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   Brian Wesbury
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  Housing Starts Increased 3.2% in November
Posted Under: Data Watch • Home Starts • Housing


Implications:  Housing starts surprised to the upside in November, but the details of the report leave something to be desired.  While new construction across all units rose 3.2% in November, single-family starts fell 4.6% for the month. In other words, the gain in November came entirely from the volatile multi-family sector, where starts jumped 22.4%.  Some pessimistic analysts will surely dwell on the fact that housing starts are down 3.6% in the past year.  But what they may not mention is that this is largely due to impacts from last year's unusually strong hurricane season. The fourth quarter of 2017 saw a storm-induced jump in new construction in the aftermath of Hurricanes Harvey and Irma.  With that in mind, year-ago comparisons involving a single month look like a poor measure of housing health.  Instead, we prefer to focus on the trend by comparing the first eleven months of this year to the same eleven months in 2017.  In contrast to the single-month comparisons, that year-to-date measure shows single-family starts up 3.2% while overall starts are up 4.7%.  And it's nearly certain that next month's report will show positive growth for 2018 as a whole, demonstrating that the broader trend in construction growth remains intact.  The forward-looking data in today's report shows permits for new construction rose 5.0% in November, the biggest single month increase in over a year.  However, once again, this gain was also almost entirely due to multi-family starts.  Using our trend measure, permits are up 2.3% in the first eleven months of 2018 compared to the same period last year.  Despite recent softness, our outlook on housing hasn't changed.  We still 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.  The problem is that there continue to be some headwinds that may temper near-term growth in home building.  For example, the increasingly tight labor market has made hiring difficult across industries, and construction is no exception, with job openings in that sector near a record high. On the bright side, prices for residential construction inputs (which rose due to tariff concerns) have started to decline, which should take some pressure off builders.  On net, there remain some difficulties within the housing sector, but they are little more than a hiccup on the continued march higher.  In other recent housing news, the NAHB index, which measures homebuilder sentiment, fell unexpectedly to 56 in December from 60 in November, remaining at a historically elevated level but hitting its lowest reading since 2015.  Homebuilders primarily cited rising interest rates causing affordability concerns for buyers as the reason for their declining optimism.  Mortgage rates peaked in early November, but have now turned lower, which should help boost sentiment as we close out the year.  On the manufacturing front, the Empire State Index, which measures factory sentiment in the New York region, fell sharply to 10.9 in December from 23.3 in November.  Despite the drop, the index remains in expansionary territory, and the forward-looking components continue to show optimism heading into next year, most notably in planned capital expenditures.   

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Posted on Tuesday, December 18, 2018 @ 12:02 PM • Post Link Share: 
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  No Housing Bubble
Posted Under: Bullish • Housing • Monday Morning Outlook

Last week in the New York Times, Yale economist Robert Shiller wrote we are "experiencing one of the greatest housing booms in United States history."  Given what happened in the aftermath of the last boom – a financial panic and the Great Recession – this will add to investors' fears about another recession lurking around the corner.

Shiller says that the national Case-Shiller (yes, the same Shiller!) home price index is up 53% since prices bottomed in the housing bust in February 2012 and prices are now 11% higher than they were at the peak of the boom in 2006.  In his mind, these are both signs of a new bubble.

We have great respect for Shiller, who correctly called the internet stock market bubble in the late 1990s as well as the housing bubble in the 2000s.  

However, there is a huge difference between housing today and where it was in the last bubble.  To assess the "fair value" of homes, we use a Price-to-Rent (P/R) ratio.  We get that by comparing the asset value of all owner-occupied housing (calculated by the Federal Reserve) to the "imputed" rental value of those homes (what owners could fetch for their homes if they rented, instead, as calculated by the Commerce Department).  Think of it like a P/E ratio: the price of all owner-occupied homes compared to what those same homes would earn if they were rented. 

For the past 60 years the P/R ratio has averaged 15.22.  At the peak of the housing bubble in the previous decade, the ratio was 20.85, a record high.  In other words, prices were 37% above fair value nationally, much more so in hot spots like Fort Myers, FL, Las Vegas, NV, and Scottsdale, AZ. 

Then, during the housing bust, the ratio plunged to 12.96, the lowest on record.  At that point, national average home prices were 15% lower than you'd expect given rents.  Temporarily, that made sense: prices had to get well below fair value in order to clear the massive backlog of excess homes produced during the bubble.                    

Today, the P/R ratio is 15.81, so homes are only 4% above their long-term average relative to rents.  That's well within the normal historical range and less than the typical transaction cost when a home is sold, and so no reason to sell. 

Shiller is right that housing prices exceed where they were at the peak of the prior boom, but he's not adjusting for the rent those homes can earn.  In the past twelve years, the asset value of owner-occupied homes is up 13% while imputed rent is up 45%.       

Another reason to believe we're not in a bubble is that the pace of home building is substantially slower than during the previous bubble.  Builders started 2.07 million homes in 2005 versus an annual need of about 1.50 million based on population growth and scrappage (teardowns, fires, floods, hurricanes,...etc.).  So not only did homes get 37% overpriced, they did so when there were plenty of homes to go around.  By contrast, this year builders will start about 1.25 million homes, below what we need to just meet population growth and scrappage. 

Residential real estate is not in a bubble.  Look for moderate price gains ahead, although with the gains tilted toward lower tax states due to tax reform.   

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

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Posted on Monday, December 17, 2018 @ 11:35 AM • Post Link Share: 
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  Industrial Production Rose 0.6% in November
Posted Under: Data Watch • Industrial Production - Cap Utilization


Implications:  Industrial production continued to climb higher in November, hitting a new record high.  However, the details of today's report were less impressive than the headline gain of 0.6%.  All of November's growth was due to gains in mining and utilities, while overall manufacturing remained unchanged for the month.  Further, downward revisions dragged the readings for both the headline index and manufacturing in October into negative territory.  That said, a look at growth in the past year shows industrial production – which counts "units" of output and is therefore a proxy for "real" growth – is up a healthy 3.9%.  Notably, the flat reading for manufacturing in November was due to a decline in the production of nondurable goods offsetting gains in motor vehicles, machinery, and high-tech equipment.  In the past year, the various capital goods indices continue to show healthy growth with business equipment up 4.1%, machinery up 6.2%, and high-tech equipment up 7.6%.  Comparing this with the more tepid year-over-year growth of 0.7% for nondurable goods, or 1.9% for manufacturing as a whole, demonstrates that capital goods production remains a valuable source of strength.  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.  The biggest monthly gain in November came from utilities which rose 3.3%, as unseasonably cold weather supported demand for heating.  Finally, after a brief dip in activity in October due to Hurricane Michael, mining rebounded 1.7% in November to return to a record high.  The advance was due to gains in oil and gas extraction and coal mining.  Mining is now up 13.2% in the past year, by far the fastest growing category in industrial production.

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Posted on Friday, December 14, 2018 @ 12:19 PM • Post Link Share: 
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  Retail Sales Rose 0.2% in November
Posted Under: Data Watch • Retail Sales


Implications:  Today's retail data should cement another 25 basis point rate hike by the Fed next week.  Overall retail sales rose 0.2% in November, but the details of the report were very strong, and prior months were revised higher.  November's 0.2% gain narrowly beat consensus, but, including revisions to prior months, sales were up 0.5%.  And the gains were broad-based, with nine of thirteen major categories showed rising sales, led by non-store retailers (think internet and mail-order sales).  Non-store retailers now make up 11.7% of all retail sales, an all-time record high, and are up 10.8% over the past year.  Sales at gas stations were the biggest laggard, down 2.3% in November, a function of lower gasoline prices for the month.  Take out sales at gas stations, and retail sales were up 0.5% for the month even without including upward revisions to prior months.  "Core" sales, which exclude autos, building materials, and gas stations (the most volatile sectors) were up 0.6% in November, were revised higher for prior months, and are up 4.6% from a year ago, while overall retail sales are up 4.2% over the same period.  Plugging today's report into our models suggests "real" (inflation-adjusted) consumer spending, on goods and services combined, will be up at around a 3.5% annual rate in Q4 while real GDP grows at around a 2.0% 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 words, there's plenty of room for consumer spending – and retail sales – to continue to trend higher in the year ahead.  In other news yesterday, initial jobless claims declined 27,000 last week to 206,000.  Meanwhile, continuing claims rose 25,000 to 1.66 million. These figures are consistent with continued robust job gains in December.  In other recent news, import prices declined 1.6% in November, while export prices fell 0.9%. The large drop in import prices was led by a 11% decline in fuel costs, the largest decline since January 2016.  Export prices declined 0.9% in November as lower prices for nonagricultural exports more than offset a rise in prices for farm exports.  Still, import prices are up 0.7% in the past year, while export prices are up 1.8%.

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Posted on Friday, December 14, 2018 @ 11:45 AM • Post Link Share: 
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  Brian Wesbury on Fox Business: Recession Fears and Bond Yield Bubbles
Posted Under: Government • Markets • Video • Fed Reserve • Interest Rates • Bonds • TV • Fox Business
Posted on Friday, December 14, 2018 @ 7:55 AM • Post Link Share: 
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  Yellen Agrees with The Austrians
Posted Under: Government • Research Reports • Fed Reserve • Interest Rates

In a recent interview, former Fed Chair Janet Yellen warned that excessive corporate debt could exacerbate the pain of the next economic downturn.  The argument goes that if something triggers a slowdown in the economy, and companies' sales decline, their higher debt service burdens will force them to lay off employees and shrink investment which could cause a sputtering recovery, or even a recession.

The strange thing about this argument is how quickly Yellen changed her mind.  Back in June 2017, when she was still Fed chair, Yellen stated "I don't believe we'll see another financial crisis in our lifetime."  Since her departure from the Fed, the pace of actual rate hikes - as exposed by the Fed's dot plots - has been adjusted upwards under Jerome Powell by only 25 basis points.  This is an insignificant change and makes us think these comments have more to do with politics and no longer being in power than her being truly concerned with cracks in the system.

What's even more confusing is that expanding credit to increase corporate borrowing is straight out of Yellen's own Keynesian playbook.  This was the entire idea behind QE and the Fed's own zero percent interest rate policy.  If you can lower overnight rates to the point that money is free and communicate that rates will be there for some time, then companies will borrow and use those resources to hire and expand operations.  This is supposed to jumpstart a recovery and lead to a virtuous cycle of economic activity that will replicate or make up for output that was lost during the recession, and eventually allow policy to return to normal.  Boosting corporate debt levels isn't a symptom, it's the prescribed antidote. 

Ironically, Yellen's warnings also echo the critiques of the Fed's biggest ideological opponents, the Austrian school economists.  From an Austrian perspective, driving interest rates to an artificially low level leads to a mismatch in the coordination of resources over time.  Companies that otherwise wouldn't see future demand for their products interpret low rates as a green light to expand even though consumers don't want more of what they're producing.  This leads to widespread "malinvestment" throughout the economy as less efficient and innovative firms take on debt they won't be able to service in the future.  Finally, as central bank interventions run their course - and rates rise once again - those companies that misinterpreted the signals go belly up.  It sure seems that sounding an alarm over rising interest rates and a debt hangover fits this Austrian framework, but we never in a million years expected to hear it from Yellen.

For the record, we don't fully agree with either one of these perspectives.  The Keynesians still venerate the Fed's low rates and QE (which supposedly boosted demand) as the source of the recovery while we believe innovation and entrepreneurship led the way.  When 2008 happened, smartphones weren't ubiquitous, the human genome wasn't cracked, the US wasn't the world's largest energy producer, and we could go on and on.  Meanwhile, some Austrians believe the recovery was all a sugar high and refuse to acknowledge that profits have consistently risen year after year as technology lowered production costs, boosted profit margins and lifted productivity in the private sector.  Don't get us wrong, the idea of unelected bureaucrats centrally planning the price of money in Washington is pure hubris and we'd love to see the Fed's power reined in, but the recovery hasn't just been monetary smoke and mirrors. 

So where does that leave us with the question of corporate debt?  Yes, nonfinancial corporate debt is at a record high but so are nonfinancial corporate assets.  Since 1980, nonfinancial corporate debt has averaged 44.9% of total assets (financial assets, real estate, equipment, inventories, and intellectual property).  Right now, these debts total 44.7% of assets, or slightly less than average.  The record was 50.4 in 1993.  Notably, 1993 was right at the beginning of the longest economic expansion in US history.  Further, both nonfinancial corporate cash holdings and profits are at a record high, and interest payments as a percentage of profits are currently at or below their long-term average.  Finally, delinquency rates for commercial and industrial loans are near record lows.

All these data point toward corporate balance sheets being remarkably healthy, and while it's inevitable that a deterioration will happen, this is currently not something investors need to concern themselves with.  Further, a real (inflation-adjusted) fed funds rate that has just now ticked positive for the first time in a decade is far from contractionary, especially with nominal GDP growth accelerating to an annualized pace of 4.8% over the past two years and $1.6 trillion in excess reserves still floating around in the banking system.  This is just another case where data trumps rhetoric, even if that rhetoric comes from a former Fed chair.

Brian S. Wesbury - Chief Economist
Bryce Gill - Macroeconomic Analyst

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Posted on Thursday, December 13, 2018 @ 10:16 AM • Post Link Share: 
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  Brian Wesbury on CNBC: Is Corporate Debt a Major Risk to the Economy?
Posted Under: Government • Video • Interest Rates • TV • CNBC
Posted on Wednesday, December 12, 2018 @ 3:44 PM • Post Link Share: 
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  The Consumer Price Index was Unchanged in November
Posted Under: CPI • Data Watch • Inflation


Implications:  Consumer prices were unchanged in November as declining energy costs offset gains in nearly every other category.  Recent months have been a textbook example of how volatility distorts the headline reading. While energy prices swung from a 0.5% decline in September, to a 2.4% increase in October, to a 2.2% decline in November, "core" inflation (which excludes the typically volatile food and energy categories) has risen steadily month-to-month. That is why, in addition to emphasizing the core measure, we focus on the trend, which shows inflation continuing to run steadily above the Fed's 2% inflation target.  In the past year, consumer prices are up 2.2%, and the index has matched or exceeded the Fed's 2% inflation target in each of the last fifteen months ("core" has exceeded 2% in each of the last nine months).  So, after running stubbornly below the Fed's inflation target for the first five years of the recovery, the much-anticipated pickup has clearly arrived.  No, this isn't runaway inflation, but with the federal funds rate well below the pace of nominal GDP growth, the odds of higher inflation – paired with a tight labor market and widespread strength in economic data - should be enough to keep the Fed on track for slow-but steady hikes through at least the end of 2019.  Looking at the details of the November report shows medical care and housing led the rise in "core" prices, up 0.4% and 0.3%, respectively.  And while new car and truck prices were unchanged in November, prices for used vehicles rose 2.4%, the second largest single month increase since the start of 2010.  Maybe the best news in today's report was that real average hourly earnings rose 0.3% in November.  These wages are up just 0.8% in the past year but are heading higher, with wages up 1.1% at an annual rate over the past three months and up 1.3% at an annual rate in the past six-months.  And importantly, 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.  It's an imperfect measure (to say the least), but we still expect a visible pickup in wage pressure in the year ahead.  The labor market remains strong and companies continue to report that finding available qualified labor remains a top headwind to even faster growth. Put it all together, and today's report shows an economy continuing to strengthen.  The Fed would do well to focus on the data as they forecast their path for 2019, rather than letting media narratives influence their actions.

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Posted on Wednesday, December 12, 2018 @ 10:32 AM • Post Link Share: 
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  The Producer Price Index Rose 0.1% in November
Posted Under: Data Watch • Inflation • PPI


Implications:  After posting the largest single-month increase in more than six years in October the producer price index continued its climb higher in November, though at a slower pace.  The main source of strength in today's report came from final demand services where prices rose 0.3%, offsetting the 0.4% decline in prices for final demand goods, keeping the headline index positive for the month.  Looking at the details of final demand services shows that prices were driven higher by increased margins to wholesalers, which rose 0.3%.  More specifically, margins for fuels and lubricants retailing soared 25.9%, probably the result of wholesalers not fully passing on November's 14% drop in gasoline prices to their customers.  Recent increases in wholesaler margins could be a sign of rising demand paired with limited supply; ISM reports have shown strong order and business activity, but companies struggling to hire and ship products due to a tight labor market.  Or it could simply be companies adjusting prices higher following months of rising input costs cutting into margins; remember, these wholesaler margins fell overall in Q3.  The biggest source of weakness in today's report was the 5% decline in final demand energy, which represents the largest monthly drop for that index since the oil price crash of 2015.  This was driven by the decline in gasoline prices mentioned above and resulted in an overall drop of 0.4% in final demand goods for November.  Some analysts have recently been citing falling energy prices as a reason for the Federal Reserve to hold off on continued rate hikes in 2019. However, no matter which way you cut it – headline prices up 2.5% in the past year or "core" prices up 2.7% -- trend inflation clearly stands above the Fed's 2% target.  These data support our expectation for one more hike this year and up to four more hikes in 2019.

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Posted on Tuesday, December 11, 2018 @ 11:26 AM • Post Link Share: 
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  The Long-Term Yield Conundrum

Last Friday, the 10-year Treasury Note closed at a yield of 2.85%.  That's up from 2.41% at the end of 2017, but down from the peak of 3.24% on November 8th, and well below where fundamentals suggest yields should be.

In the last two years, nominal GDP growth – real GDP growth plus inflation – has run at a 4.8% annual rate.  Normally, we'd expect yields to be close to nominal GDP growth, but Treasury yields have remained stubbornly low.

Some analysts are spooked by the recent movement of 3-year yields above 5-year yields, thinking this "inversion" signals a recession.  We think this is sorely mistaken.  With a lag, recessions have often (but not always) followed periods when the federal funds rate exceeds the 10-year yield. If anything, that's the inversion to look out for; feel free to ignore the rest.  But, at present, the 10-year is yielding about 70 basis points above the funds rate, well within the normal range.   

One reason that the 10-year yield has remained below where economic fundamentals suggest it should trade is that the Federal Reserve set short-term interest rates near zero.  Longer-term bonds, including the 10-year reflect the current level of short-term rates as well as the projected path of those rates in the future.  So, back when yields were essentially zero, and the Fed was signaling they could stay there for a long time, this pulled down longer-term yields.  The Fed has now lifted short-term interest rates by 200 basis points from where they were, but investors still don't believe they will go much higher. 

Part of the issue is that many think low rates themselves are the only reason the economy came out of the Great Recession. So as the Fed lifts rates, many investors expect the next recession is a small tip of the scale from returning in force.

If you're buying 10-year Notes under the premise that a recession will happen sometime in the next ten years – and you also expect the next recession to tie (or beat) '08-'09 for the title of worst recession since the Great Depression – then the yield on the 10-year Treasury makes a lot more sense. 

But we wholeheartedly disagree with your assessment.  We think the bond market is anticipating a far weaker economy over the next ten years than the data justifies.

No matter how many believe it, the bond market is not all-knowing.  In November 1971, the 10-year Treasury was yielding 5.81%.  Over the next ten years, inflation alone increased at an 8.6% annual rate and nominal GDP grew at a 10.7% annual rate.  In other words, 10-year note investors got hammered as yields soared.  And notice that back in 1971 we had a Republican president (Richard Nixon) leaning heavily on the Fed to maintain a loose monetary policy.  Sound familiar?
The next recession is unlikely to be like the last.  Our calculations suggest national average home prices were 40% overvalued at the peak of the housing boom – pumped up by government rules and subsidies artificially favoring home buying.  Meanwhile overly stringent mark-to-market accounting rules created a once in a 100-year panic.  Mark-to-market rules have now changed to allow cash flow to be used to value assets, plus banks are much better capitalized.  In other words, fundamentals suggest another panic is not in the cards.     

What's more likely is that, when the next recession hits – and we don't see one happening until at least 2021 – it will be softer than usual, more like 1990-91 or 2001, than 1973-75, 1981-82 or 2007-09.  As investors realize data trumps the rhetoric, we expect bond yields to rise.  In the end, math wins.      

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

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Posted on Monday, December 10, 2018 @ 11:42 AM • Post Link Share: 
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