Implications:  Hold off on housing starts for a moment, and take a look at this morning's reading on initial jobless claims which fell last week to 212,000, just 4,000 above the lowest reading since December 1969.  Meanwhile, continuing claims fell 39,000 to 1.72 million.  These are the types of fundamentals we focus on – rather than prognostications from the pouting pundits of pessimism – to determine if the current "trade war" is really hurting the US economy.  With that  said, on to housing starts, which eked out a small gain in July, but continue to disappoint.  Following June's decline to the slowest pace of starts since the disruptions caused by Hurricanes Harvey and Irma, new construction rose a tepid 0.9% in July, coming in below even the most pessimistic forecast.  That said, we don't think this is the beginning of the end for the housing recovery, and it's important to remember that data on housing starts are very volatile from month to month.  One way to cut through the noise is to compare the year-to-date pace of starts in 2018 to the same period in 2017.  By that measure starts are up 5.9% from a year ago.  Now, some analysts are blaming the recent weakness on higher mortgage rates, but if that were the truly the case, the faster pace of starts so far in 2018 wouldn't have happened. But, there are some real headwinds that may temper growth.  The National Association of Home Builders said 84% of developers cited labor shortages and the rising cost of building materials as their biggest problems in 2018.  And both these issues look set to continue as an increasingly tight labor market keeps the number of job openings in construction elevated and tariffs on lumber, steel, and aluminum drive up input costs.  Cost and labor concerns were also echoed in yesterday's NAHB Index, but were offset by strong buyer demand, leaving builder optimism at historically elevated levels.  One additional reason to be optimistic going forward is that the pace builders are receiving permits for new construction continues to surpass the pace of actual groundbreaking. This is the reverse of what you would expect if builders saw demand for new units as likely to dry up in the future.  Together, the data points towards a trend higher in homebuilding in the year ahead.  On the manufacturing front this morning, the Philly Fed Index, a measure of East Coast factory sentiment, fell to +11.9 in August from +25.7 in July, remaining in positive territory and signaling continued optimism from manufacturers, although not as much as in July.

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Implications:  Anyone disappointed by today's report on industrial production needs to take a closer look.  While industrial production eked out only a 0.1% gain in July, growth was held back by declines in utilities and mining, which are highly volatile month-to-month.  Manufacturing rose 0.3% in July, just as the consensus expected, with both auto and non-auto production posting gains. Plus, industrial production was revised higher for prior months.  The end result is that total production is now up 4.2% from a year ago, the largest 12-month increase since 2012.  Industrial production data counts "units" of output, and is therefore a proxy for "real" growth.  Taken as a whole, the July data suggests recent strength in real growth is sustainable.  Manufacturing activity, meanwhile, is up 2.9% in the past year, also the fastest 12-month increase since 2012.  After posting five consecutive months of gains, mining ticked negative in July, falling 0.3%.  Declines in mining outside oil and gas (think coal and other metals), as well as the drilling of new wells, swamped the continued increase in oil and gas extraction.  That said, mining is up a very healthy 12.9% over the past twelve months.  And after a slight dip in June/July, the rig count has begun to rise again in recent weeks, suggesting mining will rebound in the months ahead.  In other news this morning, the Empire State index, a measure of manufacturing sentiment in New York, rose to 25.6 in August from 22.6 in July, signaling continued optimism in the region. On the housing front, the NAHB index, which measures homebuilder sentiment, fell to 67 in August from 68 in July, remaining at a historically elevated level as concerns about rising lumber costs and a lack of labor were offset by healthy demand from buyers benefiting from a strong labor market and higher after-tax pay checks. 

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Implications:  A strong jobs market, growing economy, and higher take-home pay thanks to the tax cuts have consumers feeling great.  Retail sales grew for the sixth consecutive month, rising 0.5% in July.  And the gains in July were broad-based, with nine of thirteen major categories showing rising sales, led by restaurants & bars, internet & mail order sales, and general merchandise stores.  Retail sales are up a strong 6.4% from a year ago (and up an even stronger 7.2% excluding auto sales).  Today's report suggests consumer spending started off the third quarter on a strong note, supporting our projection of 4.0 - 4.5% real GDP growth for Q3.  Given the tailwinds from deregulation and tax cuts, we expect an average real GDP growth rate of 3%+ in both 2018 and 2019, a pace we haven't seen since 2005.  Jobs and wages are moving up, tax cuts have taken effect, consumer balance sheets look healthy, and serious (90+ day) debt delinquencies are down substantially from post-recession highs. Some may point to yesterday's NY Federal Reserve Bank report showing household debts at a record high as reason to doubt that consumption growth can continue.  But what the negative headlines didn't mention is that household assets are at a record high, as well.  Relative to assets, household debt levels are the lowest in more than 30 years.  In other words, there's plenty of room for consumer spending – and retail sales – to continue to trend higher in the months to come.  In other news today, the preliminary reading on Q2 nonfarm productivity growth came in at a 2.9% annual rate, beating the consensus expected 2.4%.  Productivity is up 1.3% versus a year ago and we expect it to accelerate in the year ahead.  Companies have increased business investment, which should generate more output per hour.  Meanwhile, the tight labor market should encourage firms to find more efficient ways to produce.  On the inflation front, import prices were unchanged in July, while export prices declined 0.5%.  The drop in export prices was due to farm products, with soybean prices falling 14.1% and farm products down 5.3% overall, likely the result of recent trade disputes.  However, the trend in import and export prices is still upward.  Import prices are up 4.8% in the past year, versus a 1.2% gain the year ending July 2017; export prices are up 4.3% in the past year versus a 0.9% increase in the year ending July 2017.  Cutting through recent gyrations, more inflation is on the way.

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Since March of 2009, the predictions of economic, and stock market collapse have been non-stop.  Doom-and-gloomers have been unrelenting.  And it's doubly frustrating since you can't disprove a negative until it doesn't happen.

We have written hundreds of pieces since the recovery - and bull market – began, arguing that the pessimism was unjustified.  We've argued that Brexit, Grexit, resetting ARMs, student loans, government debt, Obamacare, no QE4, tapering,...etc., would not stop growth.  The doomsayers have been wrong. Constantly.  For our troubles we get labeled "perma-bulls", despite our arguments proving true.  Meanwhile, the "perma-bears" have never had to answer for their fallacious forecasts.

Now they're talking Turkey, tariffs, a strengthening dollar, China selling US debt, Fed rate hikes.  They never give up.  But, we still aren't worried. 

The United States, for the time being, is a Kevlar economy.  It's practically bulletproof.  By allowing other countries to maintain higher tariffs, America, the world's biggest consumer, has helped those countries grow.  By holding corporate tax rates higher than most other countries, the US has subsidized non-US growth.

But under new management, the self-sabotage is being eliminated.  Cutting corporate tax rates and reducing regulation have made the US more competitive.  No, we are not ignoring the negative impact of tariffs on some US producers and consumers, but tariffs hurt foreign countries more than they hurt America.

Countries without the Constitutional rule of law, property rights and true free markets need foreign help to grow.  The US is removing some of that help in making itself more competitive.  As a result, the US will continue to grow, while other countries suffer a loss of investment and sales.  Once again doomsayers will be proven wrong.

Yes, it's true that a slowdown in the growth of other countries can impact corporate earnings, or even have some impact on US growth, but the damage will not be nearly as great as the pouting pundits proclaim.  We still forecast 3%+ real GDP growth over the next few years, along with continued jobs growth and the lowest unemployment rate in decades.

Doomsayers, take note.  There are five real threats to prosperity: 1) Excessively tight Fed policy.  2) Excessive government spending.  3) Excessive regulation.  4) Tax hikes and 5) Trade protectionism.

Right now, the Fed is not tight, far from it.  Government spending is too high, that's why growth isn't even higher.  The Regulatory environment is improving.  Tax rates have been cut and are not likely to be hiked anytime soon.  Finally, tariffs are going up, but by a much smaller amount than taxes were cut.  We also do not expect a protracted trade war because that would harm other countries much more than the US.  Ultimately, we expect deals to bring tariffs down.

In other words, of the five threats, two are negatives (with trade likely to turn) and three are positives – and don't forget new and unbelievably positive technologies!  Someday, a recession will happen again, but for now the Kevlar economy will only get stronger.   

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

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Source: St. Louis Federal Reserve FRED Database

Implications:  Consumer prices continue to march higher, rising 0.2% in July and, at 2.9%, matched June's reading for the largest 12-month increase going back to 2011-12.  While rising energy prices have certainly contributed to the trend since oil prices bottomed in early 2016, inflation has been broad-based.  "Core" consumer prices – which exclude both food and energy costs – also rose 0.2% in July and are up 2.4% in the past year.  More importantly, this is a trend, not a one-month anomaly. Consumer price inflation has now exceeded 2.0% on a twelve-month basis in each of the last eleven months, while "core" prices have surpassed 2.0% on a twelve-month basis for each of the last five months.  To put the rise in perspective, consumer prices increased 1.7% for the twelve-months ending July 2017 and 0.8% for the twelve-months ending July 2016.  Taking a deeper look at today's report shows energy prices fell 0.5% in July, as prices for gasoline, natural gas, and electricity all declined.  Meanwhile food prices rose 0.1% in July, led higher by costs for fruits and vegetables.  Stripping out the food and energy components shows the 0.2% increase in core prices was once again led by owners' equivalent rent (the amount an owner would need to pay in order to rent their home on the open market).  On the wages front, real average hourly earnings were flat in July and are down 0.2% in the past year.  These inflation-adjusted hourly earnings have been stubbornly slow to move, however this earnings data does not include irregular bonuses – like the ones paid by companies after the tax cut or to attract new hires.  We expect a visible pickup in wage pressures in the year ahead. Paired with continued strength in employment (see the sneaky-strong July data released last Friday), the trend in inflation has put pressure on the Fed to keep up the pace of steady rate hikes. Expect two more hikes this year (for a total of four in 2018) with four more to follow in 2019, leaving monetary policy still accommodative but at a much more appropriate level given the pace of economic growth.

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Implications:  Producer prices were flat in July – the first month of 2018 not to show an increase of at least 0.2% - as declining prices in a few select sectors held down inflation.  But even with the flat reading in July, the producer price index is up 3.3% in the past year, behind just last month for the largest twelve-month increase going back to late 2011.  A look at the details in July shows the ever-volatile food and energy sectors declined 0.1% and 0.5%, respectively.  Strip out these two components, and "core" prices rose 0.1% in July and are up 2.7% in the past year.  In other words, both core and headline PPI measures show inflation easily exceeds the Fed's 2% inflation target, reinforcing our projection for two more rate hikes this year and four hikes in 2019.  In addition to declines in food and energy prices, trade services prices (think margins to wholesalers and retailers) also dropped 0.8% in July.  This was likely the result of companies accepting smaller margins in the short-term, rather than raise prices for consumers, as input prices increase.  A look at recent ISM reports suggests strong order activity paired with difficulty finding qualified labor and freight truck drivers is putting pricing pressure on some industries.  Excluding declines in food, energy, and trade services, producer prices rose 0.3% in July.  We view July as an aberration and expect monthly data to show higher inflation in the months ahead.  In other news this morning, initial jobless claims declined 6,000 last week to 213,000.  Continuing claims rose 29,000 to 1.76 million.  These figures suggest job creation continues at a healthy pace in August.      

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Something strange happened after last Friday's jobs report - the yield on the 10-year Treasury Note fell, finishing Friday at 2.95%, down four basis points from Thursday's close.  To us, this makes no sense. If anything, it serves to reinforce our view that the bond market is making a big mistake. 

Yes, we realize that July nonfarm payrolls (at +157,000) were lighter than the consensus expected 193,000.  But, as we wrote in our Data Watch, May and June were revised upward by a total of 59,000.  In other words, July payrolls were 216,000 higher than the Labor Department estimated in June.  If we assume these new workers make the average weekly wage, that equals $10.5 billion more in annualized earnings for American workers (216,000 x $933.23 x 52) – in just one month!

Meanwhile, civilian employment (an alternative measure of jobs that includes small-business start-ups) rose 389,000 in July, helping push the jobless rate down to 3.9%.  Even more impressive, the U-6 unemployment rate - what some people refer to as the "true" rate, which includes discouraged and marginally-attached workers as well as and those with part-time jobs who say they want full-time work - fell to 7.5%, the lowest reading since 2001. 

The Hispanic unemployment rate dropped to 4.5% in July, the lowest on record dating back to the early 1970s.  At 6.6%, the black jobless rate was not at a record low, however, these figures are volatile from month to month and have averaged 6.9% in the past year, the lowest 12-month average on record.  Notably, the unemployment rate among those age 25+ who never finished high school is 5.1%, also the lowest on record dating back to the early 1990s.  You sensing a trend?   

Put it all together and we see plenty of reasons to be optimistic about economic growth in the third quarter.  It's early, but right now we're tracking 4.5% real GDP growth in Q3, which would boost the year-over-year increase to 3.3%.  Some analysts tried to discount the growth in the second quarter because of a surge in exports, but we think the more important quirk in Q2 was that companies reduced inventories at the fastest pace since 2009.  A return to a more normal pace of inventory accumulation means a large boost to growth in Q3, more than offsetting any impact from trade.              

The conventional wisdom just can't wrap their collective heads around the idea that tax cuts and deregulation are truly boosting underlying growth.  And, like much of the previous nine years, keep looking for a reason to be bearish about the economy.  This time they think housing will collapse.  After all, housing starts fell in June, so did new home sales, and existing home sales have fallen for three straight months.

That said, it's too early to rule out that this is simply statistical noise.  These figures will go through some quite substantial revisions in the months and even years ahead.  The softness could be completely revised away.      

And remember, home building is still below fundamental levels, based on population growth and scrappage.  The US has about 138 million housing units, so annual population growth of 0.7% per year suggests we need to build about 950,000 new housing units per year (0.7% of 138 million).  Add to that homes replaced due to scrappage (voluntary knock-downs, fires, floods, hurricanes, tornadoes) and the 1.25 million housing starts of the past year simply isn't enough.             

Finally, while higher mortgage rates would pose a problem for homebuyers if everything else were unchanged, that's not the case.  Mortgage rates have moved higher because of faster anticipated economic growth.  In that environment, mortgage rates should be higher, and home-buying should move higher as well.  An economy with 3% real GDP growth and a jobless rate below 4% is going to create more buyers than the Plow Horse economy that prevailed from mid-2009 through the start of 2017.

In spite of our optimism, one of the things we know for sure about the next couple of years is that, from time to time, one part of the economy (or more) will lag others.  We expect the pouting pundits to use that weakness to predict doom and gloom.  We can't prove they will be wrong, just like we can't "prove" the sun will come up tomorrow.  But, for the past nine years we've disagreed with the pessimism, and we still do.  The economy - and housing - will continue to grow.  

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

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