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   Brian Wesbury
Chief Economist
 
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  Ignore Greece
Posted Under: Double Dip • Europe • Government • Spending
Don’t let anyone tell you Greece is sticking up for its "dignity" by fighting “austerity.” The current Greek government is sticking up for socialism by fighting reality.

After several years of working toward some very minor market-friendly reforms, and finally starting to see a glimmer of economic growth, Greece elected a far left government back in January. Its economic and financial situation has gotten worse ever since. Instead of trying to boost growth and pay its debts, by trimming government spending and reducing regulation, the government is saying it won't cut retirement benefits and wants to raise taxes on what little private sector it has left.

Since Greece no longer has its own currency, it can’t just devalue and cut pension benefits by sleight-of-hand. Instead, politicians have to make tough choices. Greece finally ran out of other peoples’ money. And, since private investors will no longer buy Greek bonds, it has to count on government entities. Fortunately, so far at least, the IMF, the EU, and the ECB have refused to support the status quo.

So what does the new government do? It blames the only groups willing to lend it money and refuses to cut spending. Then, it decides to have a vote, scheduled for July 5th, on the lenders’ latest offer, which would combine higher taxes with pension cuts and some other market reforms. This referendum is all about politicians running scared. They don't want to make the choice themselves, so they put it to a vote, again.

But Greece has debt payments to make this week, before the vote, on which it’s likely to default. Worse, the government is urging citizens to vote against the lenders’ offer.

Meanwhile, Greek banks have seen massive outflows of deposits. To meet the demand for liquidity, Greek banks have been getting Euros from the Bank of Greece (their central bank), which prints them with permission from the ECB. But now that a debt default is a serious concern, the ECB has withdrawn its permission for the Bank of Greece to print more Euros.

So, the Greek government has declared a “bank holiday” until July 6, during which depositors can only withdraw 60 euros per day. Greece also imposed capital controls to try to keep Euros in the country. This is a travesty, and Greece is headed for a double-dip Depression.

Fortunately, Greece is not Lehman Brothers. It's like Detroit. When Detroit defaulted, the U.S., and even Michigan, survived just fine. Detroit had already wasted the money it had borrowed, and so has Greece. The only thing left is recognizing the loss. That does not damage the economy; it will be absorbed by the IMF, EU, and ECB.

What Europe wouldn’t be able to absorb is if it caved to the Greek government, if it let them rollover their debts without insisting on reforms that will help Greece eventually repay its obligations. That would bring more Euro leftists into government and lead to even more stagnation and default in the future.

Regardless of how this turns out, it's getting way more press than it deserves. Any sell-off in US equities is a buying opportunity. Stay the course.

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

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Posted on Monday, June 29, 2015 @ 10:55 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, June 29, 2015 @ 7:40 AM • Post Link Share: 
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  Personal Income Increased 0.5% in May
Posted Under: Data Watch • PIC

 
Implications: Whatever happened to the theory that consumers would just pocket the savings from lower energy prices instead of spending it? Instead, consumer spending came back with a vengeance in May, rising 0.9%, the fastest pace for any month since 2009. And that was back when the government was using “cash-for-clunkers” to pass out checks to car buyers. Skipping that program, we’d have to go back to 2006. “Real” (inflation-adjusted) consumer spending is up 3.4% from a year ago, also the fastest growth since 2006. Expect more of this in the year ahead. Payrolls are growing about three million per year and wage growth is accelerating as well. Private-sector wages & salaries are up a robust 5.7% in the past year. Total income – which also includes rents, small business income, dividends, interest, and government transfer payments – increased 0.5% in May and is up 4.4% in the past year, faster than the 3.6% gain in consumer spending. This is why consumers have enough income growth to keep on lifting their spending without getting into financial trouble. One part of the report we keep a close eye on is government redistribution. In the past year, government transfers to persons are up 5%, largely driven by Obamacare. However, outside Medicaid, government transfers are up a slower 4.3% in the past year and unemployment compensation is the lowest since 2007. The bad news is that overall government transfer payments – Medicare, Medicaid, Social Security, disability, welfare, food stamps, and unemployment comp. – aren’t falling back to where they were before the Panic of 2008, when they were roughly 14% of income. In early 2010, they peaked at 18%. Now they are down to 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, increased 0.3% in May. Although it’s only up 0.2% from a year ago, it’s been held down by falling energy prices. The “core” PCE deflator, which excludes food and energy, is up 1.2% from a year ago. That’s still below the Fed’s 2% inflation target, but it’s up at a 1.7% annualized rate in the past three months. Now that energy prices have leveled off, look for overall inflation to move up toward “core” inflation over the rest of the year. In other news this morning, initial claims for unemployment insurance rose 3,000 last week to 271,000, the 16th straight week below 300,000. Continuing claims for regular state benefits increased 22,000 to 2.25 million. These claims numbers are at rock bottom levels and are about as good as it gets.

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Posted on Thursday, June 25, 2015 @ 10:24 AM • Post Link Share: 
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  Real GDP Growth in Q1 was Revised up to a -0.2% Annual Rate
Posted Under: Data Watch • GDP

 
Implications: Today’s final GDP report for the first quarter showed a smaller contraction than previously reported, but still only provides a distorted “rearview mirror” picture of the economy. Real GDP growth declined at a -0.2% annual rate in Q1 versus last month’s estimate of -0.7%. However, “final” never really means “final” when it comes to government reports – it will be revised many times in the years ahead. The most recent issue with GDP data is the realization that over recent decades there has been a persistent underestimation of growth in Q1 because of faulty seasonal adjustments. In July, the BEA will attempt to fix this and we expect these revisions to show that real GDP actually increased in Q1, probably at a pace of about 1%. That’s still below the roughly 2.5% trend of the past two years, but it will show that port strikes, collapsing oil prices and harsh winter weather didn’t undermine growth completely. And, just like last year, we expect growth in Q2 and Q3 to rebound. This supports our view that the Federal Reserve will start raising short-term interest rates by September. We think a rate hike is already overdue. Nominal GDP growth – real GDP growth plus inflation – is up 3.8% from a year ago and up 3.5% annualized in the past two years, much too high for a short-term interest rate near zero. Today’s report also provided a second look at overall corporate profits, and just like GDP, the headline was revised higher. Corporate profits declined 5.2% in Q1, better than the originally reported 5.8% decline. The drop in both real GDP and profits resembles what happened in the first quarter of last year, after which profits rebounded sharply. Keep in mind that despite the drop in Q1, corporate profits are still up 4.5% from a year ago.

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Posted on Wednesday, June 24, 2015 @ 11:31 AM • Post Link Share: 
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  New Single-Family Home Sales Increased 2.2% in May
Posted Under: Data Watch • Home Sales • Housing

 
Implications: Excellent report out of the housing market today as purchases of new homes rose to the fastest pace in seven years, signaling that buyers are once again on the hunt. Sales of new homes rose 2.2% in May, exceeding even the most optimistic forecasts, and are up 19.5% from a year ago. This is one reason we think the Federal Reserve will move forward with raising rates by September. In fact, all the talk about the Fed raising rates is probably getting some buyers into the market sooner, thinking they can avoid paying higher mortgage rates in the future. Meanwhile, today’s data is very good news for homebuilding activity in the year ahead. The months’ supply of new homes fell to 4.5 in May from 4.6 in April as sales picked up but inventories remained unchanged. And although the raw inventory of unsold new homes is up in the past year, all of the increase is due to homes where construction hasn’t even been started. The number of completed homes sitting unsold is unchanged from a year ago, and still at very low levels, while the number of unsold new homes still under construction is down from a year ago. As a result, builders have plenty of room to increase both construction and inventories. However, sales still remain depressed relative to history. We think there are a few reasons for this. First, a larger share of the population is renting. Second, buyers have shifted slightly from single-family homes, which are counted in the new home sales data, to multi-family homes (think condos in cities), which are not counted in this report. Third, although we may be starting to see a thaw, financing is still more difficult than it has been in the past. Each of these is beginning to change. Recently, single-family housing starts have showed some signs of picking up relative to multi-family starts, suggesting builders (the quintessential entrepreneur) see a larger appetite for homeownership and single-family home purchases. In other housing news this morning, the FHFA index, which measures prices for homes financed with conforming mortgages, increased 0.3% in April and was up 5.3% from a year ago. In the twelve months ending in April 2014 and April 2013, the index was up 6.0% and 7.2%, respectively. In other words, while home prices continue to rise, they’re doing so at a slower rate as a more robust pace of home building brings supply closer in-line with demand. Expect more of the same in the year ahead.

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Posted on Tuesday, June 23, 2015 @ 11:25 AM • Post Link Share: 
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  New Orders for Durable Goods Declined 1.8% in May
Posted Under: Data Watch • Durable Goods

 
Implications: Don’t judge a book by its cover. Although the headline number for new orders of durable goods fell 1.8% in May, the underlying details of the report were more encouraging. The decline in overall orders was due to the very volatile transportation sector, specifically a 35.3% drop in civilian aircraft orders, which brought the overall transportation sector down 6.4% in May. Orders excluding transportation rose 0.5% as most major categories showed small gains. Orders for durables had been facing downward pressure from the drop in energy prices since the middle of last year. But, now that energy prices have stopped falling and have somewhat stabilized, orders for durables outside the transportation sector should continue to move higher. Orders for machinery used for mining and in oil and gas fields were down 40% in the year ending in March. But these machinery orders were up slightly in April and overall machinery orders were up 0.5% in April and 0.4% in May. “Core” shipments, which exclude defense and aircraft, rose 0.3% in May. If unchanged in June, “core” shipments will be up at a 1.6% annual rate in Q2 versus the Q1 average. Plugging these and other recent data into our models, we are forecasting an upward revision to Q1 real GDP growth to a -0.3% annual rate from a previous government estimate of -0.7%. However, just like last year, we expect a rapid rebound in real GDP growth in Q2. We also expect stronger gains in orders for durables in the year ahead. Consumer purchasing power is growing with more jobs and higher incomes, while debt ratios remain very low, leaving room for an upswing in big-ticket spending. Meanwhile, profit margins are high, corporate balance sheets are loaded with cash, and capacity utilization is near long-term norms, leaving more room (and need) for business investment. In other news today, the Richmond Fed index, which measures mid-Atlantic factory sentiment, rose to +6 in June from +1 in May. As a result, it looks like the national ISM Manufacturing index will be up in June.

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Posted on Tuesday, June 23, 2015 @ 10:30 AM • Post Link Share: 
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  M2 and C&I Loans
Posted Under: Government • Fed Reserve

 
Source: St. Louis Federal Reserve FRED Database
Posted on Monday, June 22, 2015 @ 12:37 PM • Post Link Share: 
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  Stocks Are Still Cheap
Posted Under: Bullish • Government • Markets • Monday Morning Outlook • Fed Reserve • Interest Rates • Stocks
You know those TV shows – the ones about ice trucking, fishing in Alaska, or digging for gold. They’re made to bring out these interesting jobs, but also the danger. They leave you hanging, and break for commercial, just when the truck starts to slide on a bridge, or just when a huge wave is approaching.

If you watch long enough, you realize that, yes, these are tough jobs, but major accidents are few and far between because “these guys and gals are good” – they know what they are doing. Things become routine and viewership falls off after season two and they’re taken off the air.

Not so with financial markets. Every day, at least for the past six years or so, investors get to see a new episode. And every day there’s another potential danger. It’s mesmerizing, the danger never stops and apparently nothing becomes routine.

Resetting ARMs were taken off the air. Cyprus, the dollar’s reserve currency status, and the hidden inventory of unsold homes, too. Greece hangs around because we can get pictures of protests and riots. But, the latest episode, the one that says earnings are slowing just when interest rates are going up, well, maybe, just maybe, this is the one that needs to be taken seriously. After all, earnings and interest rates are key components of stock market values. In fact, they are the key components of our capitalized profits market model.

So when some analysts, who we respect, highlight the recent weakness in overall corporate earnings growth, our ears finally perk up. Is this true? Is this something to worry about, or is it still just noise?

We believe it is much ado about nothing. In June of 2014, energy stocks made up 10.9% of S&P 500 market cap and we all know what happened to energy prices - oil prices and natural gas prices are both down roughly 40% from a year ago. That has dragged down overall S&P 500 earnings.

But, when we look at equity values, we use government estimates of total corporate profits, and for the economy as a whole, the energy sector generates only about 3% of total corporate profits. So the weakness in energy earnings is not as important for the whole economy as it is for energy stocks or indices that have a heavy energy weighting. Moreover, even within the S&P 500, with all Q1 results in, non-energy earnings were up 11.7% from a year-ago.

Of course, if you pick and choose which sectors to exclude, you can always find a silver lining. But consumers and businesses are only starting to shift resources away from the energy sector to other purchases and investment, it hasn’t happened overnight. As a result, weak earnings in the energy sector will, over time, generate higher earnings elsewhere.

This is why we use a Capitalized Profits Model to assess stock market value. Our model uses after-tax corporate profits discounted by the 10-year Treasury. And in spite of soft total profits in Q1, including the energy sector as well as weather-related issues, the model says the S&P 500 is still undervalued. Using the current 10-year Treasury yield (2.35%), our models say the “fair value” of the S&P 500 is 4,335.

This number is artificially high because the discount rate is being held down by the Federal Reserve keeping short-term rates artificially low. Using a 4% 10-year discount rate gives us a “fair value” calculation of 2,550 and it would take a 10-year yield north of 4.8% and no growth in corporate profits in Q2 for the model to suggest equities are fully valued.

None of this means equities are as attractive today as they were back in March 2009. Nor does it mean we won’t have a “correction” in equities at some point. What it does mean is that after considering their risk profile, age, and financial goals investors should be more tilted toward equities than they would normally be and we believe those that are should continue to enjoy attractive returns over at least the next couple of years. This bull has further to run.

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

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Posted on Monday, June 22, 2015 @ 12:22 PM • Post Link Share: 
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  Existing Home Sales Increased 5.1% in May
Posted Under: Data Watch • Home Sales • Housing

 
Implications: Today’s report on existing home sales was as good as anyone could expect, with a broad-based gain in sales and higher-prices bringing fence-sitting sellers into the market. Sales increased to a 5.35 million annual rate in May, beating consensus expectations to hit the highest level since November 2009, back when the government was passing out checks to first-time homebuyers to artificially support sales. Excluding that one month, sales were the highest since 2007. Sales were up in every major region of the country and should continue to trend upward. All-cash buyers are down to 24% of sales from 32% a year ago. As a result, while total sales are up a healthy 9.2% from a year ago, non-cash sales (where the buyer uses a mortgage loan) are up a more robust 22%. So when all-cash sales eventually bottom out, total sales will start rising at a more rapid pace. The gain in mortgage-financed sales suggests a long-overdue thaw in lending. What’s interesting is that the percentage of buyers using credit has increased as the Fed tapered and then ended QE. Those predicting a housing crash without more QE were completely wrong. In fact, some buyers may be getting into the market because they see rate hikes on the horizon. The details of the report were also solid. The inventory of existing homes increased 3.2% in May and the number of homes for sale was the highest for any May since 2012, signaling that some homeowners that had been holding out are finally putting their homes on the market. Meanwhile, houses on the market continue to sell quickly. Even though the average time it took to sell a home in May increased to 40 days from 39 in April, 45% of homes sold in May were on the market for less than a month before being purchased. In other words, the demand is there. This was reflected in the median sales price of an existing home rising to $228,700 in May, up 7.9% from a year ago, and marking 39 consecutive months of year-over-year price gains. Look for more price gains in the year ahead, but slower, as more inventory comes on the market.

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Posted on Monday, June 22, 2015 @ 12:05 PM • Post Link Share: 
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  The Consumer Price Index Increased 0.4% in May
Posted Under: CPI • Data Watch • Inflation

 
Implications: In the past four months the CPI has grown at a 3% annualized rate, the fastest pace since 2012. This is not just due to the recent (partial) rebound in energy prices: excluding the volatile food and energy sectors, the CPI is up at 2.4% annualized rate over the same period. Either way you look at it, the recent pace of inflation has been running above the Fed’s 2% target and could eventually put pressure on the Fed to raise rates faster than the market expects. Overall consumer prices rose 0.4% in May but are unchanged over the past twelve months. The lack of headline inflation in the past year is due to energy prices, which rose 4.3% in May but remain down 16.3% from a year ago. “Core” prices, which exclude food and energy, increased 0.1% in May, are up 1.7% in the past twelve months, 2.1% annualized in the last six months, and 2.4% annualized since January. In other words, core prices are gradually accelerating upward. With core prices so close to the Fed’s two percent inflation target, policymakers should remain concerned about future increases in inflation, even with overall consumer prices near zero. “Core” consumer prices in May were led higher by housing. Owners’ equivalent rent, which makes up about ¼ of the CPI, rose 0.3% in May, is up 2.8% in the past year, up at a 3.2% annual rate in the past three months, and will be a key source of higher inflation in the year ahead. Some analysts will use the fact that overall prices are flat from a year ago to warn about “Deflation.” But true deflation – of the kind we ought to be concerned about – is caused by overly tight monetary policy and price declines that are widespread, not isolated to one sector of the economy. Think of the Great Depression. On the earnings front, “real” (inflation-adjusted) average hourly earnings declined 0.1% in May, but are up a healthy 2.2% in the past year. In other news this morning, initial claims for unemployment insurance fell 12,000 last week to 267,000, the 15th straight week below 300,000. Continuing claims for regular state benefits dropped 50,000 to 2.22 million. These figures are consistent with payroll growth of about 230,000 in June. Meanwhile, the Philadelphia Fed index, a measure of strength in East Coast manufacturing, jumped to 15.2 in June, the highest so far this year, from 6.7 in May, supporting the case that the economy is reaccelerating after temporary headwinds in the first quarter.

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Posted on Thursday, June 18, 2015 @ 10:06 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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