Implications:  Following a dip in September, housing starts returned to growth in October.  The key driver of the 2019 recovery in residential construction continues to be single-family starts, which posted a fifth consecutive month of growth in October.  More broadly, single-family starts have been on a general upward trend since bottoming in February and are in spitting distance of new highs.  Meanwhile, multi-family starts have been range bound since 2015 when the upward trend ended.  On average, each single-family home contributes to GDP about twice the amount of a multi-family unit, so a continued shift back towards single-family construction will be a boon for economic growth.  And it looks like even more single-family construction is on the horizon, with permits for these units rising in October for the sixth consecutive month to a new post-recession high.   This, along with gains in multi-family permits, pushed overall permits in October to a post-recession high as well.  It looks like developers are becoming more optimistic about their prospects following an all-around tepid year for housing in 2018.  And it's not hard to see why, with sustained increases in the strength of fundamentals for potential buyers.  Mortgage rates have dropped roughly 100 basis points since the peak late last year, and wages are now growing near the fastest pace in a decade, boosting affordability.  Our outlook on housing hasn't changed: we anticipate a rising trend in home building in the next few years.  Based on fundamentals – population growth and scrappage – the US needs about 1.5 million new housing units per year but hasn't built at that pace since 2006.  In other recent housing news, the NAHB index, which measures homebuilder sentiment, fell to 70 in November from 71 in October, remaining elevated. This represents a significant and consistent rebound in optimism following the drop in the index at the end of 2018.

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Last December, almost 12 months ago, we set our year-end 2019 target for the S&P 500 at 3,100.  Many thought we were way too bullish, but our model for the stock market suggested 3,100 was well within reach.  We believed the bull market had plenty of room to run.

Now, with six weeks to go until year-end, the stock market has already closed above our initial target.  As of Friday, the S&P is up 24.5% year-to-date, and up 32.7% since its Christmas Eve low.  And that's without including dividends.      

We were so confident there wouldn't be a recession - and that the market was still cheap - that we raised our target to 3,250 in the middle of 2019.  That's only 4.2% above last Friday's close.

With one possible (and very unlikely) exception, nothing we see on the horizon suggests the bull market is nearing an end.   We're forecasting moderate economic growth for the foreseeable future, and see continued corporate profit growth as margins stay high.

Monetary policy is not tight, far from it, and we don't see any hikes to short-term interest rates through at least 2020.  And after many years of 6% M2 money supply growth, M2 has accelerated, growing at a 9.2% annualized pace in the past six months.

Corporate America is still adapting to a much more favorable tax environment.  And trade policy is more likely to get better going forward, rather than worse.

The "new NAFTA" looks likely to pass by early next year, in part because as the Democrats target President Trump with impeachment, it becomes more important for them to reach some bipartisan goals.  House Speaker Nancy Pelosi recently described a political deal on the trade pact as "imminent."  Mexico and Canada are the US's #1 and #2 trading partners.  A deal with #4, Japan, is being worked out and is already benefiting the US.   Meanwhile, news reports suggest a deal with China (#3) is approaching.             

Want more reasons for optimism?  The ball and chain of regulation continues to ease around the ankles of entrepreneurs.  And a surge in the appointment of federal judges who believe in legislation, not administrative regulation, will make it tougher for the administrative state to hamstring innovation.

In addition, consumers have plenty of purchasing power, both from wage growth and relatively low financial obligations.  Home builders still need to raise the pace of construction just to keep up with population growth and the scrappage of homes (including voluntary knock-downs, fires, floods, tornadoes, and hurricanes).

Notice, too, that the US isn't alone in the stock market rally.  The Euro Stoxx 50 is up 19.4% in dollar terms so far this year (as of the Friday close) while Japan's Nikkei is up 18.2%.

We think those gains, at least in part, reflect investors looking ahead and expecting better policies.  By cutting tax rates and regulation, the US has become more competitive.  Eventually, the political pressure on other countries is to follow suit.  When Reagan and Thatcher cut tax rates in the 1980s, many other countries took the cue, which led to a global boom.

One thing that could throw a monkey wrench into the bull market would be a shift by voters toward less growth-oriented policies of more government spending, expanded entitlements, and higher tax rates.  This would take a sweep of the White House, House, and Senate with politicians willing to pass the votes.  We put the odds of that happening at roughly 5%.  We know investors are worried about this, but it's way too early - and way too unlikely - to change investment strategies at this point.  Think about it: if a sweep like this would cut the stock market by 25%, but has only a 5% chance of occurring, that's a drag of only 1.25% on the market (5% of 25%). 

A year ago, we were in the distinct minority in remaining bullish while so many were predicting the supposed "sugar high" was over and a bear market had begun.  We didn't see it that way then, we still don't now.

Stocks are still cheap, the economy is not slipping into recession.  The policy environment is tilted more toward growth than it was three years ago, even though it could be better.  And that means the bull market should continue.

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

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Source: St. Louis Federal Reserve FRED Database

Implications:  Industrial production continued to take it on the chin in October, as the GM strike dragged on.  That said, outside autos there wasn't much to like in today's report either, with nearly every major category of production showing declines.  Autos led industrial production lower in October, declining 7.1%, and over the course of September and October the GM strike dragged auto production down by a total of 12.2%, the largest two-month decline since the recession in 2009.  The good news is that the strike has since been resolved, so autos are poised for a sharp rebound in November.  Manufacturing, excluding autos, had a more muted decline of 0.2% in October.  Despite the GM strike, over the past five months, overall manufacturing has declined at a 0.9% annualized rate, a smaller decline than the large annualized drop of 4.5% during the first five months of 2019.  We think this trend will continue and expect a return to positive growth in industrial production in the months ahead.  The strike is over, USMCA is likely to be passed soon, and a Phase 1 trade deal with China looks to be around the corner.  It's also important to remember that we had a similar slowdown in 2015-16 during the oil price crash, and no recession materialized.  And keep in mind that manufacturing is only responsible for about 11% of GDP and is much more sensitive to global demand than other sectors of the economy.  Outside the manufacturing sector, mining activity fell 0.7% in October, primarily due to a decline in coal extraction.  Utilities were also weak in October, falling 2.6% as an increase in natural gas usage was swamped by lower demand for electricity.  Given relatively harsh weather for much of the country so far in November, utility output is set to rebound.  High-tech equipment production was the one bright spot in October, rising 0.1%, and is now up 5.6% in the past year, the fastest year-over-year growth of any major category.  In other manufacturing news this morning, the Empire State Index, which measures factory sentiment in the New York region, fell to +2.9 in November from +4.0 in October, still signaling growth in that area of the country.

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Implications: Retail sales bounced back in October after falling for the first time in seven months in September.  Sales grew 0.3% in October and are up a solid 3.1% from a year ago, but the underlying details of the report were a little more mixed than the overall headline would suggest, as sales rose in only six of thirteen major categories.  Non-store retailers (think internet & mail order) and autos led the way rising 0.9% and 0.5% in October, respectively. Non-store sales are up 14.3% from a year ago, sit at record highs, and now make up 12.9% of overall retail sales, also a record.  The largest decline in sales in October was for clothing and accessory stores, which dropped 1.0%.  In spite of the lack of breadth, there should be no doubt the consumer is doing well.  "Core" sales, which exclude autos, building materials, and gas stations (the most volatile sectors) grew 0.2% in October, and are up 4.2% from a year ago and 7.8% at an annualized rate since the start of 2019, the fastest ten-month pace of growth since December 1999.  Jobs and wages are moving up, companies and consumers continue to benefit from tax cuts, consumer balance sheets look healthy, and serious (90+ day) debt delinquencies are down substantially from post-recession highs.  For these reasons, expect continued solid gains in retail sales in the year ahead. In inflation news today, import prices fell 0.5% in October, driven by a decline in petroleum prices.  Meanwhile, export prices declined 0.1% primarily due to industrial goods.  In the past year, import prices are down 3.0%, while export prices are down 2.2%.  We expect a turnaround to at least modest price gains in the year ahead.

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Implications:  Producer prices moved broadly higher in October, rising at the fastest pace in sixth months.  Energy prices rose 2.8% in October, led higher by a 7.3% jump in gasoline.  Food prices, meanwhile, rose 1.3% on the month.  Strip out these typically volatile categories, and "core" prices still rose 0.3% in October.  Increased margins to wholesalers led the rise in core prices in October, as most major categories moved higher.  Despite the move higher in October, "core" prices fell below 2.0% on a year-ago comparison basis for the first time since mid-2017.  This is largely due to the year-over-year measure leaving behind the 0.6% jump in prices (the largest monthly rise in series history) last October. Core prices slowed following that October '18 surge, but year-over-year changes still reflected it until now.  This volatility in the monthly and year-over-year statistics in now behind us and we expect a continued steady rise in prices in the months ahead will move the year-to-year comparison back towards 2%. Goods prices led the producer price index higher in October, with rising fuel and food costs more than offsetting a large decline in costs for iron and steel scrap.  Services prices rose 0.3% in October, as costs for hospital inpatient care and truck transportation cost joined wholesaler margins in moving higher.  Further down the pipeline, prices for intermediate demand processed goods rose 0.4%, while intermediate demand unprocessed goods saw prices increase 1.0%.  Both intermediate demand categories continue to show prices broadly lower compared to year-ago levels.  When you step back and view today's report in context, it shows prices continuing to move steadily higher.  Not too fast, not too slow. Paired with the very healthy employment market, it signals an economy with no need for Fed intervention.  In employment news this morning, initial jobless claims rose 14,000 last week to 225,000, while continuing claims declined 10,000 to 1.683 million.  Plugging this data into our models suggests employment continues to grow at a healthy pace in November, and with the employees from the GM strike returning to work, November could see a nonfarm payroll gain north of 200,000.

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Implications:  Consumer prices jumped in October by the fastest pace in seven months, coming off a September breather.  Energy prices rose 2.7% in October, while medical care costs rose 1.0%, both key drivers in the headline 0.4% increase in consumer prices, which came in above consensus expectations.  If you pull out the typically volatile food and energy sectors, "core" prices rose 0.2%, matching forecaster estimates.  Overall consumer prices are up 1.8% in the past year, just a hair below the Fed's 2% inflation target.  And consumer prices have been held back by declining costs for energy.  Core prices are up 2.3% in the past year, just a tick off the highest annual increase we have seen since the recovery started.  Given the Fed's 2% inflation target, that should be a signal that everything is looking A-OK. Not too fast, not too slow, just right.  Add in employment data continuing to show strength, and it makes sense that the Fed signaled after the last meeting that it plans to hold rates pat for the foreseeable future. Looking at the details of today's report shows that rising costs for medical care, housing, and used vehicles more than offset declining costs for new vehicles and apparel.  The most disappointing news in today's report was that real average hourly earnings declined 0.2% in October.  That said, these earnings remain up 1.2% in the past year, and, with the strength in the labor market, we believe earnings will trend higher in the months ahead.  Healthy consumer balance sheets, a strong job market, inflation in-line with Fed targets, and the continued tail winds from improved tax and regulatory policy, all reinforce our belief that the economy will continue to grow at a healthy pace. 

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One of our favorite economic parables is the Fish Story, from Paul Zane Pilzer's 1990 book, "Unlimited Wealth."  It is an excellent tool for thinking about wealth creation, inequality and redistribution.
 
Imagine 10 people live on an island.  Each day they wake up, catch two fish, eat them, and go back to bed.  It's subsistence living at the most basic level.  There are no savings – no stored or saved wealth.  If someone gets sick and can't fish, there's no way to help them.  No one has any extra.

Now imagine two of these people dream up a boat and a net.  They spend six days catching one fish per day, slowly starving, but they make the boat and net.  On the 7th day, they go out into the ocean and catch 20 fish in the net – it worked!!!!

At this point, the island can go one of two ways.  First, since two people now produce what previously took ten, resources are freed up to do other things.  Farming corn, picking coconuts, cleaning fish, cooking, repairing the boat and net, the possibilities are endless.  The island ends up with more (and better!) food, new technologies, higher standards of living, more assets, more wealth, and they can now afford to take care of their sick and vulnerable!

Or...the eight people who don't have a boat and net could become envious.  Two now produce ten fish per day, while everyone else can only produce two.   Income inequality now exists:  it's no longer 1:1, it's 5:1.  So, they devise a plan to tax 80% of the income of the boaters (16 fish) and redistribute two fish to each of the other inhabitants.

If the second plan is adopted, no one is better off.  Each inhabitant still only has two fish.  Moreover, the entrepreneurs have no incentive to fix their boat and net.  The island will eventually revert to subsistence.

This is the problem with taxation for redistribution: it robs the economy of the benefits of new technology.  Certainly, some of our brothers and sisters need help, sometimes permanently; sometimes temporarily.  However, taxation for redistribution doesn't make the economy stronger; redistribution hurts growth.

Everyone on the island is better off because of the boat and the net.  Taxing the inventors' wealth or income and redistributing it removes resources from a highly productive new technology.  Moreover, the income inequality that exists on the island is a sign of more opportunity, not less.

There are things the government can do that add to productivity – police and fire protection, national defense, enforcing the rule of law and protecting private property – but once government goes beyond this, it begins to undermine growth.

Today, 17% of all personal income is redistributed by government, while around 40% of all income is taxed and spent by the federal, state and local governments, combined.  This is the reason the US economy has not attained 4% real GDP growth.  European economies tax and spend even more and this is why they have grown slower than the US in recent decades.

In the meantime, government leaders around the world blame slow growth on a lack of investment by companies and attempt unsuccessfully to use negative interest rates to stimulate lending and investment.  They also propose even more government spending and redistribution to help those that big government is holding back.
 
These policies won't boost growth, and proposals to tax wealth and income because of the perceived problem of income inequality will ultimately reduce living standards.  Increasing living standards requires less government, not more.

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

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Source: St. Louis Federal Reserve FRED Database