It’s been a turbulent but ultimately rewarding first half for the stock market. In this week’s edition of Three on Thursday, we spotlight the S&P 500 Index—one of the most trusted gauges of U.S. equity performance. Remarkably, it closed June at all-time highs.  Click the link below for a deeper understanding of the events that shaped the first half of the year.

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Implications:  The ISM Services index’s brief one-month stint below 50 in May proved to be short-lived, as the index beat expectations and returned to expansion territory (albeit barely) at 50.8 in June.  It’s important to remember that Purchasing Manager’s surveys like the ISM Services index and its counterpart on the manufacturing sector often capture sentiment mixed in with actual activity.  Given the recent weak readings from both, we don’t know whether this is the front end of a much slower economy, or just a sign that uncertainty from U.S. trade policy and, more recently, the conflict in the Middle East, are impacting sentiment and temporarily holding things back.  Looking at the details of the report, new orders and business activity were responsible for the slight increase to the overall index, both climbing back into expansion territory at 51.3 and 54.2, respectively. Uncertainty from trade policy, high interest rates, and rising tensions in the Middle East are all said to be delaying activity and investment.  Service companies – once hamstrung with difficulty finding qualified labor – are now taking a cautious approach with their hiring efforts, as the employment index dropped to 47.2 in June, the third contraction in four months, with nearly twice as many industries (nine) reporting lower employment in June versus higher (five). The highest reading of any category was once again the prices index, which declined to 67.5 in June from 68.7 in May. Besides last month, that’s the highest level since late 2022, but still far from the worst we saw during the COVID supply-chain disruptions, when the index reached the low 80s. Though inflation pressures remain – the M2 measure of the money supply is barely up versus three years ago – which means we are likely to see lower inflation and growth in the year ahead.

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Implications: The U.S. trade deficit widened to $71.5 billion in May, as exports fell by $11.6 billion while imports declined by $0.3 billion.  Imports jumped at a massive rate in the first quarter as businesses were front-running President Trump’s new tariffs.  Now all that is reversing.  We like to focus on the total volume of trade, imports plus exports, as it shows the extent of business and consumer interaction across the US border.  This measure declined by $11.9 billion in May but is up 4.2% compared to a year ago, before businesses started adjusting to higher tariffs.  In May itself, nonmonetary gold led the way lower for exports dropping by $5.5 billion for the month.  Because imports subtract from GDP in national accounting, the surge in Q1 became a major drag on growth; net exports alone shaved roughly five percentage points off Q1’s growth rate, pulling real GDP down at a 0.5% annualized pace.  But now, as tariff front-running peaked in March, imports should continue to be unusually soft for the next few months and so trade should add to the GDP calculations for the current quarter.  However, erratic trade policy out of Washington adds a great deal of uncertainty in translating recent trade reports into GDP projections.  Meanwhile, the landscape of global trade continues to shift.  China, once the top exporter to the U.S., has fallen to third place behind Mexico and Canada. Also in today’s report, the dollar value of US petroleum exports exceeded imports once again. This marks the 39th consecutive month of the US being a net exporter of petroleum products.  In other recent news, cars and light trucks were sold at a 15.3 million annual rate in June, down 1.7% from May, but up 2.3% from a year ago.

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Implications:  No cheerleading today’s employment report.  Yes, the headline looks good: nonfarm payrolls rose 147,000 in June, beating the consensus expected 106,000.  Payrolls were also revised up 16,000 in prior months, bringing the net gain to a solid 163,000.   Meanwhile, the unemployment rate ticked down to 4.1% in June.  So why not celebrate?   Because private payrolls were up only 74,000 in June and were revised down 16,000 for prior months, bringing the net gain to 58,000.  In other words, the gain in June itself was roughly half due to government and all the upward revisions were due to the government, as well.  We like to follow payrolls excluding three sectors: government, education & health services, and leisure & hospitality, all of which are heavily influenced by government spending and regulation (including COVID lockdowns and re-openings).  This measure of “core payrolls” increased only 3,000 in June, the smallest so far this year.  Perhaps the worst news was a 0.3% decline for total private-sector hours worked.  Meanwhile, civilian employment, an alternative measure of jobs that includes small-business start-ups (but is volatile on a month-to-month basis) rose 93,000 in June.  So why did the unemployment rate tick down if job growth was tepid?  Because the labor force (people who are either working or looking for work) dropped 130,000, not a good sign.  Notably, in the past five months the native-born labor force is up while the foreign-born labor force is down, a sign of efforts against illegal immigration.  On the inflation front, average hourly earnings rose a tepid 0.2% in June while up 3.7% versus a year ago.  This is very close to the 3.5% gain we think the Federal Reserve would like to see and a sign that it has room for modest rate cuts in the months ahead.   Although some may claim the increase in government payrolls shows the Trump Administration is failing to trim the federal government, that’s not what the data say.  In the five months since January, federal payrolls (excluding the Post Office and Census-related jobs) are down 2.4%, the steepest drop for any 5-month period since the 1990s.  Instead, it’s been hiring by state and local governments, particularly for education jobs, that’s kept total government growing.  In other news this morning, new claims for unemployment insurance declined, 4,000 last week to 233,000.  Continuing claims remained at 1.964 million.  These figures are consistent with continued job growth but at a slower pace.

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Implications:  Activity in the manufacturing sector continued to decline in June, but not by as much as the consensus expected. This makes four consecutive months that the ISM Manufacturing Index has been below 50.  The index was below 50 for all of 2023 and 2024.  Many thought this contraction was over in January and February when the index jumped over 50.  Today’s reading, and the last four months of weak readings, are reason for caution. We don’t know whether this is the front end of a much slower economy, or just a sign that uncertainty from U.S. trade policy and, more recently, escalating conflict in the Middle East, is temporarily holding things back.  Looking at the details of the report, half of the eighteen major industries reported growth in June, versus six that reported contraction, and three that reported no change.  The slight increase in the overall index was due to the production and inventories index normalizing to more moderate levels at 50.3 and 49.2, respectively, after they contracted sharply in April (likely the reversal of tariff front-running).   Order books were already weak before this year and the added business uncertainty from on-again/off-again tariffs has put many customer orders on pause until stability returns.  That effect can be seen in the new orders index, which slipped to 46.4 in June, as well as the survey comments, which were peppered with complaints of trade policy that’s making it extremely difficult to make near-term plans and budgets.  In turn this has hurt hiring efforts, as the employment index fell to an three-month low at 45.0, with more than double the industries (ten) reporting lower employment in June versus higher (four).  Perhaps the worst part of the report is that inflation pressures remain even while manufacturing stagnates.  The prices index rose to 69.7, which is high by historical standards, but below post COVID inflation levels.  We will be watching the M2 measure of the money supply closely – which has been roughly flat for three years – as a signal for if these pressures will turn inflationary.  In other news this morning, construction spending declined 0.3% in May, led by a large drop in homebuilding as well as commercial projects.

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In 1852, Karl Marx said "Men make their own history, but they do not make it as they please; they do not make it under circumstances chosen by themselves, but under circumstances directly encountered and transmitted from the past."

He obviously knew about the Magna Carta (1215) and the English Parliament’s Bill of Rights (1689), which created a separation of powers between the King and elected representatives. What he didn’t pay much attention to was how the United States broke with history and improved upon these documents with the Declaration of Independence and Constitution so well thought out that it has only been amended twenty-seven times in 235 years.  Men and women can make their own history here.  Karl Marx was wrong.  No one puts it better than Ronald Reagan; the excerpt below comes directly from his Commencement Address at the University of Notre Dame back on May 17, 1981.

"This Nation was born when a band of men, the Founding Fathers, a group so unique we've never seen their like since, rose to such selfless heights. Lawyers, tradesmen, merchants, farmers – fifty-six men achieved security and standing in life but valued freedom more. They pledged their lives, their fortunes, and their sacred honor. Sixteen of them gave their lives. Most gave their fortunes. All preserved their sacred honor.”

“They gave us more than a nation. They brought to all mankind for the first time the concept that man was born free, that each of us has inalienable rights, ours by the grace of God, and that government was created by us for our convenience, having only the powers that we choose to give it. This is the heritage that you're about to claim as you come out to join the society made up of those who have preceded you by a few years, or some of us by a great many.”

“This experiment in man's relation to man is a few years into its third century. Saying that may make it sound quite old. But let's look at it from another viewpoint or perspective. A few years ago, someone figured out that if you could condense the entire history of life on Earth into a motion picture that would run for 24 hours a day, 365 days – maybe on leap years we could have an intermission – this idea that is the United States wouldn't appear on the screen until 3.5 seconds before midnight on December 31st. And in those 3.5 seconds not only would a new concept of society come into being, a golden hope for all mankind, but more than half the activity, economic activity in world history, would take place on this continent. Free to express their genius, individual Americans, men and women, in 3.5 seconds, would perform such miracles of invention, construction, and production as the world had never seen.”

America has proven that men and women not only can make their own history, but they can make it as they please, with circumstances chosen by themselves. Happy 4th of July to you all.  Let’s take time this week to step back and realize just how fortunate we are to live in a time and place where the fire of invention still burns hot, course corrections (however messy they may be) still take place, and the future remains bright.  May we continue to honor the legacy of those who came before us by striving to uphold the principles that have made this country a beacon of hope and freedom for the world.

(We first published a version of this same Monday Morning Outlook in celebration of July 4th, 2023.)

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:  After a hot start to 2025, both incomes and spending surprised to the downside in May.  Personal income declined 0.4%, lagging even the most pessimistic forecasts, while prior months data were revised lower as well.  However, the details show a better picture than the headline suggests.  Private-sector wages and salaries rose 0.4% in May, but were more than fully offset by a decline in government transfer payments related to social security, and a drop in farm income.  Both of those declines may sound concerning, but in reality May was simply a return back toward more “normal” levels following large one-time payments related to the Social Security Fairness Act – one of the last items signed into law by the outgoing Biden administration, which increased benefits to public sector workers not typically covered by Social Security – and the Emergency Commodity Assistance Program, which made payments to farmers producing certain commodities to help offset higher input costs and lower sale prices.  These were never reliable (or desirable) long-term sources of income like wages and salaries, so while incomes were lower in May than in April, the mix of where spending power came from improved.  What was more disappointing was the 0.1% decline in personal consumption, where spending on services rose 0.1% while goods spending declined 0.8%.  But even here the drop comes with a caveat.  Nearly the entire decline in goods spending came from a drop in motor vehicles and parts, a category where consumers picked up spending to front-run the tariffs and have since pulled back as tariffs went into place.  In addition, lower gasoline prices brought down outlays on energy goods. Within services, the largest increases came in housing & utilities as well as health care.  On the inflation front, PCE prices rose 0.1% in May while the twelve-month change increased to 2.3% from a 2.1% reading last month.  It is important to remember that inflation readings were very modest between May and November of 2024, so even modest monthly increases in inflation today may push year-to-year readings higher.  That does not mean that inflation is a rising threat, though we wouldn’t be surprised to see arguments from some for the Fed to hold rates steady until this subsides.  “Core” prices (which exclude food and energy) rose 0.2% in May and are up 2.7% versus a year ago. The Fed is unlikely to move at the July meeting, as it continues to fret about potential inflationary impacts from tariffs and continued uncertainty surrounding policy out of Washington, but we think the Fed will resume rate cuts in the later part of 2025.  In other recent news on the housing front, pending home sales, which are contracts on existing homes, rose 1.8% in May following a 6.3% decline in April, suggesting existing home sales (counted at closing) will dip slightly in June. On the manufacturing front, the Kansas City Fed Manufacturing Index, a measure of factory sentiment in that region, rose to a still weak reading of -2 in June from -3 in May.

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In this week’s “Three on Thursday,” we delve into the state of Social Security. Last week, the Social Security Trustees released their annual report, forecasting the program’s financial outlook over the next 75 years. The recent projections indicate that Social Security is only eight years from insolvency, necessitating urgent reforms.

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Implications:  New orders for durable goods soared in May at the fastest pace in more than a decade.  However, the16.4% increase in new orders was almost entirely due to the very volatile category of commercial aircraft, where orders more than tripled from April as President’s Trumps tour through Saudi Arabia, Qatar, and the United Arab Emirates was accompanied by a massive Boeing order from Qatar Airways. We anticipate airline orders to slow (and cancellations to increase) in the months ahead as companies and countries navigate the ever-shifting trade and economic environments.  But it wasn’t just transportations orders that rose in May, even excluding the transportation sector, orders for durable goods increased a healthy 0.5%.  The best news was that orders rose across the board, led by computers & electronic products (+1.5%), electrical equipment (+0.8%), and fabricated metal products (+0.7%), while machinery (+0.3%) and primary metals (+0.1%) rounded out the gains.  It must be noted the May gains are a bright spot on what has otherwise been a bumpy and modest path for ex-transportations orders, which have struggled to simply keep pace with inflation over the past year and have shown signs of slowing over recent months.  The most important number in today’s release, core shipments – a key input for business investment in the calculation of GDP – rose 0.5% in May.  If unchanged in June, these shipments would be up at a 3.3% annualized rate in Q2 versus the Q1 average.  The current environment in Washington – and geopolitical events abroad – remain uncertain, and we expect volatility in the data to be the rule rather than the exception for the foreseeable future.  In turn, the Federal Reserve must navigate what these changes mean for the path of inflation.  While we don’t currently expect any movement from the Fed at the next meeting in late July, we do believe that cuts are on the table starting in September, as economic weakness brings the employment side of the Fed’s mandate into more central focus.  In other news this morning, initial jobless claims declined 10,000 last week at 236,000, while continuing claims rose 37,000 to 1.974 million.  These figures are consistent with continued job growth in June, but at a slower pace than last year.

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Implications:   Hold off on GDP itself for a moment.  The most important part of this morning’s report was on economy-wide corporate profits, which declined 2.3% in the first quarter vs. the fourth quarter but are up 6.3% from a year ago.  Profits from domestic non-financial industries declined by 2.5%, while profits from domestic financial firms grew 2.3%. Profits from the rest of the world fell by 7.3% for the quarter.  Financial industry data include the Federal Reserve (either profits, or losses) and because the Fed pays private banks interest on reserves, and has raised interest rates, it has been generating unprecedented losses in recent quarters.  Excluding the losses at the Fed (because we want to accurately count profits in the private sector), overall corporate profits were down 2.7% in the first quarter but up 4.4% from a year ago.  However, plugging in non-Fed profits into our Capitalized Profits Model suggests stocks remain overvalued. Looking at the other details of today’s report, the final reading for real GDP growth in the fourth quarter was revised lower from last month’s estimate, coming in at a -0.5% annual rate, and the underlying components showed a weaker mix. Downward revisions in consumer spending (specifically services) and inventories easily offset a larger increase in net exports (imports grew slightly less while exports grew slightly more than originally estimated). For a more accurate measure of sustainable growth, we focus on "core" GDP, which includes consumer spending, business fixed investment, and home building, but excludes the more volatile categories like government purchases, inventories, and international trade. "Core" GDP grew at a 1.9% annual rate in Q4, lower than the prior estimate of 2.5% and the slowest pace in more than two years. Today we also got revisions to Q1 Real Gross Domestic Income (GDI), an alternative measure of economic activity.  Real GDI was revised higher to a 0.2% annual rate in Q1 and up 2.2% from a year ago.  GDP inflation was revised slightly higher to a 3.8% annual rate in Q1, and is up 2.6% over the past year, both still higher than the Fed’s 2.0% target.  Meanwhile, nominal GDP (real growth plus inflation) increased at a 3.2% annual rate in Q1 and is up 4.7% year-over-year.

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