Implications:  Following a dip in last month's report, existing home sales bounced back in December to post the fastest monthly sales pace since early 2018.  Total sales were 5.341 million units in 2019, exactly matching 2018.  Though this may seem unimpressive at first glance, it's important to note that the year started from a very low baseline, with January posting the slowest sales pace since 2015.  That said, sales have now nearly fully recovered from the 2018 decline (as the chart above shows) and are poised to hit new post-recession highs as we head into 2020.  Putting aside the positive headline number, the negative news in today's report was that the inventory of existing homes has now fallen year-over-year (the best measure for inventories given the seasonality of the data) every month since June, following ten straight months of gains.  This is concerning because it represents a consistent reversal in the upward trend in listings earlier this year and will likely be a headwind for future sales.  Keep in mind, the primary culprit behind the weak existing home market in 2018 was lack of supply.  The 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 3.0 months in December, which is the lowest reading 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 43% of homes sold in December 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, with both the number of new residential construction projects started and the total number of housing units under construction rising consistently over the past several months to 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.  What this means is that the "mix" of homes sold is more tilted toward the higher end.  When you add in mortgage rates that have fallen roughly 100 basis points since the peak in November 2018, it's no surprise that the year-over-year growth in median prices has begun to reaccelerate and is now up 7.8% in the past year versus just 3.3% in the twelve months ending December 2018. In other housing news this morning, the FHFA index, which measures prices for homes financed with conforming mortgages, increased 0.2% in November.  However, unlike median prices for existing homes, price growth has continued to decelerate in the FHFA index, up only 4.9% in the past year versus an increase of 6.0% in the twelve months ending November 2018.    

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Back in mid-November, the highly respected GDP forecasting model from the Atlanta Federal Reserve Bank (also known as "GDP Now"), estimated that real GDP would only grow at a 0.3% annual rate in the fourth quarter, which, if accurate, would have been the slowest growth for any quarter since 2015.  At the time, we were forecasting economic growth at a 3.0% rate. 

Now, nine days from the government's first official report on Q4 GDP, the Atlanta Fed's model is saying 1.8%, while we're at 2.5%.  In other words, they've moved a lot higher, we've moved a little lower.  The consensus among economists is 2.1%, right between our forecast and the Atlanta Fed's.

Here's the thing: international trade and inventory figures are likely to have a huge impact on Q4 real GDP, with international trade a positive factor and inventories a negative.  Trade relations with China were very volatile until recently, in part explaining a big drop in imports in Q4, which has a temporary positive influence on GDP.  But, at the same time, fewer imports also meant less inventory accumulation in Q4.                 

We're telling you this because the day before the GDP report next week, we will get reports on both trade and inventories, which might lead us to make a substantive revision up or down to our 2.5% forecast.

Either way, what's most important is the trend, and we see healthy economic growth coming in 2020.   Monetary policy is far from tight, companies are still adapting to a world where corporate profits earned in the US face lower tax rates, the regulatory environment has become more favorable, home building is poised to add to GDP, and consumer purchasing power (already strong) is growing.    

Here's how we get to our 2.5% real growth forecast for Q4:

Consumption:  Car and light truck sales shrank at a 5.3% annual rate in Q4, while "real" (inflation-adjusted) retail sales outside the auto sector shrank at a 1.4% rate.   So far, not so good.  But most of consumer spending is on services, and it looks like real spending on services grew at a 2.4% rate. Take the good with the bad, and it suggests real personal consumption (of goods and services combined) grew at a 1.9% annual rate, contributing 1.3 points to the real GDP growth rate (1.9 times the consumption share of GDP, which is 68%, equals 1.3).

Business Investment:  It looks like continued investment in equipment and intellectual property offset a contraction in commercial construction.  Combined, business investment grew at a roughly 3.3% annual rate in Q4, which would add 0.4 points to real GDP growth.  (3.3 times the 13% business investment share of GDP equals 0.4).

Home Building:  Residential construction turned up in Q3, the first positive quarter since 2017.  Look for another positive quarter in Q4, with growth at about a 2.7% annual rate, which would add 0.1 point to real GDP growth.  (2.7 times the 4% residential construction share of GDP equals 0.1).

Government:  Both national defense spending and public construction projects show solid growth in Q4, which means overall government purchases were probably up, as well.  Looks like an increase at a 1.7% rate, which would add 0.3 points to the real GDP growth rate.  (1.7 times the government purchase share of GDP, which is 18%, equals 0.3).

Trade:  Signs suggest China trade-policy related volatility led to an unusually large drop in imports in Q4, which translates into a large increase in net exports (exports minus imports).    At present, we're projecting that net exports will add an unusually large 1.3 points to real GDP growth in Q4 but, as we mentioned above, this number could change dramatically with next week's advance report on trade.  Also, a big plus from net exports in Q4 may lead to a large negative in Q1 as trade tensions ease and imports return to a faster pace.  Only time will tell.   

Inventories:  Inventories are also a huge wild card in Q4.  As of now, we're penciling in a drag on the real GDP growth rate of 0.9 points.  After Q4, look for a rebound in the pace of inventory accumulation, which should add to economic growth in 2020.

Add it all up, and we get 2.5% annualized real GDP growth.  Expect growth to average at least that pace in 2020, with our projection in the 2.5 to 3.0% range.  There's no recession on the way, and plenty of reason to believe better profits will see this bull market continue to run. 

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

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Source: St. Louis Federal Reserve FRED Database

Implications:  Industrial production took a breather in December, though the details of the report were much better than the headline, with the weakness coming from the volatile auto and utilities sectors.  The 4.7% decline in auto production in December represents a return to a more normal pace after the 12.8% surge in November, which was the largest monthly gain since 2009, as GM employees returned to work following the conclusion of a strike.  Excluding the auto sector, manufacturing rose a healthy 0.6%.  Notably, manufacturing has been accelerating lately, up at an annualized pace of 1.9% over the past three months versus a decline of 1.3% over the past year.  Turning to utilities, output dropped due to unseasonably warm weather in December which reduced demand for heating following unusually cold weather in November.   Finally, mining output rose 1.3% in December, fueled by an increase in oil and gas extraction.  Taking 2019 as a whole, industrial production hit a record high, eking out a 0.8% gain over 2018.  We expect faster growth in 2020 as we put some of the major headwinds for the factory sector behind us.  The GM strike is over, USMCA has been passed, and a Phase One trade deal with China has been signed.

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Implications:  Housing starts ended 2019 with a bang, posting the largest monthly gain since 2016 and absolutely crushing consensus expectations.  At an annualized sales pace of 1.608 million, starts hit the highest level since 2006.  For 2019 as a whole, builders started 1.298 million homes, a 3.9% increase versus 2018 and a tenth consecutive annual gain.  Activity was broad-based in December as well, with every major region posting gains and both single-family and multi-unit construction rising to post-recession highs.  Some of the surge in home building in December is surely weather-related, with unusually mild weather for the month in sections of the country often hit by colder winter temperatures.  As a result, expect a drop in housing starts in January.  However, 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 about 1.5 million homes to be started each year.  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.  Note that not all the news in today's report was great.  Building permits took a breather in December, falling 3.9% after hitting a post-recession high in November. The decline was due to both single-family and multi-unit properties.  As a whole, permits rose 1.5% in 2019 versus 2018.  In other recent housing news, the NAHB index, which measures sentiment among homebuilders fell one point to 75 in January after hitting a 20-year high of 76 in December.  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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Implications: A trifecta of solid news out on the economy today. First, a solid report out of the retail sector, where sales rose 0.3% in December, matching consensus expectations, and are up 5.8% from a year ago.  In December, sales gains were broad-based, rising in twelve of the thirteen major retail categories led by gas stations and building materials.  The only decline was for autos, which dropped 1.3%.   "Core" sales, which exclude autos, building materials, and gas stations (the most volatile sectors) grew 0.4% in December and are up 6.0% from a year ago.  However, core sales were revised down in October and November.  Plugging today's report into our models suggests real GDP grew at around a 2.5% annual rate in Q4, although we may adjust this estimate when we get tomorrow's report on industrial production as well as late month data on inventories and international trade in December.  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.  Second, in other news this morning, initial jobless claims fell 10,000 last week to 204,000, rock-bottom levels, while continuing claims declined 37,000 to 1.767 million.  Third, on the manufacturing front, the Philly Fed Index, a measure of East Coast factory sentiment, jumped to +17.0 in January from +2.4 in December.  This is the highest level since May of 2019. In other news this morning, import prices rose 0.3% in December, driven by an increase in fuel prices.  Export prices fell 0.2% due to both lower agricultural and nonagricultural prices.  In the past year, import prices are up 0.5% while export prices are down 0.7%.  Given loose monetary policy, expect higher inflation in 2020.

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Implications:  Following in the tracks of yesterday's report on consumer prices, today's print on producer prices shows prices moving higher, but at a modest pace.  Producer prices rose 0.1% in December as gasoline prices – up 3.7% - led the index higher.  Food prices declined in December as rising costs for fresh fruit and pork were more than offset by a decline in prices for beef and veal.  Strip out these typically volatile food and energy categories, and "core" prices rose 0.1% in December. Over the past twelve-months, core prices are up 1.1%, the smallest year-to-year increase since late 2016.  Within core prices, the cost of goods rose 0.3% in December and has shown acceleration of late.  While goods prices are up 1.1% in the past year, they have risen at a faster 1.6% annualized rate over the past six months, and a 5.3% annualized rate over the past three months. This has flowed through to the headline index as well, where producer prices are up 1.3% in the past year but up at a 2.0% annualized rate in the past three months. Service prices, meanwhile, were unchanged in December following the 0.3% decline in November, which matched the largest monthly drop for that series since early 2015.  Within services, margins for trade wholesalers fell 0.3%, but that was offset by an increase in costs for transportation and warehousing.  We expect both headline and core prices to trend toward 2% in 2020. Further down the pipeline, prices for intermediate demand processed goods rose 0.1%, while intermediate demand unprocessed goods increased 1.8%.  Both intermediate demand categories continue to show prices broadly lower compared to year-ago levels, but, as with the measures noted above, prices have been accelerating of late.  Some may point to today's report as a sign that low inflation should still be a concern for the Fed, urging them to continue rate cuts in 2020, but we think that would be a mistake.  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 Fed intervention.  In manufacturing news this morning, the Empire State Index, which measures factory sentiment in the New York region, rose to +4.8 in January from +3.3 in December, signaling continued growth in that area of the country. 

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Implications:  Consumer prices rose 0.2% in December, ending the year up 2.3%. And inflation is accelerating, up at a 2.5% annualized rate over the past six months and a 3.4% annualized rate over the past three.  Energy prices rose 1.4% in December, while food prices rose 0.2%.  Strip out the typically volatile food and energy sectors, and "core" prices rose 0.1% in December.  Within core inflation, the rise in December can largely be attributed to medical care costs, up 0.6% on the month led higher by prescription drug prices, and shelter, up 0.2%.   This upward pressure on prices was partially offset by declining costs for used vehicles and airfare, down 0.8% and 1.6%, respectively, in December.  Like the headline reading, 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-two consecutive months.  That's a signal that everything is looking A-OK.  Not too fast, not too slow, just right.  Add in employment data continuing to show strength (as it has done through both rate hikes and cuts, suggesting monetary policy is having little impact on the labor market), and it makes sense that the Fed signaled at the last meeting that it doesn't expect further rate cuts unless we see a material change in the economic outlook.  On the wage front, real average hourly earnings declined 0.1% in December 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 new year. 

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The US economy is not in an economic boom, but growth has been consistently faster than during the Plow Horse phase from mid-2009 through the end of 2016.  Real GDP has grown at a 2.6% annual rate since the start of 2017 versus 2.2% beforehand.

But most analysts expect a noticeable slowdown in 2020; not a recession, but slimmer 1.8% real GDP growth (Q4/Q4).  This is an even steeper decline than the 2.2% consensus forecast for 2019 that analysts made a year ago.  By contrast, we're forecasting real GDP growth in the 2.5 - 3.0% range in 2020. 

We're not trying to be contrarian, and don't think that label applies to us.  We're not just saying "up" because others are saying "down."  The reason our forecast is different is that most analysts are Keynesians, and we're supply-siders; they follow money, we follow incentives. 

As a result, they think the extra economic growth related to the tax cut was a temporary phenomenon, due to putting more money in the pockets of consumers and businesses.  Instead, we're focused on what the changes to the tax law do to the incentives to work, invest, and run businesses more efficiently.

That last part is particularly important given that the incentive effects of the Trump tax cut were focused so heavily on businesses.  Some analysts have claimed those tax cuts didn't work, noting that business investment in plant and equipment hasn't boomed. 

But the way businesses operate has changed substantially over recent decades.  The old way of raising worker productivity was by giving them more equipment.  Now companies push the work, the decisions, to the consumer by using Apps.  Instead of buying a shiny new computer, they figure out how to use computers and networks most effectively.  No wonder corporate profits have remained at such high levels.

This may also explain why productivity growth has accelerated in spite of lukewarm growth in the dollar value of business investment.  Productivity growth is normally strong early in an economic expansion, and then fades later on.  For example, productivity grew 3.7% in the first year of the current expansion.  In the next 6½ years it grew at a very weak 0.7% annual rate (through the end of 2016).  Since then, productivity is up at a much more respectable 1.4% rate.         

The economic expansion isn't going to last forever, but look for the US economy to continue to outperform the doubters until the doubters realize their model of how the economy works has a fundamental flaw.  

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

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