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 | Resist Inflation Complacency |
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| Posted Under: CPI • Data Watch • GDP • Government • Inflation • Markets • Monday Morning Outlook • Fed Reserve • Spending • Bonds • Stocks • COVID-19 |
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Some analysts and investors breathed a big sigh of relief on inflation when it was reported last week that the Consumer Price Index rose 0.3% in August versus a consensus expected 0.4%. But we think any sense of relief is premature.
First, in no way, shape, or form, is a 0.3% increase in consumer prices indicative of low inflation. Consumer prices rose at a 3.3% annual rate in August, which is still well above the Federal Reserve's 2.0% target. Yes, we are well aware that the official Fed inflation target is for the change in the PCE deflator, which always runs a little lower than the increase in the CPI, but it doesn't run anywhere close to 1.3 points lower, which is what it'd have to do for the Fed to hit the long-run 2.0% inflation target.
Second, a number of sectors had price declines in August that should not persist. For example, airline fares fell 9.1% in August and are now 17.4% below the average fares of 2019, which was pre-COVID. So, as COVID gradually recedes these prices should rise.
Third, housing rents are likely to accelerate sharply in the years ahead, including for both actual tenants as well as owners' equivalent rent, which is the rental value of homes occupied by homeowners. With the eviction moratorium in place, rents have grown unusually slowly for the past eighteen months. But, going back to the 1980s, rents tend to lag the Case-Shiller home price index by about two years. Now, with the national eviction moratorium finished, look for rents to make up for lost time. And because rents make up more than 30% of the overall CPI, anyone predicting lower inflation numbers in the future are saying other prices will fall.
Ultimately, however, it's important to recognize that inflation is still a monetary phenomenon and the M2 measure of the money supply is up about 33% since February 2020, pre-COVID. Eventually, that will translate into a substantial rise in overall spending or nominal GDP (real GDP growth plus inflation) and since the Fed has little to no control over real GDP growth beyond the short-term, that means higher inflation.
One way to think about it is that between the late 1950s and early 1990s, the ratio of nominal GDP to M2 hovered in a narrow range very close to 1.8. What that means is that every new dollar of M2 translated into 1.8 more dollars of spending. And if the ratio remains the same, then a 10% increase in M2 leads to a 10% increase in overall (nominal) spending.
This ratio rose in the 1990s. Interestingly, so did real GDP growth. So, the strong real growth of the 1990s was actually associated with lower inflation. Since then, the ratio of GDP to M2 has generally dropped. Immediately prior to COVID, in the last quarter of 2019, the ratio was 1.42; now it's 1.12. What this has meant is that M2 growth has not translated directly to inflation.
However, let's assume the ratio is headed back to the 1.42 that prevailed just before COVID. If nominal GDP normally grows 4% per year – 2% real GDP growth plus 2% inflation – it would take six years (so, 2027) to get back to that 1.42 ratio. But that's only if M2 doesn't grow in the interim. No change at all. More likely, M2 does grow in the interim and that additional growth feeds through directly to higher inflation.
Another way to think about it is that the ratio of nominal GDP to M2 has dropped because the velocity of money has fallen. That's the speed with which money circulates through the economy. It's hard to see velocity falling further from 1.12 because to do so means eventually going below 1, and that has not happened in any recorded history of the US.
The Fed meets this week and will be issuing its usual statement after the meeting. We don't anticipate any significant changes to monetary policy at this meeting, although we do expect a hint that the Fed will announce a tapering of quantitative easing to begin after the next meeting in early November.
However, the Fed will also be releasing a new set of economic projections as well as projections about the path of short-term interest rates. Back in June, the Fed was forecasting that inflation would be back down to roughly 2.0% in 2022. If they make a similar forecast this week, it will be a sign that it isn't taking upward inflation risk nearly as seriously as it should.
Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist
Click here for PDF version
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| | COVID-19 Tracker 9/16/2021 |
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| Posted Under: COVID-19 |
We have received a significant number of requests to continue publishing the COVID-19 tracker. With the Delta variant on everyone's mind as cases rise again, we are hearing more about school closings, mask mandates, potential shutdowns, vaccine mandates, vaccine effectiveness, the list goes on and on. The vaccines have clearly led to a lower overall level of deaths during this recent wave of Delta variant cases, and that represents considerable progress. There are still many questions out there, and it's important to follow the data closely.
Click here to view the report
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| | Recovery Tracker 9/16/2021 |
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| Posted Under: Bullish • COVID-19 |
The table and charts in the Recovery Tracker track high frequency data, which are published either weekly or daily. With most states reopening their economies and widespread distribution of COVID-19 vaccines, these indicators show continued improvement in economic activity. It won't improve in a straight line, but the trend should remain positive over the coming months and quarters. The charts in the Recovery Tracker highlight where the high frequency data indicators were in 2019, 2020, and in 2021.
Click here for this week's Recovery Tracker
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| | Retail Sales Rose 0.7% in August |
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| Posted Under: Data Watch • Employment • Government • Retail Sales • Fed Reserve • Interest Rates • Spending • COVID-19 |
Implications: Retail sales rebounded in August, surprising the consensus, increasing 0.7% for the month. Ten of thirteen major categories rose in August, with non-store retailers (internet and mail-order) leading the way, followed by general merchandise stores as back-to-school shopping was in full effect. The weakest category by far was autos as supply chain issues continue to wreak havoc on that sector. In fact, retail sales excluding autos rose 1.8% in August, the largest gain in five months. Overall sales are up a robust 15.1% from a year ago. Another way to look at it is that sales are up 17.7% versus February 2020, which was pre-COVID. "Core" sales, which exclude the most volatile categories of autos, building materials, and gas station sales, rose 2.1% in August, are up 15.0% from a year ago, and up 18.2% versus February 2020. In other words, due to temporary government support, retail sales are running hotter than they would have in the absence of COVID, even as the level of output (real GDP) is still running lower than it would have been in the absence of COVID. It has not been an even recovery for all major categories, though. For instance, non-store retailers (+34.7%) and sporting goods stores (+33.2%) have grown significantly faster than overall retail sales since February 2020. The last category of sales to get above February 2020 levels was restaurants & bars, which finally moved into the green in April and are now up 8.7% from 18 months ago. Looking ahead, given that overall retail sales are still far above the pre-COVID trend, we expect a modest trend decline in the year ahead. However, as long as policymakers don't completely panic because of the Delta variant, we also expect sales at restaurants & bars to buck that trend and move higher, along with sales of services not counted by the retail trade report, as America gets back toward normal. In the months ahead, the path of retail sales will be a battle between a number of opposing factors. Rising wages, jobs, and inflation will all be tailwinds for retail sales, while the waning of the temporary and artificial boost from "stimulus" checks along with the end to overly excessive jobless benefits will be headwinds. In other news today, initial jobless claims rose 20,000 last week to 332,000. Meanwhile continuing claims declined 187,000 to a new recovery low of 2.665 million. With the end of additional unemployment benefits nationally earlier this month, all eyes will be on the jobs recovery as we move into the final quarter of 2021. Also today, on the manufacturing front, the Philadelphia Fed Index, a measure of factory sentiment in that region, rose to a very robust 30.7 in September from 19.4 in August, signaling solid growth in that region for the month.
Click here for a PDF version
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| | Industrial Production Increased 0.4% in August |
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| Posted Under: Autos • Data Watch • Inflation • COVID-19 |
Implications: Industrial production rose less than expected in August, largely the result of the late in the month plant shutdowns related to Hurricane Ida. In fact, the Federal Reserve estimates that without the storm-related headwinds, the overall index would have risen 0.7% for the month. Looking at the details, the disruptions were concentrated in manufacturing (petrochemicals, plastic resins, refining operations) and mining (oil and gas extraction) industries that have a large presence in the Gulf of Mexico. It's not a surprise then that mining was the weakest major category in August, falling 0.6%, its first decline in four months. Meanwhile, manufacturing output managed to eke out a gain of 0.2% despite the disruptions. The gain was driven by continued growth in auto production which rose 0.1% in August after a huge 9.5% gain in July. Outside the auto sector, manufacturing rose 0.2% in August. Finally, utilities output rose 3.2% in August as unseasonably warm weather boosted demand for air conditioning. Notably, the 0.4% gain in the headline index was enough to finally push that measure above its pre-pandemic high. That said, it's important to keep in mind that despite hitting an important milestone, production still has a way to go to meet current demand. Ongoing issues with supply chains and labor shortages are hampering a more robust rise in activity, with job openings in the manufacturing sector currently at a record high and more than double pre-pandemic levels. We expect more temporary disruptions from Ida in September but a return to the upward trend in overall industrial production in the months after. It looks like the worst of Delta concerns are beginning to subside and labor disincentives are dissipating as well with the end of pandemic related unemployment payments. In other factory related news this morning, the Empire State Index, a measure of New York factory sentiment, soared to +34.3 in September from +18.3 in August. Finally, we also got trade inflation data this morning. Import prices fell 0.3% in August while export prices increased 0.4%. In the past year, import prices are up 9.0%, while export prices are up 16.8%.
Click here for a PDF version
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| | The Consumer Price Index (CPI) Increased 0.3% in August |
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| Posted Under: CPI • Data Watch • Government • Housing • Inflation • Fed Reserve • COVID-19 |
Implications: Consumer prices continued to increase in August but at the slowest pace since January, climbing 0.3% for the month. However, even with that slower increase, consumer prices are up 5.3% versus a year ago, well above the Federal Reserve's 2.0% long-term target. Although some analysts may think the August data is a "win" for the "transitory" camp, overall consumer prices were still up at a 3.3% annual rate in August, which is also well above the Fed's inflation target. Energy led the overall 0.3% price gain, rising 2.0% for the month, with food prices rising 0.4%. "Core" prices, which exclude food and energy, rose 0.1% in August. These prices were held down by an unusually wide array of price declines, including airfares (-9.1%), used cars and trucks (-1.5%), motor vehicle insurance (-2.8%), and hotels/motels (-3.3%). Combined, those four factors reduced both the headline gain in the CPI as well as core CPI growth by 0.2 percentage points. Yes, used car and truck prices may continue to decline in the months ahead after a large run-up in the past year, but airfares, and motor vehicle insurance remain below the pre-COVID trend. In the months ahead, we anticipate a faster pace of core inflation. Housing rents (both from actual tenants as well as the imputed rent of owner-occupants) make up almost 40% of the core CPI, have been accelerating lately, and should accelerate more due to the end of the national moratorium on tenant evictions. Moreover, with the national Case-Shiller home price index up 18.6% in the last year, some would-be homeowners may shift toward renting, putting further upward pressure on rents. Notably, new vehicle prices rose 1.2% in August and are up 7.6% versus a year ago, the largest increase since 1980 and a result of a continued shortage in semi-conductor chips. The hope that supply chain issues would fade after a few months has proven wrong, as recent delta-driven shutdowns in Asian country factories and ports have only made matters worse. And although used car and trucks prices declined in August, the twelve-month increase for that category remains an extremely elevated 31.9%. One way to assess the underlying trend is to measure price gains since February 2020, the last month pre-COVID, which would naturally include the price declines early-on in the shutdowns. Since then, consumer prices are up at a 3.6% annual rate while core prices are up 3.1% annualized. As the massive increase in the M2 measure of the money supply continues to gain traction, we think the ranks of those claiming the recent burst in inflation is transitory will dwindle. The Federal Reserve and many others assume inflation will be close to 2.0% next year. They are in for a rude awakening.
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| | Stocks Versus the Economy |
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| Posted Under: Bullish • Employment • GDP • Government • Inflation • Markets • Monday Morning Outlook • Retail Sales • Fed Reserve • Interest Rates • Spending • Taxes • Bonds • Stocks • COVID-19 |
If you've read our two most recent Monday Morning Outlooks, you know we raised our forecast for the S&P 500, but lowered our forecast for real GDP growth. How can that be?
The first thing to recognize is that when we say we're bullish on stocks that doesn't mean we think the stock market is going to go up every day, every week, or even every month. It won't. Nor does it exclude the possibility of a correction in equities, which based on historical frequency is past due.
We take a fundamental approach, valuing time in the market over trying to time the market. Corrections will happen from time to time, and we don't know anyone who can accurately forecast them on a consistent basis.
Without digging deeply into our capitalized profits model which estimates a fair value for stocks as a whole, we remain bullish for three main reasons. First, long-term interest rates are low and are likely to remain relatively low for at least the next year. Second, corporate profits are very high and will remain relatively high even if they pull back from record highs as the amount of government "stimulus" wanes.
Third, even if real (inflation-adjusted) GDP growth falls short of consensus expectations in the next few years, nominal GDP (which includes both real GDP growth and inflation), should remain robust due to the Federal Reserve's overly loose monetary policy – see point one above – which will remain extremely loose even as the Fed starts tapering later this year and ends quantitative easing around mid-2022.
The key problem for real GDP is that the massive and unsustainable fiscal stimulus and income support that happened during COVID pushed retail sales well above the pre-COVID trend. Retail sales in July were 17.5% above the level in February 2020. To put that in perspective, in the seventeen months before COVID, retail sales were up 5.1%. There is only one way retail sales can grow 3x its normal rate while millions are unemployed and the economy was locked down – the government pulled out the credit card.
Those handouts are now slowing down and retail sales likely dropped in August (official data to be reported Thursday morning) and are likely to moderate from the 17.5% peak growth rate, on a trend basis, for at least the next year.
Retail sales make up about 30% of GDP. So other sectors of the economy will need to pick up the slack – replenishing inventories, home building, and the consumption of services, such as travel and leisure activities. But, after such massive artificial stimulus, it will be difficult for real GDP to keep growing as it has in the past nine months.
GDP includes revenues that are earned by publicly traded companies, but it also includes Main Street businesses that are not listed. It is those latter businesses that have been hurt the most by lockdowns. That's one reason listed-company profits and their stock prices have outperformed the economy.
The bottom line is that we are bullish for now, but fully recognize that we have been in a pristine environment for stocks. A slowdown in GDP will likely slow profit growth, while rising inflation will eventually lift long term interest rates. Tax hikes are still a threat, as are tougher COVID-related restrictions that limit a service-sector recovery. However, with the Fed as easy as it is, the tailwinds from easy money remain strong. The market is not overvalued, but it is not as undervalued as it once was.
Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist
Click here for a PDF version
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| | Recovery Tracker 9/10/2021 |
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| Posted Under: Bullish • COVID-19 |
The table and charts in the Recovery Tracker track high frequency data, which are published either weekly or daily. With most states reopening their economies and widespread distribution of COVID-19 vaccines, these indicators show continued improvement in economic activity. It won't improve in a straight line, but the trend should remain positive over the coming months and quarters. The charts in the Recovery Tracker highlight where the high frequency data indicators were in 2019, 2020, and in 2021.
Click here for this week's Recovery Tracker
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| | The Producer Price Index (PPI) Rose 0.7% in August |
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| Posted Under: Data Watch • Employment • Government • Inflation • PPI • Spending • COVID-19 |
Implications: Producer prices continued to surge in August, rising 0.7% for the month and bringing the annualized rate of change to date in 2021 to a whopping 10.7%. While for years after the financial crisis the question from many was whether the Fed could induce even 2% inflation, the question now is whether the Fed will be able to get back down near 2% in the foreseeable future. Producer prices are now up 8.3% year-to-year, the highest in more than a decade. And prices are accelerating, up at an 10.4% annualized pace in the past six months. While the Fed has continued to say higher inflation is "transitory," it's getting increasingly difficult to play down rising numbers. Supply-chain issues continue to be a significant pressure on prices, with no end in sight. From the shortage in semiconductors that has slowed production of everything from cars and trucks to household appliances, to difficulties finding labor to fill the record number of job openings in the US, supply simply hasn't kept up with demand. And that demand is being supported by an M2 money supply that is 33% above pre-COVID levels, leaving both consumer and corporate pockets flush with cash. While supply-chain issues are temporary, the huge increase in the money supply is what will drive inflation over the long term. The Fed seems to anticipate that inflation will subside later this year and into 2022, but we think any waning in inflation later this year will be temporary, as the increase in the money supply continues to gain traction. In terms of the details for August, prices for services led the overall index higher, rising 0.7% (while prices for goods rose by a greater percentage in August, services represent a roughly 2/3rds weighting in the index and so contributed more to the headline number). The most notable increase came from final demand trade services, which tracks margins received by wholesalers and retailers. While prices for producer inputs are rising, they have the pricing power to pass on those costs to consumers. Goods prices rose 1.0% in August, led by food (+2.9%) – more specifically, meat prices which increased 8.5% on the month – which was partially offset by a decline in costs for iron and steel scrap (-3.7%). Stripping out the typically volatile food and energy components shows "core" prices rose 0.6% in August and are up 6.7% in the past year. In spite of inflation running well above the 2% target no matter how you cut it, we don't expect the Fed to signal any change in plans to keep short-term rates near zero for the foreseeable future. We also don't expect the Fed to announce a tapering of quantitative easing until the fourth quarter. The Fed wants inflation to trend above the 2% target for a prolonged period, while the labor market – the other side of the Fed's dual mandate – has to heal considerably further to get the Fed to seriously consider a move higher (for details of last week's disappointing August jobs report, click here). In recent news on employment front, initial jobless claims fell 35,000 last week to 310,000. Meanwhile continuing claims declined 22,000 to a new recovery low of 2.783 million. With the ending of additional unemployment benefits nationally this past Monday, all eyes will be on the jobs recovery as we move into the final quarter of 2021.
Click here for a PDF version
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| | COVID-19 Tracker 9/9/2021 |
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| Posted Under: COVID-19 |
We have received a significant number of requests to continue publishing the COVID-19 tracker. With the Delta variant on everyone's mind as cases rise again, we are hearing more about school closings, mask mandates, potential shutdowns, vaccine mandates, vaccine effectiveness, the list goes on and on. The vaccines have clearly led to a lower overall level of deaths during this recent wave of Delta variant cases, and that represents considerable progress. Now, with cases looking like they have peaked in the South we will be watching closely to see if seasonality once again leads to a rise in cases in the Northern areas of the U.S. this Fall/Winter. There are still many questions out there, and it's important to follow the data closely.
Click here to view the report
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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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The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. By providing this information, First Trust is not undertaking to give advice in any fiduciary capacity within the meaning of ERISA, the Internal Revenue Code or any other regulatory framework. Financial professionals are responsible for evaluating investment risks independently and for exercising independent judgment in determining whether investments are appropriate for their clients.
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