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   Brian Wesbury
Chief Economist
 
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   Bob Stein
Deputy Chief Economist
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  The Producer Price Index Increased 0.4% in November
Posted Under: Data Watch • Inflation • PPI

 

Implications:  Producer prices continued their steady march higher in November and are up more than 3% in the past year, the largest twelve month increase since 2012.  It's fitting that today's report on rising inflation comes as the Fed starts their December meeting, where a rate hike announcement now looks all but set in stone.  Prices for goods led the way in November, rising 1.0% as gasoline prices surged 15.8%.  Food prices also moved higher in November, rising 0.3% on increased costs for meats, fruits, and vegetables.  But even stripping out the increases in the food and energy groupings shows "core" producer prices rose 0.3% in November and are up 2.4% in the past year.  No matter how you cut it, it's clear inflation is on the rise. In fact, nearly every category in today's report shows inflation pressures that are likely to flow through to consumer prices in the months ahead.  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 November and are up 5.3% from a year ago, while unprocessed goods increased 3.2% in November and are up 10.6% in the past year.  Given these figures, the real focus on tomorrow's Fed release will be on the survey of economic projections (the Fed "dot plots") to see if FOMC participants shift up their expectations for the number of rate hikes they expect in 2018. With employment growth remaining strong and inflation rising, we still 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 as the markets are currently pricing in. 

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Posted on Tuesday, December 12, 2017 @ 10:37 AM • Post Link Share: 
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  The Fallacy of Weak Productivity
Posted Under: Government • Monday Morning Outlook • Productivity

Models of the economy are pretty useful tools.  And simple models are some of the most useful.  They help people envision how the world works.  They help organize thinking.

For example, the model that says potential U.S. economic growth is determined by "population (labor force) growth" plus "productivity" is an elegant model that shows how adding workers, or having them become more productive, leads to more economic growth.

But, even an elegant model can lead people astray when the inputs are misunderstood.  As they say: Garbage in, Garbage out!

Population growth is relatively straight-forward and doesn't change much.  It's growing at about 0.8% per year over the last decade.  Yes, immigration and the participation rate add some complexity, but labor force growth is the easiest part of the model to deal with.

Productivity growth, on the other hand varies, and is the true key to this model.  Non-farm productivity growth, as measured by the government, has averaged slightly above 1% per year lately.  That's slow by most historical standards.

Add these two up (Population, 0.8%) + (Productivity, 1.0%) = 1.8% growth; which is why many economists argue that the U.S. economy has a potential growth rate of just 2% per year, possibly less.  And they also say it can't be fixed.

But, can this really be true?  New technologies are boosting productivity everywhere.  As recently as 2009 it took over a month to drill and complete a new oil well; now it takes around a week.  Farmers have boosted the bushels of corn they get from every acre of farmland by 2.4% per year since the early 1990s – while new tech (drones, GPS, ground sensors) helps to save on inputs of hours, water, fuel, and fertilizer.

Smartphones, tablets, apps, the cloud, 3-D printing, drones, and many other new technologies are clearly boosting productivity.  And not just in tech industries.

So, why do so many people think productivity is weak?  Yes, government data sources say it's weak.  But anyone who goes outside instead of living in the data knows nearly everything is getting better, faster, and cheaper.
 
That suggests something is wrong with the government data.  One problem is that things that are free – like maps, step counters, language translators, radios, or calculator apps on your smartphone – are hard for the government to count.

But there's a bigger problem.  The government is a negative productivity machine.  For example, productivity in electric power generation and distribution fell 13% between 2006 and 2016.  And commercial banking productivity has risen less than 0.1% per year in the past seven years.  How could this be?  Why are these industries stagnating despite constant improvements in technology?

The answer:  Too much government.  The government has subsidized wind and solar electricity power generation, which are far more labor intensive and less productive.  And, excessive banking regulations shifted many jobs from profit generation to oversight and reporting in that industry.  The tax code itself absorbs millions of hours in non-productive labor.

In other words, while productivity in private activity hums along, big government is throwing a wet blanket over entire industries, and dragging down total market productivity.  It's simply not true that potential growth is as weak as the model says.  What is true is that shrinking government burdens will boost real (and reported) productivity, growth, wages, and living standards.

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

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Posted on Monday, December 11, 2017 @ 11:36 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, December 11, 2017 @ 10:31 AM • Post Link Share: 
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  Inversion in 2018? Not Likely!
Posted Under: Bullish • Government • Markets • Video • Fed Reserve • Interest Rates • Bonds • Stocks • Wesbury 101
Posted on Friday, December 8, 2017 @ 2:44 PM • Post Link Share: 
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  Nonfarm Payrolls Rose 228,000 in November
Posted Under: Data Watch • Employment

 

Implications:  The labor market picture keeps getting brighter for American workers.  Nonfarm payrolls increased 228,000 in November, beating consensus expectations.  In the past year, payrolls are up an average of 173,000 per month.  Although civilian employment, an alternative measure of jobs that includes small business start-ups, increased only 57,000 in November, that gauge is up 196,000 per month in the past year, so some convergence in the two measures of jobs should be expected.  The unemployment rate stayed at 4.1%, as expected, but we anticipate continued declines in 2018-19.  The lowest unemployment rate since the late 1960s was 3.8% in 2000 at the peak of that era's tech boom.  We expect to beat that by the end of 2018.  The lowest jobless rate in the 1960s was 3.4%; assuming we stay on track for a major cut in the corporate tax rate, we think that record will fall in 2019, eventually hitting the lowest levels since the early 1950s.  Although a relatively low participation rate makes it easier to have a lower unemployment rate, the participation rate is slightly higher than a year ago and the size of the labor force is up 1.6 million in the past year after a gain of 1.8 million in the year ending November 2016.  In other words, the jobless rate has been falling even though the labor force has been expanding.  Other good news in today's report includes a drop in the median duration of unemployment to 9.6 weeks, tying the low so far in this expansion.  As usual, we like to follow total earnings, which combines the total number of hours worked and average hourly earnings.  Total earnings are up a sturdy 4.8% from a year ago, signaling plenty of growth in consumer purchasing power.  This is not about the "rich getting richer;" a separate report on the earnings of full-time workers shows wages are rising faster in the lower income ranges than in the higher ones.  Put it all together, and we have a recipe that makes a rate hike at next Wednesday's Fed meeting almost certain.  The Fed will also likely say it foresees three rate hikes in 2018.  We think that's about right, but we also think the odds of four rate hikes next year are higher than the odds of only two rate hikes.  

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Posted on Friday, December 8, 2017 @ 10:31 AM • Post Link Share: 
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  The ISM Non-Manufacturing Index Declined to 57.4 in November
Posted Under: Data Watch • ISM Non-Manufacturing

 

Implications:  It shows how far the economy has come that a robust reading of 57.4 for the ISM Services index is a disappointing number.  Growth in the service sector slowed in November, coming off October's reading of the fastest expansion in more than a decade.  Sixteen of eighteen industries reported growth (one reported contraction), while all major measures of activity stand comfortably in expansion territory.  The most forward looking indices – new orders and business activity – both remain at very healthy levels, signaling that activity should remain healthy in the months ahead.  The prices paid index declined to a still high 60.7 in November, with labor shortages and rising fuel costs cited by respondents.  There may be some remnants of hurricane impacts in both the pricing data and supply chains, with supplier delivery backlogs improving but still above pre-storm levels.  But a look at the trend in the data shows that improvements were well underway before the hurricanes provided a temporary bump in business.  So while prices and supplier deliveries will moderate over the coming months, we expect service activity will remain strong heading into 2018.  On the jobs front, the employment index declined to 55.3 from 57.5 in October. Our forecasts may change with ADP and initial claims reports in the coming days, but we are currently forecasting nonfarm jobs growth of 207,000 for November.  Put it all together and the service sector, like the manufacturing sector, shows why the economy is picking up the pace.  In other recent news, automakers reported sales of cars and light trucks at a 17.5 million annual rate for November, down 3.1% from October and down 1% from a year ago.  It looks like the surge in auto sales after Hurricanes Harvey and Irma has just about run its course.  After hitting a calendar-year record high of 17.5 million in 2016, sales for all of 2017 should be 17.2 million.  Look for a further modest decline next year as US consumers shift their spending to other sectors.

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Posted on Tuesday, December 5, 2017 @ 10:54 AM • Post Link Share: 
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  The Trade Deficit in Goods and Services Came in at $48.7 Billion in October
Posted Under: Data Watch • Trade

 

Implications: The trade deficit expanded in October, coming in at $48.7 billion, a larger trade deficit than the consensus expected.  Exports were unchanged, remaining at their highest level since December 2014.  Imports rose $3.8 billion, hitting a new record high, with all major categories growing except for capital goods.  Both exports and imports are up from a year ago: exports by 5.6%, imports by 7.0%.  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 6.3% in the past year, a great sign.  Look for more of that in the year to come as economic growth accelerates in Europe and Japan.  Better growth in Europe will increase global trade and US exports as well.  In fact, exports to the EU are up 11.8% in the past year.  Although rising imports are a positive sign for the underlying strength of the American 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 significant drag on real GDP growth in Q4, subtracting 0.5 to 1.0 percentage points from the real GDP growth rate for the quarter.  In turn, this suggests real GDP is growing at the low end of our prior range of 3.0 – 4.0% for Q4.  Trade is one of our four pillars to prosperity; freer trade leads to improved economic growth over time.  And while we have our qualms with some of the talk coming out of Washington related to paring back free trade, there has been significantly more hot air than substance.  We will continue to watch trade policy as it develops, but still don't see any reason yet to be sounding alarm bells.

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Posted on Tuesday, December 5, 2017 @ 10:32 AM • Post Link Share: 
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  Don't Fear Higher Interest Rates
Posted Under: Bullish • Government • Markets • Monday Morning Outlook • Fed Reserve • Interest Rates • Stocks

The Federal Reserve has a problem.  At 4.1%, the jobless rate is already well below the 4.6% it thinks unemployment would/could/should average over the long run.  We think the unemployment rate should get to 3.5% by the end of 2019 and wouldn't be shocked if it got that low in 2018, either.

Add in extra economic growth from tax cuts and the Fed will be worried that it is "behind the curve."  As a result, we think the Fed will raise rates three times next year, on top of this year's three rate hikes, counting the almost certain hike this month.  And a fourth rate hike in 2018 is still certainly on the table.  By contrast, the futures market is only pricing in one or two rate hikes next year – exactly as it did for 2017.  In other words, the futures markets are likely to be wrong for the second year in a row.

And as short-term interest rates head higher, we expect long-term interest rates to head up as well.  So, get ready, because the bears will seize on this rising rate environment as one more reason for the bull market in stocks to end.

They'll be wrong again.  The bull market, and the US economy, have further to run.  Rising rates won't kill the recovery or bull market anytime in the near future.

Higher interest rates reflect a higher after-tax return to capital, a natural result of cutting taxes on corporate investment via a lower tax rate on corporate profits as well as shifting to full expensing of equipment and away from depreciation for tax purposes. 

Lower taxes on capital means business will more aggressively pursue investment opportunities, helping boost economic growth and the demand for labor – leading to more jobs and higher wages.  Stronger growth means higher rates.

For a recent example of why higher rates don't mean the end of the bull market in stocks look no further than 2013.  Economic growth accelerated that year, with real GDP growing 2.7% versus 1.3% the year before.  Meanwhile, the yield on the 10-year Treasury Note jumped to 3.04% from 1.78%.  And during that year the S&P 500 jumped 29.6%, the best calendar year performance since 1997.   

This was not a fluke.  The 10-year yield rose in 2003 and 2006, by 44 and 32 basis points, respectively.  How did the S&P 500 do those years: up 26.4% in 2003, up 13.8% in 2006.

Sure, in theory, if interest rates climb to reflect the risk of rising inflation, without any corresponding increase in real GDP growth, then higher interest rates would not be a good sign for equities.  That'd be like the late 1960s through the early 1980s.  But with Congress and the president likely to soon agree to major pro-growth changes in the tax code on top of an ongoing shift toward deregulation, we think the growth trend is positive, not negative.

It's also true that interest on the national debt will rise as well.  But federal interest costs relative to both GDP and tax revenue are still hovering near the lowest levels of the past fifty years.  As we've argued, sensible debt financing that locks in today's low rates would be prudent. However, it will take many years for higher interest rates to lift the cost of borrowing needed to finance the government back to the levels we saw for much of the 1980s and 1990s.  And as we all remember the 80s and 90s were not bad for stocks.

Bottom line: interest rates across the yield curve are headed higher.  But, for stocks, it's just another wall of worry not a signal that the bull market is anywhere near an end.

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

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Posted on Monday, December 4, 2017 @ 10:23 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, December 4, 2017 @ 7:52 AM • Post Link Share: 
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  The ISM Manufacturing Index Declined to 58.2 in November
Posted Under: Data Watch • ISM

 

Implications: Manufacturing activity continues to hum along as we head into the final month of 2017.  And baring a sharp decline in December, the ISM manufacturing index will average the highest for a calendar year going all the way back to 2004.  In November, the ISM manufacturing index showed a slight decline from October, but the underlying mix of growth was positive and strength remains broad-based, with fourteen of eighteen industries reporting growth in November (two reported declines).  The supplier deliveries index was the primary driver of the modest slowdown in the pace of growth in November (remember, readings above 50 signal expansion, so a decline above 50 represents continued growth, but at a slower pace), but that is a function of boosted readings in September and October as manufacturers worked to fill hurricane related backlogs.  The best news in today's report is that the two most forward-looking indices - new orders and production – both rose and continue to shine with readings above 60.  This suggests that the strength shown by the manufacturing sector throughout 2017 should carry over into 2018.  If Washington follows through on tax and regulatory reform, the pace of growth could pick up even further.  On the jobs front, the employment index declined to 59.7 in November from 59.8 in October.  While our final forecast may change with ADP and initial claims data next week, we are currently forecast solid jobs growth of 207,000 for November. In other news this morning, construction spending rose 1.4% in October (+1.8% including revisions to prior months).  A jump in spending on education facilities and offices more than offset a decline in spending on commercial projects.  These figures support the case that the Plow Horse economy is now on a steady trot.

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Posted on Friday, December 1, 2017 @ 12:00 PM • 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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