds were more attractive.  But that doesn't factor-in the potential of corporate earnings growth.  And, in the end, despite the deepest recession since the Great Depression, earnings growth helped generate a higher return for stocks than for bonds.  In the ten years after May 2007, the S&P generated a total return of 6.9% per year, beating the 4.75% on a 10-year Treasury Note.

Where does this leave us today?  A Shiller P-E of 30.5 corresponds to an earnings yield of 3.28%, which is already more generous than the yield on any Treasury security.

The 10-year Note yield would have to be 7.3% today for the stock market to be as bad a deal relative to bonds as it was back in 1999.  (Take today's earnings yield and add the gap between the Treasury yield and earnings yield in 1999, or 3.28% + (6.28% - 2.26%) = 7.30%)  

For stocks to be as "bad" a deal as they were in May 2007, the 10-year Note yield would have to be about 4.4% today, which remember, even then didn't mean bonds beat stocks.

Moreover, all these comparisons will look even better once the 2008-09 atypical earnings swoon drops out of the ten-year earnings window.

This economic expansion is not over.  Earnings have, and will, continue to grow.  And, as we said four years ago, those who swear by the Shiller P-E are going to be underinvested in stocks.  This bull market has a long way to go.       

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

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Posted on Monday, August 7, 2017 @ 10:08 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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