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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  Industrial Production Increased 1.1% in April
Posted Under: Data Watch • Employment • Government • Industrial Production - Cap Utilization • Inflation • Retail Sales • COVID-19

Implications:  Industrial activity continued its V-shaped recovery in April, rising for the fourth month in a row, and by more than double consensus expectations. Moreover, the gains in April were broad-based, with nearly every major category posting gains.  Looking at the details, manufacturing output was the main contributor to today's headline increase, rising 0.8% to post a third consecutive gain.  Notably, a large portion of this came from the volatile auto sector, where activity rose 3.9%.  That said, manufacturing outside the auto sector also rose 0.5% in March.  Meanwhile, the mining sector (think oil rigs in the Gulf) continued to make strong progress, rising 1.6% in April.  We expect continued gains from this sector in the months ahead, with oil prices currently above $110 a barrel for the first time since 2013, incentivizing new exploration. While the Biden Administration had recently announced it would be more flexible on new leases to drill and extract fossil fuels on federal land, it also made headlines recently with high-profile cancellations of leases in both Alaska and the Gulf of Mexico, so government policy continues to look contradictory and unhelpful on the energy front.  The good news is that capacity continues to come back online despite this, with Baker Hughes reporting that the total number of oil and gas rigs in operation in the US is rapidly approaching pre-pandemic levels.  Finally, the utilities sector, which is volatile from month to month and largely dependent on weather, rose 2.4% in April.  Overall, we expect a continued upward trend in industrial production in 2022.  Business inventories remain lean, order backlogs are elevated, and demand continues to outstrip supply.  For example, this report puts industrial production 4.2% above pre-pandemic levels.  Meanwhile, this morning's report on retail sales showed that even after adjusting for inflation, "real" retail sales are up 15.6% over the same period.  Ongoing issues with supply chains and labor shortages are hampering a more robust rise in activity, with job openings in the manufacturing sector currently more than double pre-pandemic levels.  This mismatch between supply and demand shows why inflation remains uncomfortably high.  In other recent manufacturing news, the Empire State Index, a measure of New York factory sentiment, fell unexpectedly to -11.6 in May from +24.6 in April.  Notably the 36.2-point decline in May comes on the heels of a 36.4-point surge in April, illustrating abnormally high volatility as the factory sector copes with uncertainty in the aftermath of the invasion of Ukraine and fears of a growth slowdown at home.

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Posted on Tuesday, May 17, 2022 @ 11:47 AM • Post Link Share: 
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  Retail Sales Rose 0.9% in April
Posted Under: CPI • Data Watch • Government • Inflation • Retail Sales • Fed Reserve • Interest Rates • Spending • COVID-19

Implications:  First, the good news.  Retail sales grew a robust 0.9% in April and were revised up for March.  Nine of the thirteen major sales categories increased in April, led by autos, non-store retailers, and restaurants & bars.  The gain in auto sales is a sign that supply-chain issues are gradually easing while the gain in sales at restaurants & bars is a sign of continued progress toward normalcy.  "Core" sales, which exclude the most volatile categories of autos, building materials, and gas station sales, rose 1.2% in April, are up 8.9% from a year ago, and up 26.6% versus February 2020.  Now, the bad news.  One of the key drivers of overall spending is inflation.  Yes, consumers are spending more, but they are not taking home the same amount of goods.  Adjusted for the consumer price index (CPI), overall retail sales rose 0.6% in April.  But, although retail sales are up 8.2% from a year ago, that pace lags inflation, with the CPI up 8.3% over the same period.  Due to very loose monetary policy and the massive increase in government transfer payments in response to COVID, retail sales are still running much hotter than they would have had COVID never happened.  However, loose monetary policy, which helped finance that big increase in government spending, is translating into high inflation, which is why "real" (inflation-adjusted) retail sales are roughly flat versus a year ago.  What to expect in the months ahead?  Continued gains in retail sales, but gains that struggle to keep pace with inflation.  For example, spending at gas stations fell in April, but is likely to rebound for May because of increases in gas prices.  Meanwhile, look for modest overall gains in consumer spending due to the service sector.

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Posted on Tuesday, May 17, 2022 @ 11:31 AM • Post Link Share: 
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  Recession Unlikely in 2022
Posted Under: Employment • GDP • Government • Housing • Inflation • Markets • Monday Morning Outlook • Fed Reserve • Interest Rates • Spending • Bonds • Stocks • COVID-19
The consensus among economists puts the odds of a recession starting sometime in the next year at 30%, according to Bloomberg's most recent survey.  No wonder the S&P 500 is deep in correction territory and flirting with an official bear market.

We think the near-term pessimism is overdone.  Yes, a recession is likely on the way, but it probably has about two more years before it arrives, which means corporate earnings have plenty of room to exceed expectations in the year ahead and for equities to rebound before year-end.

Plenty of reasons suggest we are not about to have a recession that starts in 2022 or early 2023.

First, the most probable cause of the next recession is the tighter monetary policy needed to wrestle inflation under control.  But, so far, monetary policy isn't tight.  The Federal Reserve has raised short-term interest rates by less than one percentage point and, although it's been announced, Quantitative Tightening has yet to start.  Yes, the growth in the M2 measure of the money supply has slowed recently, but the time lag between tighter money and slower economic growth should be at least twelve months.

Second, tax rates haven't gone up and are increasingly unlikely to do so anytime soon.  The gradual demise of the President's Build Back Better agenda means tax rates remain at the lowered levels set by the Tax Cuts and Jobs Act, which was enacted 2018.

Third, although businesses are replenishing inventories at a rapid pace – a pace that will eventually slow and then reduce the real GDP growth rate – the level of inventories at manufacturers, retailers, and wholesalers are still very low relative to sales, which means plenty of room for businesses to keep restocking shelves and showrooms in the months ahead.

Fourth, although higher mortgage rates will almost certainly be a headwind for home sales in the months ahead, home builders have under-built housing in the past decade, and so total home construction should not falter significantly.  Fewer home sales, yes, but rental units have to be built, too.

Fifth, there were 11.5 million job openings as of March compared to 7.0 million immediately prior to COVID.  Demand for workers remains robust.
Some investors fear that the rise in long-term interest rates and drop in stocks, all by themselves, represent a form of financial tightening that could tip the economy into recession, but the size of the recent movements in financial markets have not been automatically linked with recessions in the past.

Meanwhile, debt service costs are low for both consumers and US companies.  As of the fourth quarter, consumers needed to use only 14.0% of their after-tax incomes to meet their financial obligations, which are debt service payments plus rents and payments for car leases and similar costs.  For comparison, that's lower than it ever was pre-COVID, dating back to at least 1980.

We track the debt securities and loans of nonfinancial companies relative to their assets as well as their net interest payments relative to their profits.  Both measures are low by historical standards.

Again, we want to be clear that we are not dismissing the risk of a recession.  We think one is on the horizon given the overly loose stance of monetary policy in the past couple of years, and the response necessary to correct the resulting inflation.  But market pessimism has gotten ahead of itself and there is room for economic news to come in better than expected in the immediate year ahead.

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

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Posted on Monday, May 16, 2022 @ 12:20 PM • Post Link Share: 
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  Recovery Tracker 5/13/2022

The table and charts in the Recovery Tracker track high frequency data, which are published either weekly or daily. With 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 from 2019 to 2022.

Click here to view the report
Posted on Friday, May 13, 2022 @ 5:09 PM • Post Link Share: 
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  The Producer Price Index (PPI) Rose 0.5% in April
Posted Under: Data Watch • Employment • Government • Inflation • PPI • Fed Reserve • Interest Rates • Spending

Implications:  Inflation pressures appear to be peaking, but that doesn't mean a return to 2% inflation is anywhere on the horizon.  Producer prices rose 0.5% in April following three consecutive monthly increases of 1.0% or more to start 2022.  Producer prices are now up 11.0% versus a year ago, which is a modest improvement from the March reading of 11.2%, but nothing that should persuade the Fed that anything other than combating inflation is – and rightfully should be – their primary mission for the foreseeable future.  Looking at the details of the April report, goods prices led the overall index higher.  Energy prices rose 1.7% in April, while food prices rose 1.5% on the month, but the main drivers of inflation came from outside of these typically volatile categories.  Prices for motor vehicles and equipment rose 0.8%, leading "core" producer prices higher by 0.4% in April, bringing the twelve-month increase in core prices to 8.8%.  And price pressures remain elevated further back in the supply chain, as prices for processed and unprocessed goods for intermediate demand are up 21.9% and 48.1%, respectively, in the past year.  On the services side of the economy, a 3.6% rise in the costs for transportation and warehousing services was offset by a decline in margins to services producers (trade services – which measures the margins received by wholesalers and retailers – fell 0.5% in April), leaving services prices unchanged for the month.  In short, inflation continues to run at the highest pace in decades.  This is what happens when you add money to the system at a faster pace than you can grow output.  Fed Chair Jerome Powell was right in saying that the Fed needs to act "expeditiously" to address the damaging impacts of inflation, but a focus on raising interest rates and reducing the size of the Fed balance sheet are not enough by themselves.  Until the Fed gets money growth under control, high inflation is here to stay. We can only hope that those in Washington learn the lesson that their actions have very real (and lasting) consequences.  In other news this morning, initial unemployment claims rose 1,000 last week to 203,000.  Continuing claims fell 44,000 to 1.343 million.  These figures are consistent with continued growth in May. 

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Posted on Thursday, May 12, 2022 @ 11:00 AM • Post Link Share: 
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  The Consumer Price Index (CPI) Increased 0.3% in April
Posted Under: CPI • Data Watch • Government • Inflation • Fed Reserve • Interest Rates • Spending • COVID-19

Implications:  The inflation report for April shows that inflation is nowhere near "transitory" and is likely to be with us for multiple years to come.  Consumer prices rose 0.3% in April, which was higher than the consensus expected +0.2%.  But, more importantly, "core" prices, which exclude food and energy, rose 0.6% versus a consensus expected 0.4%.  Although some analysts and investors might take solace in the fact that headline inflation ticked down on a year-ago comparison basis, to 8.3% in April from 8.5% in March, that doesn't mean inflation is going to drop anywhere as fast as the Federal Reserve hopes.  Looking at the details of today's report, prices for shelter, food, and airline fares were the main drivers of April's increase.  Historically, food and energy prices have been very volatile month to month. That was true once again in April, as food prices rose 0.9% and energy fell 2.7%.  But "core" prices showed more substantial inflation pressure.  Housing rents (for both actual tenants and the rental value of owner-occupied homes) continued to move higher in April, rising 0.5% for the month.  We expect rents to be a key driver for inflation in 2022 and beyond because they make up more than 30% of the overall CPI and still have a long way to go to catch up to home prices, which have skyrocketed more than 30% since COVID started.  Airline fares posted the largest monthly increase on record (+18.6%) dating back to 1963, signaling increased demand from COVID re-opening.  Meanwhile, the auto sector had a split picture for inflation for the month.  New vehicle prices rose 1.1% in April and are up 13.2% from a year ago.  Used cars and trucks, however, are starting to see a turn in prices; although they're up 22.7% from a year ago, they declined 0.4% in April for the third straight monthly decline.  The M2 measure of the money supply soared during COVID and now consumers are paying the price in much higher inflation.  Until the Fed gets growth in the money supply under persistent control, high inflation is here to stay.

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Posted on Wednesday, May 11, 2022 @ 11:10 AM • Post Link Share: 
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  Reducing Our Stock Market Forecasts
Posted Under: GDP • Government • Markets • Monday Morning Outlook • Fed Reserve • Interest Rates • Bonds • Stocks
At the end of 2021, we set out our projections for the stock market in 2022: 5,250 for the S&P 500 and 40,000 for the Dow Jones Industrial Average.  Those projections were based on our expectations for both profit growth in 2022 and the yield on the 10-year Treasury note.  At that time, given interest rates, the US stock market was still under our estimate of fair value. 

This is no longer true.  Given the surge in long-term interest rates this year, the US stock market is now fairly valued for the first time in over a dozen years, dating back to the Panic of 2008.  During many of these past twelve years, with the US stock market well under fair value year after year, we often lifted our year end forecast during the year.

We use our Capitalized Profits Model to assess fair value on the stock market.  The model starts with the government's measure of economy-wide corporate profits and uses the yield on the 10-year Treasury Note to discount those profits.

The yield on the 10-year Treasury finished last year at about 1.5%, which made the stock market look extremely attractive and undervalued.  But to be cautious – and because we knew the 10-year Treasury yield was being held back by excessively accommodative Federal Reserve policy – we used a 2.5% yield to discount profits, instead.  Using a 2.5% yield suggested fair value for the S&P 500 was 5,250, which became our forecast for the market at the end of 2022.

But here we are in early May and a vicious sell-off in the bond market has pushed the 10-year yield to 3.1%, substantially higher than the end of last year and above our 2.5% estimate.  This higher yield makes a world of difference in how our model sees the stock market.  Using a yield of 3.13% and fourth quarter profits suggests we were already at fair value as of Friday, with the S&P 500 closing Friday near 4,100.

This is a good point to stop and discuss our model.  Our capitalized profits model is not a trading tool.  It is a valuation tool.  Just because the model says we are over-valued, does not mean stocks will automatically fall.  Nor, if under-valued, do they automatically rise.  The odds change, but we cannot use this model to trade.  For example, from 1996 to 2000, our model showed US stocks grew increasingly more over-valued, but the markets did not peak until early 2000.  At that time of the peak, the over-valuation was 60% and the subsequent dot.com crash was significant.

When we say the stock market is fairly valued – as it is today – that means there is an equal chance that it goes up or down from here.  And the prime factor determining the outcome is whether the economy experiences a recession or not.

A stock market at fair value should be expected to rise over time as long as profits tend to rise.  Recessions typically drag down profits, and with that the stock market as well.

We think the outlook through year end suggests a larger gain than normal when stocks are at fair value.  First, some investors are already pricing in a recession for this year or early 2023.  But we don't see a recession starting that soon.  As the most pessimistic investors realize they were wrong, that's an adjustment that should drive equities upward.  It's a classic wall of worry that can help boost stocks, with bad news in the near term already over-priced in.

One way to think about this is to look at the yield curve.  When the Fed gets too tight, the bond market starts to signal that the Fed will need to reverse course, and short-term rates rise above long-term rates – an inverted yield curve.  That is not happening today.  Long-term rates have been rising faster than short-term rates, and the yield curve has steepened.  The reopening of the economy following the pandemic is still underway, and we still expect profits to rise this year.

Second, some investors are concerned about a wider war in Eastern Europe, perhaps triggering NATO's call for mutual defense, which could lead to World War III.  We think the conflict is more likely to be contained to Ukraine and as the weeks and months pass without a widening of the conflict, that's another wall of worry for stocks to climb.

Third, we think the stars are aligned for large Republican gains in the House and Senate, even after factoring in what appears to be an overturning of Roe vs Wade.  Our best guess is that the GOP ends up with a solid House majority near the post-World War II high-water mark of 247 seats (of 435 total) set in the 2014 mid-term election.  In addition, it looks like the GOP is heading toward about 53 Senate seats.

This is not to say Republican wins are always good for equities; they're not, far from it.  It is to say that in the current political situation a Republican Congress creates a divided government where the odds of tax hikes would be dead at the same time the Judicial Branch is taking a tougher line on federal regulations.
Put it all together, and we think there's a recipe here for an equity rally into year end with the S&P 500 ending the year at 4,900 and the Dow at 39,000. 

However, assuming some modest increases in interest rates from here, such a rally would also put the stock market in overvalued territory.  So the rally we're projecting would be something for equity investors to enjoy, but not a reason to become complacent.

For now, our best guess is that the next recession starts in the Spring or Summer of 2024.  If so, equity gains from our projected year-end level would be limited and it might be time then to think about a significant, albeit temporary, shift in the investment outlook.

One issue making the current environment even more uncertain is that the Federal Reserve is trying to reverse course for the first time under a brand-new monetary regime.  Quantitative easing/tightening, along with the payment of interest to banks on the reserves they hold at the Fed, has never faced a test like it does today.

Under monetary policy before 2008, interest rates and bank reserves were connected.  The Fed operated with a "scarce reserve" model.  If they pulled reserves down, the federal funds rate would go up.  If they added reserves, the rate would fall.  But now, interest rates and bank reserves are decoupled.  In other words, the Fed can push rates up without changing the amount of money on its balance sheet.

In fact, that is what it has done in recent months.  The Fed has lifted interest rates twice (by a total of 75 bps) but has not done any quantitative tightening.  In other words, the Fed has not become tight, just moderately less loose.

We do not know, and neither does the Fed, whether the interest rate it pays banks on reserves will actually slow down the growth of the money supply.

The bottom line is that recessions typically happen when the Fed tightens too much.  And with inflation well above current interest rate levels, the yield curve positively sloped, and the money supply still expanding, the Fed is not tight.

It would take a recession for us to believe that a true bear market, not just a correction, would occur.  Right now, we do not expect a recession in 2022.

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

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Posted on Monday, May 9, 2022 @ 12:16 PM • Post Link Share: 
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  Recovery Tracker 5/6/2022

The table and charts in the Recovery Tracker track high frequency data, which are published either weekly or daily. With 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 from 2019 to 2022.

Click here to view the report
Posted on Friday, May 6, 2022 @ 1:48 PM • Post Link Share: 
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  Nonfarm Payrolls Increased 428,000 in April
Posted Under: CPI • Data Watch • Employment • Government • Inflation • Fed Reserve • Interest Rates • Spending • COVID-19

Implications:  Let this be your monthly reminder that although the Federal Reserve is getting less loose, it's not yet tight and the US job market continues to improve.  Nonfarm payrolls rose 428,000 in April, beating consensus expectations.  And although payrolls are still about 1.2 million below where they were before COVID, the total number of hours worked rose 0.4% in April to reach a new record high, finally beating the pre-COVID peak.  However, not all the news on the labor market was as good.  Civilian employment, an alternative measure of jobs that includes small-business start-ups, declined 353,000 in April.  That helped keep the unemployment rate at 3.6%.  The labor force – people who are either working or looking for work – dropped 363,000.  As a result, the participation rate declined to 62.2% in April from 62.4% in March, while the share of adults who are working ticked down to 60.0% from 60.1%.  Although average hourly wages grew what would normally be a respectable 0.3% for the month, that's not so respectable in an era with high inflation.  Average hourly earnings are up 5.5% from a year ago while consumer prices are up near 8.5%.  That means an overly loose monetary policy has generated so much inflation that the average worker is falling behind in hourly pay even as his nominal wages go up.  Where does all this data leave the Fed?  In the same bind it was yesterday.  Inflation is running too hot and it needs to move as rapidly as possible to a restrictive monetary policy to bring it down.  Ultimately that entails increasing the risk of a recession, but that recession is very unlikely to materialize this year.  Investors should expect continued job growth in the months ahead, although at a slower pace than the 518,000 average monthly pace so far this year.               

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Posted on Friday, May 6, 2022 @ 10:18 AM • Post Link Share: 
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  Nonfarm Productivity Declined 7.5% at an Annual Rate in Q1
Posted Under: Data Watch • Employment • GDP • Government • Inflation • Productivity • COVID-19

Implications:  Productivity in the first quarter fell by the most since 1947, with labor costs surging and rising inflation remaining a key headwind for workers' purchasing power.  The 7.5% annualized decline in productivity in Q1 came as output declined while hours worked rose, both combining to reduce output per hour. Productivity is down 0.6% from a year ago, but stands 2.6% above the level in the fourth quarter of 2019 pre-COVID.  Although "real" (inflation-adjusted) compensation per hour fell at a 5.5% annualized rate in Q1, that doesn't mean workers are being paid less.  In fact, wages have been rising, they just haven't been able to keep up with the high inflation.  This is likely to remain an ongoing issue in the coming quarters, as inflation remains elevated while the rehiring of lower-paid workers puts downward pressure on the average amount paid per hour.  On the manufacturing front, productivity rose at a 0.7% annualized rate as output rose quicker than hours. We are now well into a recovery, but expect hours and output will rise in the quarters ahead as the labor force continues to heal, supply-chain issues improve, and we work to get back to the level of output the U.S. would have seen had COVID never happened.  Productivity growth historically can be very volatile from quarter to quarter, and the policy reactions due to the pandemic have only added to further volatility.  It will take many more quarters or even years to clearly settle out how much the trend has changed in light of COVID and related policies, but the early read is that the growth potential of the economy is weaker than it was pre-COVID.  In other news today, initial unemployment claims rose 19,000 last week to 200,000.  Continuing claims fell 19,000 to 1.384 million.  These figures are consistent with our forecast that nonfarm payrolls rose 375,000 in April.

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Posted on Thursday, May 5, 2022 @ 11:44 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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