Implications:  Existing home sales surged in February after three consecutive months of declines and a broader downward trend since Q1 2018.  Sales rose 11.8%, the second largest monthly gain on record behind only December 2015, when sales surged due to a change in federal rules surrounding the closing process.  February's gain returns the sales pace to Q1 2018 levels, wiping out nearly a year's worth of declines.  It is important not to read too much into any single month of data, but the fundamentals have improved of late for existing homes.  First, despite median prices rising for the 84th month in a row on a year-over-year basis, the rate of growth has been slowing, with February showing a modest increase of 3.6%.  This means wages are now growing nearly as fast as prices, which – along with falling mortgage rates –boosts affordability.  The primary culprit behind the tempered existing housing market in 2018 was lack of supply, but here too there has been progress.  Inventories have turned a corner, rising on a year-over-year basis (the best measure for inventories given the seasonality of the data) for the seventh month in a row after 38 straight months of stagnation and declines.  It looks like sellers really are changing their behavior, and a reversal in the steady decline of listings since mid-2015 is a welcome reprieve for buyers, boosting supply and sales, while keeping a lid on price growth.  That said, some headwinds for sales remain.  First, potential homebuyers in high-tax states are likely still reeling from the $10,000 cap on state and local tax deductions.  Second, the months' supply of existing homes – how long it would take to sell the current inventory at the most recent sales pace – was only 3.5 months in February and has now stood below 5.0 (the level the National Association of Realtors considers tight) since late 2015.  It won't be a straight line higher for sales in 2019 but fears the housing recovery has ended are overblown.  In other housing market news, the NAHB index, which measures homebuilder sentiment, remained unchanged at 62 in March.  This signals a continued rebound in sentiment from builders after the index hit a three year low of 56 in December.  On the manufacturing front, the Philly Fed Index, a measure of East Coast factory sentiment, rebounded to +13.7 in March from -4.1 in February, signaling a return to optimism after the index briefly touched negative territory for the first time since mid-2016.  Finally, on the employment front, new claims for unemployment benefits fell 9,000 last week to 221,000.  Continuing claims fell 27,000 to 1.750 million.  Look for March to show a sharp rebound in job creation after February's lull. 

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The environment on Capitol Hill has made populism a bipartisan affair, with Republican Senator Marco Rubio now joining the fray with a call to tax corporate stock buybacks.

His argument? Corporations are buying back stock instead of making productive investments.  He's not alone in arguing that weak investment is the reason the economy isn't growing faster.  Meanwhile others argue the corporate tax cut of 2017 fell flat as tax savings went towards a surge in buybacks, not investment.

Rubio also bemoans that stock buybacks face a lower tax rate than dividends.  But qualified dividends (which are the vast majority of dividends paid by public companies) are taxed at the same rate as capital gains, so we're not quite sure how he comes to this conclusion.

Let's break down the issues with his argument. To start, companies have been investing.  Think about it.  If companies were under-investing, there would be shortages, and that is simply not the case.

Another reason his argument fails scrutiny – and probably the most common misperception when it comes to corporate investments – is that people mistake nominal investment for real investment.

The price of technology has fallen dramatically while its capabilities have surged.  You can buy a smartphone or tablet today for hundreds of dollars, while just a decade ago those embedded technologies would have cost millions of dollars (and required a suitcase to lug around).  Airlines can now book passengers using an App instead of a ticket office.  Brick and mortar stores are being replaced by logistics software and delivery vehicles.  A decade ago it took more than two months to frack a well, now it takes two weeks.

In other words, the price of production is falling while profit margins have improved.  The declining costs for improved performance make it appear that companies aren't investing, when in reality they are.  In fact, productivity at the corporate level is booming, and that's exactly why corporations can return so much capital to shareholders.  On a nominal basis, business investment was 13.7% of GDP in the last quarter of 2018, exactly where it was in 2001 and 2008.  But on a real basis (where inflation – or in the case of technology, deflation -is accounted for), business investment was 14.7% of GDP, the highest on record.

It's this lack of perspective that has people pining for the past.   And it makes no sense.  If it took longer to frack a well, companies needed office space to sell airline tickets, or we had no online retail, then yes, investment would be higher, but then profits would be lower.  But we guess Rubio's "problem" would be fixed, as companies wouldn't have the profits for stock buybacks or dividends.

Now to address the second misperception. Both buybacks and dividends reduce cash on corporate balance sheets.  As economist John Cochrane has explained, a buyback does not necessarily leave a remaining shareholder in a better position.  Let's say a company has two shares in circulation, $100 in cash, and assets capable of producing future profits worth $100 today.  Each of the two shares should be worth $100.  If the cash is used to buy back one share, there would only be one share remaining and $100 in future profits, so the share should still be worth $100.  If the company paid a dividend of $100 ($50 per share), the price of each share would fall from $100 to $50, creating a capital loss of $50.  If the shareholder took the loss it would offset the tax on the dividend.  Either way, the government captures zero dollars.

Simple math says that, either way, profits for shareholders and tax receipts should not be different as long as capital gains and dividends are taxed equally.  And if a politician believes one is taxed less than the other, we think that politician should find a way to reduce the higher tax rate, not raise the lower one.  Cutting tax rates is the best way to boost incentives for work, savings and investment.

Finally, the government has proven itself a terrible fiduciary.  In 2017, after eight years of economic recovery, and before the Trump corporate tax cut went into effect, the budget deficit was $680 billion.  Even John Maynard Keynes must have been rolling over in his grave.  So, why would anyone trust government to start telling private citizens what to do with their own money?

Can you imagine politicians telling you that you aren't allowed to pay down your mortgage because your after-interest income would be too high if you did?

In the end, government needs to focus on fixing its own fiscal house rather than trying to manage the private sector.  While it's always possible to find some corporate managers who make bad decisions, a vast majority of them are very responsible in their fiduciary duties.  In the past decade they have done well by their shareholders.  It's politicians that have failed in their fiduciary duties.  No matter which side of the aisle they hail from, interfering with private decisions is wrong.

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

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Source: St. Louis Federal Reserve FRED Database

Implications:  After falling unexpectedly for the first time in eight months in January, industrial production rebounded in February, eking out a 0.1% increase.  Despite the positive headline number though, the details of today's report show there wasn't much to like.  Manufacturing activity fell for the second month in a row, dropping 0.4% after a 0.5% decline in January.  However, February's weakness was more broad-based, coming primarily from the non-auto sector, though the auto sector fell as well.  This is in contrast to January's decline which was entirely due to a 7.6% decline in autos.  Further, February saw big monthly declines for both business equipment and machinery, which fell 1.0% and 1.9% respectively. That said, it looks like the true culprit behind the weakness in non-auto manufacturing in February came from nondurable goods, which tell us less about future economic growth and which fell 0.8% for the month versus only a 0.1% decline for durable goods.  In the past year, the various capital goods indices continue to show healthy growth that surpasses headline industrial production, with business equipment up 3.8%, machinery up 4.4%, and high-tech equipment up 3.8%.  Comparing this with the slower year-over-year growth of 1.0% for manufacturing as a whole, or non-durable goods which are dead flat, demonstrates that capital goods production remains a valuable source of strength in the sector.  In turn, more capital goods should help push productivity growth higher, making it easier for the economy to grow in spite of a tight labor market.  Looking outside the manufacturing sector, mining activity grew for the thirteenth month in a row in February and is now up 12.6% in the past year.  Finally, utilities jumped 3.7% in February, rebounding as things returned toward normal after unseasonably warm weather in parts of the country reduced demand for heating in January.  In other news this morning, the Empire State Index, which measures factory sentiment in the New York region, fell to 3.7 in March from 8.8 in February. That said, the decline masked strong readings for both the future capital expenditures and future technology spending indices, which signal continued strength for the factory sector in the year ahead.

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Implications:  Following three consecutive months of declines, the producer price index ticked back into positive territory in February. The rebound in February can be traced to goods, which rose 0.4% after also falling three months in a row.  About 80% of the gain in goods prices came solely from rising energy prices, which were up 1.8% in February.  The recent weakness in the headline numbers have primarily been about falling oil prices, but now with crude rebounding it's not surprising to see a return to price growth.  The Federal Reserve is well aware of the short-term price volatility from the energy sector, which is why we think talk of "muted" headline inflation won't be enough to dissuade them from further rate hikes later in 2019 as long as the yield on the 10-year Treasury Note rises, as well.  Stripping out the volatile food and energy categories shows "core" inflation stands comfortably above the Fed's inflation target, up 2.5% in the past year (if you are feeling a bit of deja vu, yesterday's report on consumer prices showed a similar pattern).  That said, price pressures in the service sector, which represents about two-thirds of the overall index, may be abating, rising at only a 1.0% annual rate over the past three months versus 2.5% over the past year.   This slowdown was the result of February service sector prices remaining unchanged, as unexpected declines in prices for trade, transportation & warehousing services (think wholesaler margins) were offset elsewhere.  Notably, private capital equipment prices are up 3.5% in the past year, the fastest year-over-year growth of any major category, possibly signaling rising demand for business investment which will provide a boost to economic activity in the year ahead.  Looking further down the price pipeline suggests we will continue to see some volatility in the month-to-month readings for the producer price index.  But with both the ISM Manufacturing and Non-Manufacturing indices comfortably in expansion territory, and an increasingly-tight labor market for qualified labor to both produce and transport goods, we expect wages - and general prices – will push higher at a faster pace in the year ahead.  At the end of the day, the trend in core prices – where the Fed will focus their attention – suggests inflation of around 2.5% in 2019.

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Implications:  Durable goods orders surprised to the upside in January on the back of rising aircraft orders, while orders outside the transportation sector left something to be desired.  Stripping out the typically volatile transportation sector – which rose 1.2% in January – shows durable goods orders declined 0.1%.  With the transportation sector likely to be more volatile than usual in coming months (as Boeing deals with fallout from the 737 Max 8), the ex-transportation reading will take on even greater importance as a monitor of short-term activity.   A closer look at the details of the January report shows that rising orders for computers and communication equipment couldn't offset declines in the broader "computers and electronic products" category, while a healthy pickup in machinery orders was largely offset by declining orders for both primary and fabricated metal products.  More important than month-to-month changes in either direction, the trend continues to show a healthy pace of activity, with total orders up 8.4% in the past year, while orders excluding transportation are up 4.5%.  Among the most important data released in the durable goods report are shipments of non-defense capital goods ex-aircraft (a key input for business investment in the calculation of GDP growth), which rose 0.8% in January and, if unchanged in February and March, will be up at a 3.0% annualized rate in Q1 vs the Q4 average.  This healthy growth in "core" shipments continues the trend seen in 2018, which posted the fastest full-year growth rate in "core" shipments in six years.  Clearly, the promised benefits to business investment from the Tax Cuts and Jobs Act have, in fact, materialized.  Healthy growth in durable goods orders and a strong labor market suggests that the economy will continue to grow near the fastest pace in a decade. Why some continue to warn of recession is a mystery.  As far as the data show, companies (and consumers) don't seem nearly as worried as the pouting pundits, and political posturing has little chance of denting the strong growth track that entrepreneurs and innovators have set us on.  In other news this morning, construction spending rose 1.3% in January (-0.1% including revisions to prior months).  The increase in spending in January was led by highways and streets, educational facilities, and transportation projects.  Construction spending ended 2018 on a weak note but looks to be accelerating early in 2019.

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Implications:  Following three consecutive months of no change, consumer prices moved higher in February, rising 0.2%.  That may sound like inflation has been virtually non-existent as of late, but rather, it's a textbook case of how volatile categories can distort readings.  Energy prices fell 2.8% in November, 2.6% in December, and 3.1% in January.  So while the consumer price index showed no change in overall prices during that period, "core" inflation (which excludes the volatile food and energy categories) rose a steady 0.2% in all three months.  Now February saw both food and energy prices rise 0.4%, while "core" inflation rose 0.1%.  The distortion becomes increasingly clear when you look at the trend. The consumer price index is up 1.5% in the past year, but decelerating, up 1.0% annualized over the past six months and 0.6% annualized over the last three.  On the other hand, "core" prices are up 2.1% in the past year and that pace has remained steady, up 2.3% annualized over the past six months and 2.1% annualized over the last three.  In other words, the Fed (which understands the short-term volatility coming primarily from the energy sector) continues to have ample support for a path of continued rate hikes.  What's restraining the Fed from raising rates is the low level of the yield on the 10-year Treasury Note, which doesn't yet reflect the underlying strength of the economy, and the fear that raising rates would invert the yield curve.  We think continued solid economic growth and further resolution of trade tensions will bring more confidence to the financial markets and a return to a more "risk on" environment will put upward pressure on interest rates.  Looking at the details of the February report shows housing led the rise in "core" prices, up 0.2%, while higher prices for apparel, education, and personal care (think cosmetics, toothpaste, and hair products) offset declining costs for medical care and motor vehicles.  Arguably the best news in today's report was that real average hourly earnings rose 0.3% in February and are accelerating.  These real wages are up 1.9% in the past year, up 2.2% at an annual rate over the past six months, and up 3.0% at an annual rate in the past three-months. Remember, "real" wage growth represents increases in earnings above the pace of inflation, so these are direct gains to consumer purchasing power.  And these earnings do not include irregular bonuses – like the ones paid by companies after the tax cut or to attract new hires – or the value of benefits.  Strong employment growth (don't let February's weak headline payrolls shade your vision), healthy corporate earnings, and continued growth in orders suggest this trend will hold through 2019.  The data show pretty much exactly what you would expect from an economy growing at a healthy pace.

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It's March 8, 2009.  The market's down 56% from its all-time high, unemployment is over 8% and hurtling toward 10%, it's just been reported that real GDP dropped at a 6.2% annual rate in Q4 of 2008, and it feels like the world is coming to an end.  You're tired, exhausted from living through this, and you fall into a deep sleep.  So deep, in fact, that you don't wake up until today, 10 years later. 

First thing you do is run to your computer and see the S&P 500 is up 305% since the bottom. You are blown away.  No way this could be true!  Things were so bad when you fell asleep.  Little did you know the S&P 500 bottomed the next day.

So you run over to your friend's house and knock on the door.  Your friend answers, wondering where you've been for 10 years!  You ask what possibly could have happened to drive the stock market up more than 300%.

Your friend pulls out a list.  Let's call them the "golden geese."

After-tax economy-wide corporate profits are at record highs, up 175% since the bottom, or around 11% annualized growth.

Then your friend tells you about Apple. When you fell asleep, Apple had been selling the iPhone for about a year and a half.  Over that period, they sold a record-breaking 17.4 million of them.  But since you've been asleep, Apple has sold about 1.3 billion of them.  Every calendar quarter Apple sells about three times what it sold in that first year and a half.

Then there's Uber.  Your friend tells you how you can press a button on a phone and a few minutes later a car will come by and, before you get in, you know who the driver is, his rating, how much it'll cost, and how long it will take to get to your destination.  All cheaper than a taxi.  It seems like science fiction!

You see unemployment is only 3.8% and think it's a typo, because when you fell asleep it was more than double that.

Your friend shows you a video of a self-driving semi-truck that Budweiser used to carry 51,744 cans of beer from Fort Collins, CO, to Colorado Springs, CO.  About 130 miles on I-25 with no driver!  Now Amazon is deploying similar trucks.

But what may be most amazing is that that there have been several years over the last 10 that the US has run a trade surplus with OPEC.  You wonder how this can be since the US was in an energy crisis when you fell asleep.  In fact, oil production had been on a declining trend for about 50 years.  Your friend tells you it's all changed.  Since you have been asleep, because of new technology, oil production has more than doubled, from about 5 million barrels per day to around 12.1 million barrels per day.  In fact, the US is now the world's biggest oil producer. Bigger than Russia and Saudi Arabia!  The state of Texas, by itself, just surpassed Iran to become the world's fifth biggest oil producer!

You continue through the list and are more and more blown away.  It's been only 10 years and the world is completely different, for the better! You barely recognize it, so many things have happened that you wouldn't have even dreamt possible.

And notice, you have no idea who is President, what's been going on with interest rates, Quantitative Easing, China, or North Korea.  You've never heard of "AOC" and you missed the whole Greek debt crisis.  All you know about are these "golden geese."  And that's all you need to know. The entrepreneur, alive and well, has continued to revolutionize the world over the past 10 years. That's what has been driving economic growth and the stock market.

Imagine where we will be 10 years from now.  Our guess is that it will be better than you can think.

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As a side note, celebrating the 10-year anniversary of the current recovery and bull market is very satisfying to us.

We believed the Panic of 2008 was made significantly worse (trillions of dollars worse) than it needed to be because of overly strict mark-to-market accounting.  Forcing banks and other financial institutions to write the value of assets down to fire sale prices based on frozen markets put the whole financial system at risk.

No amount of money from the Federal Government would have ever stopped it.  Private investors stopped investing in banks.  Markets stopped trading.  All because assets were being written down well below the amount of cash they generated.

Quantitative Easing and TARP were both unnecessary, and useless.  QE was started in September of 2008 and TARP was passed in October.  During the next five months, the S&P 500 fell an additional 47% and financial stocks declined 70%.  There is no evidence (unless you value self-proclaimed victories) that either worked.

The market turned on March 9, 2009, when the House of Representatives decided to push the Financial Accounting Standards Board to reverse the damaging mark-to-market rules.  The change wasn't made until April 2009, but the market knew it was coming.  The change allowed banks to use cash flows to value investments.  And guess what, private investors came back.  They invested in banks and other equities and that was the turning point.

While government will tell you that it saved the economy, it didn't.  Once mark-to-market accounting rules returned to the way they were from the late 1930s through 2007, the economy could recover.  And that's exactly what it did.  This recovery and the bull market are based on entrepreneurship.  It's not – and never was - a Sugar High.

TARP would have never been enough to save the system because assets would have continued to be marked down.  And QE was unnecessary because the problem wasn't due to a lack of money in the system.

Some members of the Federal Reserve try to compare 2008/09 to the Great Depression, and argue Milton Friedman would have wanted QE.  But in the Great Depression, the money supply was declining.  It never declined in 2007 or through September 2008, when QE was started.  The problems in the system were capital problems, not liquidity problems.

In fact, it is our belief that without those overly strict mark-to market accounting rules, Bear Stearns, Lehman Brothers, WAMU and Wachovia would never had needed to go under.

Thank goodness the rules were changed, allowing the free market and entrepreneurship to once again work the magic that has transformed this great country since its start.

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

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