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   Brian Wesbury
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  Housing Starts Increased 9.7% in January
Posted Under: Data Watch • Home Starts • Housing


Implications:  After posting the best year in a decade in 2017, housing starts surprised to the upside in January, beating even the most optimistic forecast by any economics group.  Starts rose 9.7% in January to a 1.326 million annual rate, the second fastest post-recession pace.  It is important to note that while single-family starts did rise in January, 74% of the month's gain was due to the volatile multi-unit sector.  But, looking past monthly volatility, single-family starts are still the main driver of trend growth, as the chart to the right shows.  The horizon also looks bright for future activity, with permits for new construction, the number of units authorized but not started, and units currently being built all sitting at post-recession highs.  Notably, this has all happened despite a significant uptick in mortgage rates in the past year, which some analysts claimed would derail the housing recovery.  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 tax reform trimmed the principal limit against which borrowers can take a mortgage interest deduction to $750,000 versus the current law amount of $1 million, the law only affects 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 taxes and land prices.  In other recent housing news, the NAHB index, which measures homebuilder sentiment, remained unchanged at 72 in February, a historically elevated level signaling strong optimism from developers.  On the inflation front, import prices jumped 1% in January while export prices rose 0.8%.  In the past year, import prices are up 3.6% while export prices have increased 3.4%, reinforcing other recent data showing a rising trend in inflation.

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Posted on Friday, February 16, 2018 @ 10:36 AM • Post Link Share: 
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  Stocks even more undervalued after the correction?
Posted Under: Bullish • Government • Inflation • Markets • Video • Interest Rates • Stocks • TV • Fox Business
Posted on Thursday, February 15, 2018 @ 11:40 AM • Post Link Share: 
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  Inflation, Interest Rates, and Stocks
Posted Under: Bullish • Government • Inflation • Markets • Video • Interest Rates • Stocks • Wesbury 101
Posted on Thursday, February 15, 2018 @ 11:23 AM • Post Link Share: 
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  Industrial Production Declined 0.1% in January
Posted Under: Data Watch • Industrial Production - Cap Utilization


Implications:  Industrial production started 2018 on a soft note, falling for the first time in five months.  The headline series declined 0.1% in January.  However, this is not the end of growth in the industrial sector.  Industrial production is still up 3.6% from a year ago.  The biggest drag in today's report was mining, which dropped 1% and can be very volatile from month to month.  Remember, January's ISM manufacturing report posted its strongest level for that month in seven years.  As a result, we expect a rebound in industrial sector growth in the months ahead as tax reform spurs investment, and stronger growth, both in the U.S and abroad, gives a tailwind to the factory sector.  Meanwhile, although mining has dropped the past two months, it's still up 8.8% from a year ago.  Notably, oil and gas-well drilling stumbled in January, falling 1.4%, after a rebound of 0.9% in December.  Even though drilling slowed in the second half of 2017, most likely associated with hurricanes Harvey and Irma, it remains up 30.1% from a year ago.  In addition, the rig count has surged in recent weeks, suggesting a rebound in drilling activity in the months ahead.  In other factory news this morning, the Empire State index, a measure of manufacturing sentiment in New York, dropped to a still healthy 13.1 in February from 17.7 in January.  Meanwhile, the Philly Fed index, its counterpart among East Coast manufacturers, jumped to 25.8 in February from 22.2 in January, signaling growing optimism.

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Posted on Thursday, February 15, 2018 @ 11:21 AM • Post Link Share: 
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  The Producer Price Index Rose 0.4% in January
Posted Under: Data Watch • Inflation • PPI


Implications:  Producer prices jumped in January, rising 0.4% as nearly every major category showed increased prices.  And producer prices are up 2.7% in the past year, exceeding the Fed's 2% inflation target.  This follows suit with yesterday's CPI report that shows inflation pressures have been picking up of late, and it's not difficult to see why.  The Federal Reserve is running an incredibly loose monetary policy.  Yes, the Fed Funds rate is slowly and steadily on the rise, but there are still more than two trillion dollars of excess reserves in the banking system, and monetary policy won't be tight until that excess slack is removed.  This is especially true because anti-bank attitudes and regulation have been reversed, which reduces the headwinds to monetary growth.  To put it mildly, new Fed Chair Jerome Powell and the rest of the FOMC have their work cut out for them.  Taking a look at the details of today's PPI report shows rising costs for hospital services, apparel, and gasoline leading the way.  Energy, led by a 7.1% jump in gasoline prices, increased 3.4% in January.  Meanwhile food prices declined 0.2% in January.  Strip out the typically volatile food and energy groupings, and "core" producer prices rose 0.4% in January and are up 2.2% in the past year.  For comparison, "core" prices rose 1.4% in the twelve months ending January 2017, and were up 0.8% in the twelve months ending January 2016.  And a look further down the pipeline shows the trend higher should continue in the year to come.  Intermediate processed goods rose 0.7% in January and are up 4.6% from a year ago, while unprocessed goods increased 0.9% in January and are up 2.5% in the past year.  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 four rate hikes in 2018.  On the jobs front, initial jobless claims rose 7,000 last week to 230,000, while continuing claims rose 15,000 to 1.942 million.  Both measures remain near the lowest levels seen in decades, so look for another solid jobs report in February, although heavy snow in parts 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, February 15, 2018 @ 11:00 AM • Post Link Share: 
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  Retail Sales Declined 0.3% in January
Posted Under: Data Watch • Retail Sales


Implications: Retail sales fell well short of expectations in January and were revised down for November and December.  Overall, a dismal report relative to expectations that have improved with growing optimism about the economy.  Retail sales in January itself declined 0.3%, versus the consensus expected gain of 0.2%.  As a result, it now looks like real GDP grew at a 2.3% annual rate in the fourth quarter instead of the original report of 2.6%.  In addition, it also looks like real GDP is growing at about a 3.0% annual rate in Q1 versus our prior estimate of 4.0%.  That said, today's report has more to do with the timing of economic growth; it does not alter our general optimism about an acceleration of growth in 2018.  At present we estimate that real GDP will grow 3.4% this year, which would be the best year since 2003.  It is not unusual for retail sales to fall three or four months in a year, even during periods of robust growth.  January was one of those months.  Hurricanes in the second half of last year pulled some sales forward. It makes sense that autos and building materials were the largest decliners in January, as hurricane victims were fixing and replacing houses and buying new cars at a rapid clip late last year.  As we get back to normal, expect retail sales to resume their trend higher in the months to come.  Even with today's decline, both overall retail sales and "core" sales, which exclude autos, building materials, and gas, are up a respectable 3.6% from a year ago.  Why are we optimistic about retail sales growth in the months ahead?  Jobs and wages are moving up, tax cuts are taking effect, consumers' financial obligations are less than average relative to incomes, and serious (90+ day) debt delinquencies are down substantially from post-recession highs.

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Posted on Wednesday, February 14, 2018 @ 10:23 AM • Post Link Share: 
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  The Consumer Price Index Rose 0.5% in January
Posted Under: CPI • Data Watch • Inflation


Implications:  New Fed Chief Jerome Powell has his work cut out for him, with consumer prices in January rising at the fastest monthly pace in more than five years.  The consumer price index rose 0.5% in January and is up 2.1% in the past year, marking a fifth consecutive month of year-to-year prices rising more than 2%.  In the past three months, CPI is up at a 4.4% annual rate, showing clear acceleration above the Fed's 2% target.  A look at the details of today's report shows rising prices across most major categories. Energy prices increased 3% in January, while food prices rose 0.2%. But even stripping out volatile food and energy prices shows rising inflation.  "Core" prices rose 0.3% in January, the fastest monthly pace since 2005.  Core prices are up 1.8% in the past year, but are showing acceleration in recent months, up at a 2.6% annual rate over the past six-months and a 2.9% rate in the past three months.  In other words, both headline and core inflation stand above the Fed's 2% target, and both have been rising of late.  Housing costs led the increase in "core" prices in January,  rising 0.2%, and up 2.8% in the past year. Meanwhile prices for services rose 0.3% in January 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.  The most disappointing news in today's report is that real average hourly earnings declined 0.2% in January.  However, these earnings are up 0.8% in the past year. And, given the strength of the labor market, with the unemployment rate 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, expect upward pressure on wages in the months ahead.  Add it all up, and the Fed is on track to raise rates at least three times in 2018, with a fourth rate hike more likely than not.

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Posted on Wednesday, February 14, 2018 @ 10:08 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 Tuesday, February 13, 2018 @ 10:46 AM • Post Link Share: 
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  Snatching Slow Growth from the Jaws of Fast Growth
The U.S. economy continues to be lifted by an incredible wave of new technology.  Fracking, 3-D printing, smartphones, apps, and the cloud have boosted productivity and profits.  Yet taxes, regulation and spending all increased markedly in the past decade, raising the burden of government and dragging down the real GDP growth rate to a modest 2.2% from mid-2009 to early 2017.

Then 2017 saw the tides start to shift. Regulation was cut dramatically and the U.S. saw the most sweeping corporate tax reform in history.  Guess what?  Growth picked up to almost 3% annualized in the last three quarters of 2017 and real GDP looks set for about 4% growth in the first quarter of 2018.

But the dream of getting back to long-term 4% growth died this week in a bipartisan orgy of government spending.  Congress lifted the budget caps on "discretionary" (non-entitlement) spending by about $300 billion over the next two years, and spending is now set to rise by 10% this year.

No, this won't kill the economy tomorrow (or this year), but unless the Congress gets control of federal spending, the benefits from the tax cuts and deregulation will be short-lived.

Many argued that making corporate tax cuts temporary would limit their effectiveness because corporations would not change their behavior.  So, what does a corporate CFO do now?  Trillion dollar deficits as far as the eye can see mean Congress has a reason – and an excuse - to raise tax rates in the future.  This doesn't mean they're going back to 35%, but massive deficits will make it hard to sustain a 21% tax rate over time.  In other words, while Congress passed permanent tax cuts, it now makes them almost impossible to sustain. 

Every dollar the government spends must be either taxed or borrowed from the private sector.  The bigger the government, the smaller the private sector.  Not only does increased spending mean higher tax rates are expected in the future, but also a smaller private sector as it's forced to fund a bigger government.  It's the Spending that crowds out growth, not deficits themselves

Look, we get it.  The world is a dangerous place and we are sure there are parts of our military that need better funding.  But the government can't do everything.  If we need more spending on defense, those funds should be found by reducing spending elsewhere. Otherwise, eventually, the country won't be able to afford to defend itself, either. 

But, in order to reach the minimum of 60 votes needed in the US Senate, Republicans capitulated to Democrats demands for more non-military spending.  The result was a budget blow-out.

So, where does that leave us?  Optimistic about an acceleration in growth this year and 2019, which will help lift stock prices as well, but not as optimistic beyond that as we were before the budget deal.  The Plow Horse is not coming back overnight, but unless we get our fiscal house in order, it's still lurking in the barn.

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Posted on Monday, February 12, 2018 @ 10:32 AM • Post Link Share: 
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  This is Just a Correction…
Posted Under: Bullish • Government • Markets • Research Reports • Fed Reserve • Interest Rates • Spending • Taxes • Stocks

Last year US stock markets experienced the least volatile year on record, hitting new highs seemingly every day.  Then came the tax reform bill to end 2017, and a huge January with the S&P 500 rising 5.6%.  Investors, especially individuals who finally became convinced that the rally would go on, piled in.  It wasn't massive 1999-style euphoria, but many investors finally succumbed to the fear of missing out.

And as if on cue, sentiment (but not fundamentals) shifted, and stock markets gave up their 2018 gains.  The S&P 500 - as of the close on February 8th - was down 10.2% from its all-time closing high set on January 26th.

Everyone wants to find a "reason" for a correction, to explain what happened, especially when it takes them by surprise.  And these days the prime culprit, according to the financial press, is interest rates heading higher.  Some attribute this increase to rising wage pressures and inflation, some blame ballooning budget deficits.  But beneath it all is a widely-held belief that stock market gains have been propped up by easy money and low interest rates – a sugar high.  

Our answer to this: No!  The stock market has been driven higher by earnings growth.  In fact, given the recent downdraft in stock prices and the simultaneous increase in earnings estimates, the S&P 500 is now trading at roughly 16.7 times 2018 earnings estimates.  That's not high by historical standards. In fact, that is lower than the 30 year average of 19.4.

More importantly, we have been expecting interest rates to go higher and have urged the Fed to raise rates more quickly.  Given the pace of economic growth, the Fed is a long way from being tight.  At the same time, economic data has been strengthening and earnings are booming.  With 337 S&P 500 companies having reported Q4 earnings as of the 8th of February, 76.9% have beaten estimates, and earnings are up 17.0% from a year ago. This double-digit earnings growth is forecast to continue through 2018, even with higher interest rates. Corporate balance sheets are stronger than they have been in decades, spending is accelerating and the recent tax cut is an unambiguous positive.

Corrections scare the snot out of people.  For many, who thought markets only go up, they feel like the end of the world.  This is especially true when pundits start trying to explain the drop in stock prices by arguing that there are fundamental problems with the economy.  This time is no different.  But, in our opinion, this is an emotional correction, not a fundamental one.  The US is not entering a recession, and higher interest rates over the next few years do not spell doom for the economy or markets.

In fact, because of better policy, economic growth this year looks set to accelerate to 3%+ (we are forecasting 4% real GDP growth in Q1). That is why interest rates are rising, because of better than expected economic growth.  This is a good thing!  Not a reason to sell stocks.  In this case higher interest rates are a byproduct of a stronger economy, not the unwinding of QE or higher deficits.

Retail sales rose 0.4% in December, are up 9.0% annualized over the past six months and are up 5.5% year over year.  January's ISM Manufacturing and Non-Manufacturing indexes just hit the highest readings for a January in seven and 14 years respectively.  In January, hourly earnings were up 2.9% from a year ago, the best reading since 2009. At the same time, initial claims have been below 300,000 for 153 consecutive weeks.  Private payrolls were up 196,000 in January, and the unemployment rate is down to 4.1% and headed lower.  And no, this is not a "part-time" recovery.  In the past twelve months, full-time employment has grown by 2.39 million jobs while part-time employment is down 92,000!  With 5.8 million unfilled jobs and quit rates at the highest levels of the recovery, there should be little question why the Fed continues to hike rates.

We use a Capitalized Profits Model (the government's measure of profits from the GDP reports divided by interest rates) to measure fair value for stocks. Our traditional measure, using a current 10-year Treasury yield of 2.85% suggests the S&P 500 is still massively undervalued. The model needs a 10-year yield of 3.9% today to conclude that the S&P 500 is already at fair value with current profits.  Fair value, not over-valued.

What we focus on are the Four Pillars of Prosperity: Monetary Policy, Tax Policy, Trade Policy, and Spending & Regulation. So, let's see where those stand:

1. Monetary Policy – The Fed is still easy and will be for the foreseeable future. Remember, there are still over $2 trillion in excess reserves!

2. Tax Policy – Tax policy has improved dramatically on the margin, a tailwind for growth and earnings.

3. Trade Policy - The protectionist talk coming from Washington is worrisome, but, so far, there has been much more hot air than substance. In fact, total trade (exports + imports) sits at record highs.

4. Spending & Regulation – This is a mixed, but still positive, bag.  On the regulation front, 2017 saw the biggest decline in regulation, at least since the Reagan-era, and possibly in history.  That's great news for growth.  The spending side is still a concern.  The recent budget deal reached in the U.S. Senate boosts spending at least as fast as GDP growth over the next couple of years.  That's not a recipe for long-term economic acceleration, but also not an immediate threat to growth.

The bottom line shows that the fundamentals of the economy are strengthening.  Higher interest rates are a byproduct of a stronger economy. And, out of the four potential threats to the economy, only one is moderately negative.

It's not often you get a substantial pullback in the market when both economic and earnings growth are strengthening.  Stay calm. Stay invested in equities.  Don't fight the fundamentals.

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

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Posted on Friday, February 9, 2018 @ 8:50 AM • Post Link Share: 
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These posts were prepared by First Trust Advisors L. P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
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