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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  Yes, There Was a Housing Bubble, But Not Now
Posted Under: Home Starts • Housing • Monday Morning Outlook

One of the worst bipartisan policy decisions in the past generation was the aggressive government push in the 1990s and 2000s to promote homeownership, beyond what the free market could handle.  Policymakers encouraged Fannie Mae and Freddie Mac to gobble up lots of subprime debt, in turn boosting lending to borrowers who couldn't handle their loans.           

But now a bizarre idea is making the rounds that, looking back on it, maybe there wasn't a housing bubble at all! 

The theory is that home prices are already up substantially from where they were at the prior peak during the "bubble," so maybe those "bubble" prices were not that high after all.  Compared to the prior peak in 2007, the national Case-Shiller index is up 15%, while the FHFA index, which measures the prices of homes financed with conforming mortgages, is up 24%. 

But a great deal has changed since the prior peak, which makes it much easier to justify the higher prices of today.  To assess the "fair value" of homes, we use a Price-to-Rent (P/R) ratio, which compares the asset value of all owner-occupied homes (calculated by the Federal Reserve) to the "imputed" rental value of those homes (what owners could fetch for their homes if they rented them, as calculated by the Commerce Department).  Think of it like a P/E ratio: the price of all owner-occupied homes, compared to what those same homes would earn if they were rented. 

For the past 40 years, the median P/R ratio is 16.0.  At the peak of the housing bubble, the ratio hit a record-high of 21.4.  In other words, prices were 34% above fair value.  During the housing bust, the ratio plunged to 14.1, meaning national average home prices were 12% lower than you'd expect given rents.  Temporarily, that made sense: prices had to get below fair value to clear the excess inventory.                    

Today, the P/R ratio stands at 17.0, which means home prices are 6% above their long-term average relative to rents.  That's well within the normal historical range, and no reason to sell.

Comparing home values to replacement costs shows a similar pattern.  That median ratio in the past forty years has been 1.58, compared with 1.59 today (almost exactly fair value) and 1.94 at the peak in 2005 (23% above fair value).

Either way you slice it, bubble era home prices really were far in excess of what you'd expect given rents and replacement costs, while prices today look reasonable. 

We expect home prices to keep moving higher, but not as fast as in the last few years.  Meanwhile, the climb in average home prices will diverge at the local level.  Due to the limit on state and local tax deductions, expect high tax states to show flat home prices (on average), while low-tax states experience stronger price gains.    

One of the reasons we remain optimistic about economic growth in general is the continued recovery in home building. 

Housing starts bottomed in 2009, when builders began just 554,000 homes, 73% below the 2.073 million pace at the peak of the housing boom in 2005.  Since 2010, the number of housing starts has increased in every year, hitting 1.300 million in 2019. 

Starts have been much higher in recent months due to the unusually mild winter weather throughout much of the country.  And while we may see a pullback in the coming months as weather patterns return to normal, we anticipate at least a few more years of gains in home building.  Given population growth and scrappage (knock downs, fires, floods, hurricanes, tornadoes...etc), builders have simply started too few homes since the bust.  Now it looks like they need to overshoot to make up for lost time.  In turn, expect new home sales to follow starts higher.  

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

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Posted on Monday, February 24, 2020 @ 11:47 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, February 24, 2020 @ 8:49 AM • Post Link Share: 
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  Existing Home Sales Declined 1.3% in January
Posted Under: Data Watch • Home Sales • Housing


Implications:  Existing home sales fell slightly in January, but remained on the broader upward trend that began a year ago.  The decline in January was entirely contained to the West region while in the rest of the country sales remained unchanged or eked out small gains.  That said, the details in today's report were disappointing, as the inventory of existing homes was down 10.7% versus a year ago (the best measure for inventories given the seasonality of the data).  Unless reversed soon, this will likely be a headwind for future sales.  The primary culprit behind the weak existing home market in 2018 was lack of supply.  A consistent decline in inventories along with a rising sales pace has driven down the months' supply – how long it would take to sell the current inventory at the most recent sales pace – to only 3.1 months in January, just above December's reading of 3.0 which was the lowest on record going back to 1999.  Notably, this measure has now been below 5.0 months (the level the National Association of Realtors considers tight) since late 2015.  With demand so strong that 42% of homes sold in January were on the market for less than a month, inventories remain crucial to sales activity going forward.  The good news is that builders are beginning to respond. The total number of housing units under construction and the number of new housing starts have been rising lately and now sit at or just below post-recession highs.  As these properties are finished, and people trade up or down to a new home, more inventory of existing homes will become available.  More construction will be doubly important for properties worth $250k or less, where sales have sputtered and the decline in inventories has been the greatest.  In other recent news, initial claims for unemployment benefits rose 4,000 last week to 210,000 while continuing claims rose 25,000 to 1.726 million.  Despite the increase, both measures remain subdued and signal continued growth in payrolls in February.  On the manufacturing front, the Philly Fed Index, a measure of East Coast factory sentiment, surged to +36.7 in February from +17.0 in January.  This is the highest reading since early 2017 and echoes a recent rebound in the Empire State Index, pointing to a continued recovery in the US manufacturing sector.

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Posted on Friday, February 21, 2020 @ 11:37 AM • Post Link Share: 
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  Housing Starts Declined 3.6% in January
Posted Under: Data Watch • Home Starts • Housing


Implications:  Great news on the housing market in January.  Although housing starts fell versus December, they came in substantially higher than the consensus expected.  In fact, with the exception of the massive surge in December, the 1.567 million annualized pace of starts in January was the highest since 2006.  The recent strength in housing starts is in part due to unusually mild weather through much of the country so far this winter.  However, it's not just about the weather.  Building permits jumped 9.2% in January and hit the highest level since 2007, a good sign for construction later in 2020.  We think home building will remain on the upward trend it's been in since 2011.  Based, on fundamentals (population growth and scrappage) the US needs to start about 1.5 million homes each year, a level that was only recently hit in December 2019.  Given how long it's taken to get back to that level, there's also some room for overshooting to make up for lost time.  In other recent housing news, the NAHB index, which measures sentiment among homebuilders fell one point to 74 in February from 75 in January, remaining just below the 20-year high of 76 set in December 2019.  It's not hard to see why builders remain optimistic about the housing market.  Mortgage rates have dropped roughly 110 basis points since the peak in late 2018 while wages continue to grow at a healthy pace, boosting affordability.  Our outlook on housing hasn't changed: we continue to anticipate a rising trend in home building in the next few years.

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Posted on Wednesday, February 19, 2020 @ 11:31 AM • Post Link Share: 
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  The Producer Price Index Rose 0.5% in January
Posted Under: Data Watch • PPI


Implications:  Producer prices surged 0.5% in January, the largest monthly increase since late 2018.  With the January rise, producer prices are up 2.1% in the past year, breaching the 2% level last seen in May of 2019.  Services led prices higher in January, rising 0.7%, while prices for goods increased 0.1%.  Goods prices were held lower by energy costs, which declined 0.7%.  Food prices rose 0.2% in January, as rising costs for vegetables and grains more than offset a decline in prices for eggs.  Strip out the typically volatile food and energy categories, and "core" prices also rose 0.5% in January, tied for the largest monthly increase since the series began back in 2010.  Within core prices, the rise was led by margins to retailers, particularly apparel, jewelry, footwear, and accessories, which saw prices jump 10.3% in January.  "Core" goods rose 0.3% in January, with prices for iron and steel scrap up 13.9%.  In the past year, services prices are up 2.0% while goods prices are up 1.8%.  Core prices as a whole are up 1.7% over the past twelve months.  We expect core prices to follow the headline number toward 2% in 2020. Further down the pipeline, prices for intermediate demand processed goods declined 0.3%, while intermediate demand unprocessed goods fell 0.6%.  Both intermediate demand categories continue to show prices broadly lower compared to year-ago levels.  Taken altogether, today's report reinforces the Fed's plan to leave rates unchanged in 2020.  Core consumer inflation stands above 2% on a twelve-month basis, while core PCE prices (the Fed's preferred measure) are up 1.6% in the past year.  Paired with the very healthy employment market, these signal an economy with no need for more Fed rate cuts.  In recent manufacturing news, the Empire State Index, which measures factory sentiment in the New York region, jumped to +12.9 in February from +4.8 in January as rising orders and shipments led the index higher.  We're still waiting in other regional surveys arriving late this month, but the gain in the Empire index hints at an increase in the national manufacturing index for February. 

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Posted on Wednesday, February 19, 2020 @ 11:21 AM • Post Link Share: 
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  Lessons from Japan?
Posted Under: Government • Markets • Monday Morning Outlook • Fed Reserve • Interest Rates • Spending • Stocks

Thirty years ago, many in the US were in fear that a rising power in Asia was on the verge of eclipsing the US.  Now it's China, back then it was Japan.

Back in the late 1980s Japan had become the second largest economy in the world after the US and seemed like a juggernaut that couldn't be stopped.  Many center-left economists thought that the post-World War II experience of Japan proved that industrial policy could work, with the government picking winners and losers and making sure favored industries and companies always got the credit they needed to grow.  They were eager to bring that approach to the US. 

History, however, had other plans.  Japanese government policies bottled up capital in favored industries and pulled it away from widespread entrepreneurship.  This meant the massive savings generated by Japanese workers were misallocated into a limited pool of domestic assets, with capital gains tax rates that favored listed stocks and drove up real estate prices.  The result was dual massive bubbles, with stocks far more overvalued than US stocks were in 2000 while Japanese real estate was far more overvalued than the US was in 2005.  As a sign of how large that bubble was, the Nikkei is still about 40% below the high set in 1989. 

That peak in asset prices also coincided with a dramatic slowdown in economic growth that has lasted thirty years.  To put an exclamation point on that, Japanese real GDP fell at a 6.3% annual rate in the fourth quarter of 2019.  This was before any impact from the coronavirus and the largest quarterly decline in six years.  While pandemics are serious and scary, the real cause of the drop was a national sales tax hike from 8% to 10%.  Real GDP is now down 0.4% from a year ago.

It's deja vu.  Japan keeps trying over and over again to boost economic growth with government policy – a combination of high government spending, high budget deficits, high taxes, quantitative easing, and, beginning in 2016, negative interest rates.  Sounds exactly like what policymakers in Europe have tried, but more of it and for longer.

None of this has worked, and it won't work in the US, either.  Not now, and not if we eventually go into a recession, which, thankfully we don't foresee anytime soon. 

In contrast to Japan, the US has lower taxes, lower (but still too high) government spending, a central bank that maintains positive short-term interest rates, and a much healthier economy, with equities at or near record highs while the jobless rate heads toward what could be the lowest unemployment rate since the Korean War.  

Instead of more of the same, we think Japan would benefit from shifting the mix of policies toward the supply-side, with big tax cuts on business investment and profits, and ending negative interest rates like Sweden just did.  And, given a falling population, this could be coupled with much larger tax deductions for parents.

Meanwhile, instead of raising the sales tax, with long-term interest rates at essentially zero, Japan should take a page from Great Britain's history and convert their debt into "perpetual" securities (called "consols"), paying whatever interest rate the market demands (near zero!) but without the need to repay principal.

Don't hold your breath waiting for this kind of policy shift.  Instead, Japan looks poised to continue to muddle through continuing to believe that government can manage economic growth and not trusting entrepreneurs and freedom.  Unless Japan starts trusting supply-side policies instead of demand-side fallacies, they will continue to be doomed to make the same mistakes.

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

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Posted on Tuesday, February 18, 2020 @ 11:49 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 Tuesday, February 18, 2020 @ 8:39 AM • Post Link Share: 
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  Industrial Production Declined 0.3% in January
Posted Under: Data Watch • Industrial Production - Cap Utilization


Implications:  Industrial production started off 2020 on a soft note as warmer than usual weather pushed down utilities output and problems at Boeing weighed on manufacturing.  The production halt surrounding the 737 MAX caused a decline of 9.1% in the production of aerospace products and parts in January.  However, excluding the production of aircraft and parts, manufacturing rose a healthy 0.3%.  The auto sector also rebounded in January, posting a gain of 2.4%.  Notably, even with the Boeing disruption, manufacturing has been accelerating lately, up at an annualized pace of 3.9% over the past three months versus a decline of 0.9% over the past year.  It will remain difficult to get a true reading on manufacturing over the next couple months as issues surrounding coronavirus and Boeing distort the data, but we expect a rebound in activity in 2020 as we put some of the major headwinds for the factory sector in 2019  behind us.  The GM strike is over, USMCA has been passed, and a Phase One trade deal with China has been signed.  Turning to utilities, output dropped for a second consecutive month as unseasonably warm weather throughout much of the country continued in January and reduced demand for heating.  Finally, mining output rose 1.2% in January, fueled by a broad-based increase in oil, gas, and mineral extraction. This is somewhat surprising as the price of WTI crude fell 18.5% in January, demonstrating the resiliency of US producers.  In the past year mining activity is up 3.1%, the best performer of all major categories.   

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Posted on Friday, February 14, 2020 @ 11:28 AM • Post Link Share: 
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  Retail Sales Rose 0.3% in January
Posted Under: Data Watch • Retail Sales


Implications:   A respectable report on the US consumer.  Retail sales grew 0.3% in January and are up a solid 4.4% from a year ago.  The gain was widespread, as sales rose in nine of thirteen major categories.  Restaurants & bars, along with building materials, led the way rising 1.2% and 2.1% in January, respectively.  Building materials grew by the most since August of last year, partly due to the unusually mild January weather. This milder weather most likely affected sales at clothing and accessory stores, as well, holding down this category.  Less need to buy winter apparel when temperatures are higher than usual.  There should be no doubt the consumer is doing well.  "Core" sales, which exclude autos, building materials, and gas stations (the most volatile sectors) grew 0.2% in January, and are up 3.8% from a year ago.  Jobs and wages are moving up, companies and consumers continue to benefit from tax cuts, consumer balance sheets look healthy, and serious (90+ day) debt delinquencies are down substantially from post-recession highs.  For these reasons, expect continued solid gains in retail sales in the year ahead.  In inflation news today, import prices were unchanged in January, as falling fuel prices offset increasing prices for nonfuel imports.  Meanwhile, export prices rose 0.7%, with rising prices for both agricultural and nonagricultural exports contributing to the overall increase.  In the past year, import prices are up 0.3%, while export prices are up 0.5%.  Given loose monetary policy, expect higher inflation by later this year.

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Posted on Friday, February 14, 2020 @ 11:19 AM • Post Link Share: 
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  The Consumer Price Index (CPI) Rose 0.1% in January
Posted Under: CPI • Data Watch • Government • Inflation • Fed Reserve

Implications:  Consumer prices increased 0.1% in January, with prices rising in nearly every major category.  Prices for housing, medical care, and food led the index higher in January, partially offset by a decline in the cost of gasoline.  Consumer prices are up 2.5% in the past year, tied for the largest twelve-month increase going back to August of 2018.  Strip out the typically volatile food and energy sectors, and "core" prices rose 0.2% in January.  In addition to housing and medical care, prices for apparel, recreation, education, and airline fares pushed the core reading higher.  Core prices are up 2.3% in the past year, just a tick off the highest annual increase we have seen since the recovery started.  And "core" prices have hovered at or above the Fed's 2% inflation target for twenty-three consecutive months.  Add in employment data continuing to show strength and it makes sense the Fed doesn't expect further rate cuts unless we see a material change in the economic outlook.  On the wage front, average hourly earnings rose 0.2% in January and have increased 3.1% in the past year.  Take out inflation, and "real" earnings rose 0.1% in January and are up a modest 0.6% in the past year.  With the strength of the labor market, we believe earnings will trend higher in 2020.  Healthy consumer balance sheets, a strong job market, inflation in-line with Fed targets, and the continued tail winds from improved tax and regulatory policy, all reinforce our belief that the economy will continue to grow at a healthy pace in the year ahead.  In other news this morning, new claims for unemployment benefits rose 2,000 last week to a very low 205,000.  Continuing claims fell 61,000 to 1.698 million.  These figures are consistent with continued solid payroll growth in February.

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Posted on Thursday, February 13, 2020 @ 10:37 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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