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   Brian Wesbury
Chief Economist
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   Bob Stein
Deputy Chief Economist
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  Housing Starts Declined 8.2% in December
Posted Under: Data Watch • Home Starts • Housing


Implications:  Housing starts retreated in December, as the surge in construction in the southern region following Hurricanes Harvey and Irma ran its course.  Starts fell 8.2% in December and are now down 6.0% in the past year.  The South alone was responsible for 90% of the drop in the pace of construction in December.  According to the Census Bureau, the counties affected by the hurricanes accounted for 26% of new construction authorized in the southern region in 2016, which explains why the storms have had such a large effect on the data in the past few months. However, this is just a temporary lull in new construction as the storm-related rebound subsides.  Despite today's negative headline number, 2017 annual totals for starts, permits, and home completions were all at their highest levels in a decade, signaling the trend will remain upward.  Though overall starts are now down 6% from a year earlier, this is entirely due to multi-family starts, which are down 22.6% over that same period. Single-family starts are up 3.5% from a year ago.  Multi-family construction led the way in the early stages of the housing recovery (2011-15); by 2015, 35.7% of all starts were in the multi-family sector, the largest share since the mid-1980s, when the last wave of Baby Boomers was growing up and moving to cities.  Since then, the multi-family share of starts has been trending down.  We expect this trend to continue and view the shift toward single-family construction as a positive sign for the economy.  On average, each single-family home contributes to GDP about twice the amount of a multi-family unit.  Based on population growth and "scrappage," housing starts should eventually rise to about 1.5 million units per year.  And the longer this process takes, the more room the housing market will have to eventually overshoot the 1.5 million mark.  Although the tax bill looks set to trim the principal limit against which borrowers can take a mortgage interest deduction to $750,000 versus the current law amount of $1 million, the bill would only affect new mortgages.  In addition, large reductions to marginal tax rates in the early 1980s, which reduced the value of the mortgage interest deduction, coincided with a rebound in housing.  In other words, we don't expect the changes in the deduction to cause problems for the housing industry at the national level, although we do expect some shift in building toward regions with lower land prices.  In other news this morning, initial jobless claims fell 41,000 last week to 220,000, hitting their lowest level since 1973.  Meanwhile, continuing claims rose 76,000 to 1.952 million.  On the factory front, the Philly Fed Index, a measure of sentiment among East Coast manufacturers, fell to a still high 22.2 in January from 27.9 in December.

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Posted on Thursday, January 18, 2018 @ 11:15 AM • Post Link Share: 
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  Industrial Production Increased 0.9% in December
Posted Under: Data Watch • Industrial Production - Cap Utilization


Implications:  Industrial production finished 2017 with a bang, beating consensus expectations and posting the largest calendar-year gain since 2010.  The headline series rose 0.9% in December and is now up 3.6% in the past year.  Further, overall production rebounded 10.7% at an annual rate in Q4 – its fastest quarterly pace since 2009 – after being held back in Q3 by Hurricanes Harvey and Irma.  Even though the overall number was strong in December, it is important to note that the details of the report show the strength was primarily due to the volatile utilities and mining components.  Manufacturing, which rose 0.1% in December has undergone a major shift.  Back in December 2016, automobile manufacturing was up 6% from the prior year while non-auto manufacturing was up 0.2%.  Now the leadership has reversed, with auto manufacturing up only 0.4% in the past year while non-auto manufacturing is up 2.6%.  This demonstrates that the revival of manufacturing outside the auto sector in the US hasn't been all talk.  The biggest source of strength in today's report came from utilities, a volatile category that is very dependent on weather, which rebounded 5.7% in December, after coming in weak in November.  Given low January temperatures in much of the country, utilities may have another month of growth in them before reverting to normal.  Another bright spot in December came from mining, which rose 1.6% amid broad-based gains in the sector.  Notably, after five consecutive months of declines, oil and gas-well drilling rose 0.9% in December.  Despite the weakness following the storms, today's gain signals it may have turned the corner.  Look for a surge in drilling activity in the months ahead.  In other recent news, the Empire State index, a measure of manufacturing sentiment in New York, dropped to 17.7 in January from 19.6 in December.  On the housing front, the NAHB index, which measures homebuilder sentiment, fell to a still high 72 in January from 74 in December, signaling continued optimism from developers.

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Posted on Wednesday, January 17, 2018 @ 11:43 AM • Post Link Share: 
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  Don't Time a Correction
Posted Under: Bullish • Government • Markets • Monday Morning Outlook • Fed Reserve • Spending • Taxes • Stocks

The stock market is on a tear.  The S&P 500 rose 19.4% in 2017 excluding dividends, and is already up over 4% in 2018.  It's not a bubble or a sugar high.  Our capitalized profits model, says the broad U.S. stock market, is, and was, undervalued.

We never believed the "sugar high" theory that QE was driving stocks.  So, slowly unwinding QE and slowly raising the federal funds rate, as the Fed did in 2017, was never a worry.  But, now a truly positive fundamental has changed – the Trump Tax Cut, particularly the long-awaited cut in business tax rates.  With it in place, we think our forecast for 3,100 on the S&P 500 by year-end is not only in reach, but could be eclipsed.

Before you consider us overly optimistic, we did not expect the stock market to surge like it has so early in the year.  In fact, we would not have been surprised if the market experienced a correction after the tax cut.  There's an old saying; "buy on rumor, sell on fact."  So, with tax cuts approaching, optimism could build, but once they became law, the market would be left hanging for better news.

We would never forecast a correction, because we're not traders.  We're investors.  Anyone lucky enough to pick the beginning of a bear market never knows exactly when to get back in.  In 2016, it happened twice and we know many investors are still bandaging up their wounds from being whipsawed.

The market got off to a terrible start in 2016, one of the worst in years.  The pouting pundits were talking recession and bear market, only to experience a head-snapping rebound.  Then, during the Brexit vote, the stock market fell 5% in two days – which was seen as another indicator of recession.  But, it turned out to be a great buying opportunity, like every sell-off since March 2009.

The better strategy for most investors is don't sell.  Some sort of correction is inevitable but no one knows for sure when it will happen and few have the discipline to take advantage of the situation.

This is particularly true when risks to the economy remain low and the stock market is undervalued, which is exactly how we see the world today.

Earnings are strong (even with charge-offs related to tax reform), and according to Factset, since the tax law passed analysts have lifted 2018 profit estimates more rapidly than at any time in the past decade.  Even the political opponents of the tax cuts are saying it will likely lift economic growth for at least the next couple of years. 

Continuing unemployment claims are the lowest since 1973, payrolls are still growing at a robust pace, and wages are growing faster for workers at the lower end of the income spectrum than the top.  Auto sales are trending down, but home building has much further to grow to keep up with population growth and the inevitable need to scrap older homes.  Consumer debts remain very low relative to assets, while financial obligations are less than average relative to incomes.

In addition, monetary policy isn't remotely tight and there is evidence that the velocity of money is picking up.  Banks are in solid financial shape, and deregulation is going to increase their willingness to take more lending risk.  The fiscal policy pendulum has swung and the U.S. is not about to embark on a series of new Great Society-style social programs.  In fact, some fiscal discipline on the entitlement side of the fiscal ledger may finally be imposed.

Bottom line: This is not a recipe for recession.

It's true, rising protectionism remains a possibility, but we think there's going to be much more smoke than fire on this issue, and that deals will be cut to keep the good parts of NAFTA in place.

Put it all together, and we think the stock market, is set for much higher highs in 2018.  If you're brave enough to attempt trading the inevitable ups and downs of markets, more power to you, but as hedge fund performance shows, even the so-called pros have a hard time doing this.  Stay bullish!

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

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Posted on Tuesday, January 16, 2018 @ 10:46 AM • Post Link Share: 
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  The Consumer Price Index Rose 0.1% in December


Implications:  Consumer prices rose 0.1% in December, ending 2017 up 2.1% for the year, exactly the same as the increase seen in 2016. However, in the past three months CPI is up at a 2.6% annual rate, signaling that inflation is accelerating further above the Fed's 2% target.  A look at the details of today's report shows energy prices declined 1.2% in December, tempering increased prices seen across nearly all other categories.  Food prices increased 0.2%, while "core" prices – which exclude the typically volatile food and energy components – rose 0.3% in December.  "Core" prices are up 1.8% in the past year, but are showing acceleration in recent months, up at a 2.2% annual rate over the past six-months and 2.5% annualized in the past three months.  In other words, both headline and "core" inflation stand near or above the Fed's 2% inflation target, and both have been rising of late.  Housing costs led the increase in "core" prices in December,  rising 0.3%, and are up 2.9% in the past year. Meanwhile prices for services also rose 0.3% in December and are up 2.6% over the past twelve months.  Both remain key components pushing "core" prices higher and should maintain that role in the year ahead.  Add in yesterday's report on producer prices that showed rising inflation in the pipeline and we expect consumer price inflation to move to around 2.5% or higher by the end of 2018.  Given the strength of the labor market, with the unemployment at the lowest level in more than a decade and headed lower, paired with a pickup in the pace of economic activity thanks to improved policy out of Washington, the Fed is on track to raise rates at least three times in 2018, with a fourth hike looking increasingly likely.

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Posted on Friday, January 12, 2018 @ 11:27 AM • Post Link Share: 
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  Retail Sales Increased 0.4% in December
Posted Under: Data Watch • Retail Sales


Implications: The Plow Horse economy has officially picked up her gait! Retailers capped off the strongest year of sales since 2012 on a high note with another solid month of sales in December.  Retail sales rose 0.4% in December, coming on the back of a 0.9% gain in November, a 0.7% gain in October and a 2.0% surge in September!  In contrast to September and October, when the rise in spending was led by autos, as people replaced vehicles destroyed in Hurricanes Harvey and Irma, the gain in December was broad-based, with 9 of the 13 major categories showing gains.  Non-store retailers (internet and mail-order) led the charge higher followed by restaurants & bars.  Non-store retail sales grew by 1.2% in December, and now make up 11.2% of retail sales, the largest share ever. More great news today was the considerable strength for "core" sales, which exclude volatile categories (autos, building materials, and gas).  Core sales grew 0.4% in December, but including prior months' positive revisions were up 0.9% and are up 5.4% from a year ago.  Although conventional wisdom argues that traditional retailers are in trouble because of the Internet, this is an overly pessimistic view.  Traditional retailers are not sitting still.  They are learning how to compete in today's new world.  Jobs and wages are moving up, consumers' financial obligations are less than average relative to incomes, and serious (90+ day) debt delinquencies are down substantially from post-recession highs. As a result of all of today's data, our model for GDP suggests a real GDP growth rate around 3.0% in the fourth quarter. 

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Posted on Friday, January 12, 2018 @ 10:48 AM • Post Link Share: 
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  The Producer Price Index Declined 0.1% in December
Posted Under: Data Watch • Inflation • PPI


Implications:  Producer prices fell in December, the first drop for any month in more than a year.  However, price changes from a year ago remain comfortably above the Fed's 2% inflation target.  Declining margins for wholesalers – most notably automotive fuel dealers – and lower food prices led producer prices lower in December.  Energy prices were unchanged in December, as a 3.9% decline in gas prices was offset by rising costs for electric, natural gas, and heating oil.  Meanwhile food prices, which were up in the prior two months, declined in December, led by a 6.3% drop in prices for beef and veal.  Strip out the typically volatile food and energy groupings, and "core" producer prices fell 0.1% in December but are up 2.3% in the past year.  For comparison, "core" prices rose 1.7% in the twelve months ending December 2016, and were up 0.2% in the twelve months ending December 2015.  No matter how you cut it, it's clear inflation is on the rise. And a look further down the pipeline shows the trend higher should continue in the months to come.  Intermediate processed goods rose 0.5% in December and are up 5.1% from a year ago, while unprocessed goods increased 2.1% in December and are up 5.2% in the past year.  And both categories have seen a pickup in price increases over the past six and three-month periods.  Given these figures, and with employment growth remaining strong and inflation rising, we expect three rate hikes in 2018, but believe the chance of a fourth rate hike is much higher than the likelihood we see just two.  In other recent inflation news, import prices rose 0.1% in December while export prices declined 0.1%.  In the past year, import prices are up 3.0% while export prices have increased 2.6%.  On the jobs front, initial jobless claims rose 11,000 last week – likely impacted by significant winter storms on the east coast - while continuing claims fell 35,000.  Continuing claims are now the lowest since 1973.  Look for another solid jobs report in January, although the continued cold spell in much of the country might put some temporary downward pressure on payrolls for the month.  If so, don't fall into the trap of thinking the good times are over.  Job gains should rebound in the following months.

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Posted on Thursday, January 11, 2018 @ 10:00 AM • Post Link Share: 
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  Bond Bull-Market Is Over
Posted Under: Government • Markets • Monday Morning Outlook • Fed Reserve • Interest Rates • Bonds

Bonds have been in a "bull market" for the past thirty-seven years.  Not every quarter, or every month, but bond yields have fallen consistently since Paul Volcker ended the inflation of the 1970s.

And just like any long-term bull market or bubble justifications proliferate.  The current 10-year Treasury yield is 2.46%, which equates to a 40.7 price-earnings multiple.  If the stock market had a P-E multiple anywhere near that, the nattering nabobs would be screaming from the mountaintops.

But the bond market has become the "knower of all things" – it's never wrong according to the bulls.  Low yields are not only justified, they tell us the future.

There are three main bullish arguments.

1) The U.S. faces secular stagnation – permanently low growth and low inflation.

2) Foreign yields are lower than U.S. yields, so market arbitrage will keep U.S. yields from rising.

3) The Fed is raising short-term rates which will cause the yield curve to invert, leading to recession and lower yields over time.

But there are serious issues with all these arguments.  First, it's not true the bond market is never wrong.  In 1972, the 10-year U.S. Treasury yield averaged 6.2%, but inflation averaged 8.7% between 1972 and 1982.  In 1981, the U.S. Treasury yield averaged 13.9%, but inflation averaged just 4.1% between 1981 and 1991.  In other words, the bond market underestimated inflation in the 1970s and severely overestimated it in the 1980s.

The main reason was that the Fed artificially held down short-term interest rates in the 1970s, which pulled the entire yield curve too low.  And in the 1980s, it did the reverse, and held short-term interest rates artificially high.

The past nine years are similar to the 1970s.  The Fed has pulled the entire yield curve down, while big government (taxes, regulation, and spending) have held growth back.  Now, growth and inflation are picking up, while the Fed lifts short-term rates.  Just like in the 1980s, tax cuts, regulatory rollback, and contained government spending will disprove secular stagnation.  Fed tightening will push the yield curve up and bond yields will rise.

We've never believed the low foreign bond yield story.  Japanese bond yields have been near zero for at least two decades.  If international arbitrage works to bring rates together, why aren't U.S. yields near zero (and why did Japanese bonds never move higher)?  Isn't 20 years enough time for this arbitrage to take place?  It comes down to fundamentals.

Every country has different growth rates, different currencies and inflation, different trade flows, credit ratings, tax rates, and banking rules.  Every country is unique; why should bond yields be the same? The currency futures market signals that investors expect the Euro and Yen to appreciate versus the Dollar, which helps offset different interest rates. As we said earlier, bubbles twist logic to support the bubble, but that twisted logic doesn't hold up under intellectual scrutiny.

This year, the Fed is on track to ratchet the federal funds rate higher in three, possibly four, quarter point moves.  With real GDP growth picking up to roughly 3%, and inflation moving toward 2.5%, or higher, nominal GDP will grow at roughly a 5.5% rate.  That's the fastest top-line growth the U.S. has experienced since 2006.  And in 2006, the 10-year Treasury yield averaged 4.8%.

We don't think yields are headed back to 4.8% any time soon.  Our forecast for the 10-year Treasury is 3.0% in 2018.  But, the risk is to the upside on bond yields, not the downside.  The bullish case for bonds has finally run out of steam.

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

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Posted on Monday, January 8, 2018 @ 10:22 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, January 8, 2018 @ 7:55 AM • Post Link Share: 
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Posted Under: Bullish • Government • Markets • Video • Taxes • Stocks • Wesbury 101
Posted on Friday, January 5, 2018 @ 3:51 PM • Post Link Share: 
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  The Trade Deficit in Goods and Services Came in at $50.5 Billion in November
Posted Under: Data Watch • Trade


Implications: The trade deficit expanded in November, coming in at $50.5 billion, the largest trade deficit in almost six years.  This may cause worry, as larger trade deficits are considered by many as a negative. In fact, this was a great report!  Exports and imports both hit new record highs, rising by $4.4 and $6.0 billion, respectively.  Both exports and imports are up strongly from a year ago: exports by 8.3%, imports by 8.4%.  We see expanded trade with the rest of the world as positive for the global economy, and total trade (imports plus exports), which is what really matters, is up 8.4% in the past year.  Look for more increases in total trade in the year to come as economic growth accelerates in Europe and Japan.  Exports to the EU are up 13.1% in the past year.  In addition, the composition of US trade may change dramatically over the next few years, at least in terms of how the government measures the trade balance.  A lower corporate tax rate means firms that had previously placed production facilities and "paper" assets (like intellectual property) abroad, so they could claim a lower foreign tax rate, will locate some of those assets back in US.  As a result, the sales generated by those assets will count as domestic production, not imports, reducing our official trade deficit.  In the meantime, although rising imports are a positive sign about the underlying strength of the US economy, for GDP accounting purposes they mean growth in production is temporarily lagging behind the growth in spending.  Because of this, international trade is on track to be a substantial drag on GDP, subtracting about one percentage point from the real GDP growth rate in the fourth quarter.  This suggests real GDP grew in the 2.5 – 3.0% annual rate range in the fourth quarter, even though domestic growth accelerated.  In other recent news, automakers reported sales of cars and light trucks at a 17.9 million annual rate for December, up 1.9% from November but down 1.7% from a year ago.  After hitting a calendar-year record high of 17.5 million in 2016, sales for all of 2017 were 17.3 million, in spite of the surge in sales following Hurricanes Harvey and Irma.  Look for a further sales drop in 2018 to an annual rate of about 16.7 million, reflecting a shift in consumer purchasing power to other sectors as well as a smaller boost from the hurricanes.

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Posted on Friday, January 5, 2018 @ 12:01 PM • Post Link Share: 
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