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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  Industrial Production Declined 0.6% in January
Posted Under: Data Watch • Industrial Production - Cap Utilization


Implications:  Industrial production started 2019 on a disappointing note, falling unexpectedly to post the first decline in eight months.  However, there are a couple reasons why you should take today's report with a grain of salt.  First, the details show that most of the decline in the overall index was due to an 8.8% drop in the volatile auto sector, which is now down 0.7% from a year ago.  By contrast, non-auto manufacturing declined a more modest 0.3% in January and remains up 3.1% versus a year ago.  Second, today's report on industrial production is in sharp contrast with the January reading on the ISM manufacturing index from earlier this month, which rebounded on strength in the new orders and production indices, which posted their largest monthly gains since 2014 and 2010, respectively.  It is too soon to tell which report will be right, but for the time being any talk of a sharp slowdown in the factory sector is too early and making too much of one month's data.  In the past year, the various capital goods indices continue to show healthy growth with business equipment up 3.8%, machinery up 5.1%, and high-tech equipment up 6.5%.  Comparing this with the slower year-over-year growth of 2.4% for nondurable goods and 2.8% for manufacturing as a whole demonstrates that capital goods production remains a valuable source of strength in the sector.  In turn, more capital goods should help push productivity growth higher, making it easier for the economy to grow in spite of a tight labor market.  Looking outside the manufacturing sector, mining activity grew for the twelfth month in a row in January and is now up 15.3% in the past year.  Finally, utilities rose 0.4% in January, rebounding as things returned toward normal after unseasonably warm weather in much of the country reduced demand for heating in December.  In other news this morning, the Empire State Index, which measures factory sentiment in the New York region, rebounded to 8.8 in February from 3.9 in January, signaling rising optimism.  On the inflation front, import prices declined 0.5% in January, while export prices fell 0.6%. In the past year, import prices are now down 1.7%, while export prices are down 0.2%.  Expect these figures to rebound soon in response to the turnaround in oil prices as well as a deal with China on some of our trade issues.

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Posted on Friday, February 15, 2019 @ 10:57 AM • Post Link Share: 
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  The Producer Price Index Declined 0.1% in January
Posted Under: Data Watch • Inflation • PPI


Implications:  With two consecutive months of declines for the producer price index – and prices down at a 0.3% annual rate in the past three months - are we seeing a softening in inflation that justifies the bears' calls for a prolonged Fed pause?  Not even close.  Strip out the ever-volatile food and energy categories - which fell 1.7% and 3.8%, respectively, in January – and producer prices rose 0.3%.  And the pace of "core" inflation stands comfortably above the Fed's inflation target, up 2.6% in the past year (if you are feeling a bit of deja vu, yesterday's report on consumer prices showed a similar pattern).  In fact, outside of food and energy, not a single other major category of final demand prices fell in January. Within core PPI, prices for trade services (think wholesaler margins) rose 0.8%, and transportation & warehousing services increased 0.5%.  Notably, private capital equipment prices rose 0.6% in January, and are up 3.7% in the past year, possibly signaling rising business investment which will provide a boost to economic activity in the year ahead.  In other words, policymakers in Washington, DC – both Republicans and Democrats – need to stop wasting time trying to manipulate how companies use their resources.  Looking further down the price pipeline suggests we will continue to see some volatility in the month-to-month readings for the producer price index.  But with both the ISM Manufacturing and Non-Manufacturing indices comfortably in expansion territory, and an increasingly-tight labor market for qualified labor to both produce and transport goods, we expect wages - and general prices – will push higher at a faster pace in the year ahead.  At the end of the day, the trend in core prices – where the Fed will focus their attention – suggests inflation of around 2.5% in 2019. 

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Posted on Thursday, February 14, 2019 @ 11:37 AM • Post Link Share: 
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  Retail Sales Declined 1.2% in December
Posted Under: Data Watch • Retail Sales


Implications:  There's no way around it, today's retail data for December were ugly.  Our first inclination, given how inconsistent the report is with other economic data – like surging employment, accelerating wages, and the Johnson-Redbook measure of same-store sales – is to suspect that the partial government shutdown hampered the Census Bureau's ability to collect and process the data.  Yes, we know Census said there was no problem, but it certainly appears to be an odd coincidence.  Another oddity is that the report shows a 3.9% decline in sales at non-store retailers, which includes internet sales, the largest percentage drop since November 2008 in the midst of the financial crisis.   We find that hard to believe and expect either a substantial upward revision or a steep rebound for January.  Looking at the report, overall retail sales declined 1.2% in December, falling by the most in nine years, and coming in much lower than any economic forecasting group expected.  The declines were broad-based, as eleven of thirteen major categories showed a drop in sales.  Sales at gas stations fell 5.1% in December.  "Core" sales, which exclude autos, building materials, and gas stations (the most volatile sectors) were down 1.6%, were revised lower for prior months, but are still up 2.3% from a year ago. Plugging today's report into our models suggests "real" (inflation-adjusted) consumer spending, on goods and services combined, will be up at around a 3.0% annual rate in Q4 while real GDP grows at around a 2.5% rate.  Given the tailwinds from deregulation and tax cuts, we expect an average real GDP growth rate of close to 3% in both 2018 and 2019, a pace we haven't seen since 2004-05.  Jobs and wages are moving up, tax cuts have taken effect, consumer balance sheets look healthy, and serious (90+ day) debt delinquencies are down substantially from post-recession highs. Some may point to household debt at a record high as reason to doubt that consumption growth can continue.  But household assets are near a record high, as well.  Relative to assets, household debt levels are near the lowest in more than 30 years.  In other news today, initial jobless claims rose 4,000 last week to 239,000.  Meanwhile, continuing claims rose 37,000 to 1.77 million.  However, both remain at very healthy levels and we expect a solid gain in payrolls for February.

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Posted on Thursday, February 14, 2019 @ 11:24 AM • Post Link Share: 
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  The Consumer Price Index was Unchanged in January
Posted Under: CPI • Data Watch • Inflation


Implications:  Consumer prices were unchanged for a third consecutive month in January, though the headline number masks the real story.  Recent months have been a textbook example of how volatility distorts readings. Energy prices fell 2.8% in November, 2.6% in December, and 3.1% in January.  But while the consumer price index showed no change in overall price inflation over that period, "core" inflation (which excludes the typically volatile food and energy categories) rose a steady 0.2% in all three months.  Over the past three months, overall inflation has declined 0.2% annualized, while "core" prices are up at a 2.6% annual rate.  In other words, the Fed (which understands the short-term volatility coming from the energy sectors) continues to see ample data to support a path of continued rate hikes if – and this is important – we see longer term interest rates begin to rise.  The Fed does not want to force a yield curve inversion, but we believe continued solid economic growth and further resolution of trade tensions will bring confidence back to the markets and a return to a more "risk on" environment will put upward pressure on interest rates.  As we stated in our annual forecasts release, we expect the 10-year Treasury to end the year at 3.4%, giving the Fed room for two, maybe three hikes in 2019.  Looking at the details of the January report shows housing and medical care led the rise in "core" prices, both up 0.2%.  Arguably the best news in today's report was that real average hourly earnings rose 0.2% in January and are accelerating.  These real wages are up 1.7% in the past year, up 2.4% at an annual rate over the past six months, and up 3.4% at an annual rate in the past three-months. Remember, "real" wage growth represents increases in earnings above the pace of inflation, so these are direct gains to consumer purchasing power. And these earnings do not include irregular bonuses – like the ones paid by companies after the tax cut or to attract new hires – or the value of benefits.  Strong employment growth, healthy corporate earnings, and the continued pickup in new orders suggest that this trend will continue through 2019.  So ignore the CPI headline and any pouting pundits that try to spin today's report as a sign of weakness. That's just sloppy reporting and a lack of understanding.   The data show pretty much exactly what you would expect from an economy growing at a healthy pace.

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Posted on Wednesday, February 13, 2019 @ 9:56 AM • Post Link Share: 
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  Where’s the Recession?
Posted Under: GDP • Government • Markets • Monday Morning Outlook • Taxes • Stocks

Whatever happened to the recession calls? 

Seems like just a few weeks ago that the correction in the stock market as well as the partial government shutdown had convinced many analysts and investors the US was about to enter a recession.  

Fortunately, the data haven't cooperated.  Ten days ago we got the employment report for January, which showed a payroll increase of 304,000 and the highest share of adults working since 2008.  Yes, February has seen both initial and continuing unemployment claims average higher than in January, but only slightly.  In other words, job growth looks set to continue shutting down economic naysayers. 

Meanwhile, the ISM Manufacturing index, which had moved down to a still-solid 54.3 in December, rebounded to a robust 56.6 for January.  Traditionally, this measure needs to fall to 45.0, or below, to signal a US recession, and we're not even close.  The ISM Non-Manufacturing (services sector) index fell to 56.7 in January, which is still robust relative to historical standards.  And that index, compared to the one for manufacturing, tends to be more sensitive to temporary shifts in sentiment rather than changes in underlying business activity.

Last week we started clearing out some of the major backlog of government economic data created by the partial shutdown, including the report on international trade which showed a much smaller trade deficit than anticipated.  This further strengthens our expectation that the economy grew at a 2.5% annual rate in the fourth quarter of last year and will continue to grow at around that pace in the first quarter of 2019.   

This week, we'll get several reports to keep an eye on.  In particular, we'll finally find out about retail sales in December and also get industrial production in January, both of which play key roles in estimating real GDP growth.  

Superficially, we're not optimistic about retail sales, estimating that they were unchanged for the month.  But that was back in December when gas prices were plummeting.  Excluding gas, retail sales were likely OK.  Industrial production comes out Friday and we expect a modest increase of 0.2%.  If we're right, that'll mean production is up about 4.5% from a year ago, another sign we're nowhere close to recession.    

And in the meantime, we continue to get reports on corporate profits as well as forward guidance.  Profits compared to a year ago are doing well; estimates for the future, not so much.  But those estimates for the future appear excessively pessimistic.  The recession many anticipated isn't happening and consumers and businesses have plenty of purchasing power, which means top-line growth should offset any pressure on margins.       

In addition, the power of improved incentives has only begun to play out.  Dropping the corporate tax rate to 21% from 35% means companies have more reason to shift operations to the US.  But these shifts take time and it's only been a year.

Those predicting the next recession are going to be waiting for a while before they finally get one "right."      

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

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Posted on Monday, February 11, 2019 @ 11:53 AM • Post Link Share: 
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  M2 and C&I Loan Growth
Posted Under: Government • Fed Reserve


Source: St Louis Federal Reserve FRED Database

Posted on Monday, February 11, 2019 @ 9:35 AM • Post Link Share: 
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  The Trade Deficit in Goods and Services Came in at $49.3 Billion in November
Posted Under: Data Watch • Trade


Implications: When President Trump sees today's report on the trade deficit in November, he may chalk it up as a win for his confrontational policy approach with our partners abroad as the trade deficit shrunk in November to $49.3 billion.  But, today's report should not be celebrated, and is a perfect example of why deficits or surpluses can be misleading. What matters more than the headline trade deficit number - and which you will not hear about as much - is the total volume of trade – imports plus exports – which signals how much businesses and consumers interact across borders.  Looking at that data, US trade came substantially off its record all-time highs in October as exports declined by $1.3 billion while imports declined by $7.7 billion. So, the reason the trade deficit shrunk so drastically in November was because imports fell much faster than exports, nothing to get excited about. Overall, in the past year exports are up 3.7%, while imports are up 3.2%, signaling still healthy gains in the overall volume of international trade.  While many are worried about protectionism from Washington, especially regarding China, we continue to think this is a trade skirmish, and the odds of an all-out trade war that noticeably hurts the US economy are slim.  We believe better trade agreements for the United States and world are on the way.  We have already seen it happen with several countries, and now China looks to be extending a bit of an olive branch, too. Average tariffs in China were cut from 9.8% in 2017 to 7.5% in 2018. We see this as real progress, and just the start.  The US's negotiating position simply continues to strengthen, in no small part due to the rise of the US as an energy powerhouse.  As recently as 2005, the US was importing more than ten times the petroleum products that we were exporting.  As of November, imports are down to 1.04 times exports and this trend should continue.  Not only does this reduce US reliance on foreign trade partners and lower their bargaining power, it has served to shift power dynamics on a global scale (witness the political turmoil in Saudi Arabia).  So at the end of the day, we will continue to watch trade policy as it develops, but don't see any reason to sound alarm bells. 

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Posted on Wednesday, February 6, 2019 @ 11:50 AM • Post Link Share: 
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  The ISM Non-Manufacturing Index Declined to 56.7 in January
Posted Under: Data Watch • ISM Non-Manufacturing


Implications:  The pace of service sector growth slowed in January, but remains comfortably in expansion territory.  The more measured growth was due, in part, to sentiment-related impacts from both the government shutdown and ongoing trade dispute, which peppered respondent's comments once again.  With the government reopened (at least for now), and some apparent progress on trade discussions, look for a rebound in the pace of growth in February.  Even with the uncertainty apparently weighing, details of today's report show growth continues to be broad-based, with eleven of eighteen industries reporting expansion in January while seven reported a decline.  In addition to the breadth of growth, the two most forward-looking indices – new orders and business activity – remain comfortably in growth territory, even with the 5-point decline in the new orders index.  In other words, the outlook for activity looks bright for the months ahead. The employment index was the sole major measure of activity to move higher in January, which jives with last Friday's booming jobs report.  Finally, the supplier deliveries index was unchanged in January at 51.5, as respondents noted both component shortages and capacity constraints.  These ongoing delays, paired with the continued growth in new orders, are putting upward pressure on prices – which once again rose in January.  While we don't expect prices will soar any time soon, inflation should remain near-or-above the Fed's 2% target, meaning that the economic picture will continue to justify further rate hikes, though the Fed will need to see more movement at the longer end of the yield curve before they make their next move.  In other recent news, automakers reported selling cars and light trucks at a 16.6 million annual rate in January, down 5.1% from December, down 3.0% from a year ago, and coming in below the consensus expected 17.2 million pace.  Extreme cold temperatures across the country played a role, keeping potential buyers indoors at the end of the month. But while we expect a modest rebound in February, the outlook for autos suggests a gradual decline in sales in the coming years in spite of solid economic growth.   

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Posted on Tuesday, February 5, 2019 @ 12:51 PM • Post Link Share: 
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  2008 Myth and Reality
Posted Under: Government • Markets • Monday Morning Outlook • Fed Reserve • Stocks

We've written about it over and over, and while many advisors seem to understand, the media, politicians, and many analysts don't...or won't.  So, we thought we'd try again to explain why so many people don't understand the nearly ten-year long bull market in U.S. equity values.

Conventional Wisdom places the blame for the 2008 Financial Panic at the feet of Wall Street, and heaps praise on QE, TARP, and bank stress tests for saving the world.  It has been repeated so often that even many conservative/libertarian analysts have succumbed to thinking the crises was papered-over by government money and that any day now the "sugar high" will come to an end.

This is why "corrections," like the US stock markets experienced late last year generate so much fear.  There is a cadre of traders, media-types, and just plain old hangers on who can't wait to be the next Nouriel Roubini and make one great call in a row.

What makes it worse is that the truth is there for the taking, but the conventional wisdom simply ignores it.  In Peter Wallison's book "Hidden in Plain Sight," he very clearly shows it was Fannie Mae and Freddie Mac who pushed the subprime loan space.  Congress and HUD urged mandated that Fannie and Freddie buy more subprime paper, and by 2007 - along with the federal government - they owned 76% of it.  Yes, Wall Street is culpable too, but government drove the marketplace.  Wall Street simply wouldn't have been issuing these bonds without Fannie and Freddie's voracious appetites.

Even Ben Bernanke has argued that subprime loans themselves weren't large enough to take down the system.  He blames derivatives, undercapitalization, and interconnected banks.  By his verdict, the government gets off scot-free.

But this completely ignores the role that FASB 157, otherwise known as mark-to-market accounting, played.  Mark-to-market accounting forces banks to take a few bids from the marketplace and use those bids to value assets.  Cash flow doesn't matter, underlying asset values don't matter.  And what happened was a disaster.  The market for loans froze, and even assets that were still paying on time sold at fire-sale prices. 

If a bank owned a pool of 1000 mortgages and 300 of them defaulted (which given the collapse in underwriting standards by Fannie and Freddie wasn't impossible to expect), then that pool still payed 70 cents on the dollar.  But, because the market was frozen, bids fell into the teens for an asset paying 70 cents in cash.  FASB 157 forced banks to take the "bid," push it through their income statement, and subtract the losses from capital.  This, in turn, created the bigger problems.  There was no willingness to invest in banks when, at any time, they could be wiped out by mark-to-market losses.  The fire became an inferno.  

This was a capital problem, not a liquidity problem.  But, the Federal Reserve started Quantitative Easing anyway in September 2008.  Hank Paulson pushed the $700 billion TARP bill through that October.  Nonetheless, the market kept falling. The S&P 500 fell an additional 40% after TARP – bank stocks fell 73%.  QE and TARP weren't the cure.

It was March 9, 2009, when Barney Frank's Financial Services Committee announced a hearing with FASB on this really dumb accounting rule, that the market turned around.  Yes, it's true that the actual rule wasn't reversed until April, but on March 9th the financial markets realized the change was coming.

What happened after that is recorded for history.  The market is up 300%, banks healed, asset values rose, and a "normal recovery" began.  New technology – fracking, apps, 3D printing, the cloud, smartphones – lifted productivity and profits, and stocks responded.  It was not QE that lifted the stock market; TARP didn't save the banks.

Unfortunately, because so many Republicans back the government-led version of history, many younger Americans have come to believe that free markets fail, and governments can engineer growth.  No wonder there are so many fine young thinkers who seem to back socialism these days.  After all, even Republicans support government intervention.  President George W. Bush defended TARP by saying we had to "violate free market principles in order to save the free market."

Nothing could be further from the truth.  Either you believe in free markets, or you don't.  The Bush administration and its supporters bowed to the popular, but false, narrative.  They have yet to find a way to explain their positions.  As a result, socialist tendencies are rising in America.

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

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Posted on Monday, February 4, 2019 @ 11:12 AM • Post Link Share: 
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  M2 and C&I Loan Growth


Source: St. Louis Federal Reserve FRED Database

Posted on Monday, February 4, 2019 @ 10:33 AM • Post Link Share: 
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