With the first quarter of 2026 coming to a close last week, this week’s edition of “Three on Thursday” looks at the S&P 500 Index (the “Index”) over that period. As of yesterday’s close, the Index is down 2.2% on a total return basis since hitting its all-time high on January 27 of this year. Market breadth has shown signs of improvement. For a fuller picture of the events that unfolded in the first quarter, click on the link below.

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Implications: Incomes fell and spending rose in February, while inflation remained on everyone’s radar.  The decline in income was a surprise, but not as unpleasant as the headline suggests.  The drop was due to a 0.4% decline in government transfer payments, particularly smaller subsidy payments under the Affordable Care Act.  Our view is that over time less government spending will help boost the private sector.  In February itself, private-sector wages and salaries rose 0.2% and are up 4.6% in the past year.  However, government transfers are still up 6.0% from a year ago, which shows more work needs to be done on controlling government spending.  Meanwhile, personal consumption rose 0.5% in February, with a 0.9% jump in spending on goods while services spending rose 0.3%.  In the past year, spending on services is up 6.4%, compared to a 3.0% increase for goods.  The combination of stronger spending and weaker incomes left the savings rate at 4.0% – abysmally low. At the same time, inflation remains uncomfortably high with PCE prices – the Fed’s preferred inflation metric – up 0.4% in February, while the year-ago reading stands at 2.8%, matching where it stood in January, and virtually unchanged from the 2.7% reading for the twelve-months ending in February 2025.  “Core” prices, which strip out the volatile food and energy categories, also rose 0.4% in February, with the year-ago comparison remaining at 3.0%, exactly matching the pace seen for the twelve-months ending in February 2025.  Accounting for inflation, real consumption rose a modest 0.1% in February after a flat reading in January (and incomes fell). Expect volatility in the inflation readings in the months ahead as the geopolitical events in Iran, which escalated in March, start showing in the data.  In other news this morning, initial jobless claims rose 16,000 last week to 219,000, while continuing claims fell 38,000 to 1.794 million, suggesting jobs growth continues, but at a modest pace.

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Implications: Hold off on GDP itself for a moment.  The most important part of this morning’s report was on economy-wide corporate profits, which grew 6.0% in the fourth quarter vs. the third quarter and are up 9.6% from a year ago.  The best news was that profits in all major areas were up. Profits from domestic non-financial industries grew 2.5% in the fourth quarter, while profits from domestic financial firms rose 8.8%.  Profits from the rest of the world jumped 20.2% for the quarter.  Financial industry data include the Federal Reserve (either profits, or losses) and because the Fed pays private banks interest on reserves it has been generating unprecedented losses in recent years.  However, that changed in Q4 with the Fed earning positive profits for the first time since 2022. Excluding the Fed (because we want to accurately count profits in the private sector), overall corporate profits were up 5.1% in the fourth quarter and up 8.2% from a year ago.  One note of caution is that plugging in non-Fed profits into our Capitalized Profits Model suggests stocks remain overvalued.  Looking at the other details of today’s report, the final reading for real GDP growth in the fourth quarter was revised slightly lower from last month’s estimate, coming in at a 0.5% annual rate, finishing 2.0% higher in 2025. A downward revision to inventories more than offset small upward revisions to business investment and government purchases.  For a more accurate measure of sustainable growth, we focus on "core" GDP, which includes consumer spending, business fixed investment, and home building, but excludes the more volatile categories like government purchases, inventories, and international trade. "Core" GDP grew at a 1.8% annual rate in Q4, slightly lower than last month’s prior estimate of 1.9% and marking the lowest quarterly growth rate in three years, but still up 2.4% from a year ago.  Today we also got Q4 Real Gross Domestic Income (GDI), an alternative measure of economic activity.  Real GDI was up at a 2.6% annual rate in Q4 and up 2.4% from a year ago.  GDP inflation was revised slightly lower to a 3.7% annual rate in Q4, and is up 3.3% over the past year, both still higher than the Fed’s 2.0% target.  In other news this morning, cars and light trucks were sold at a 16.3 million annual rate in March, up 3.7% from February but down 8.7% from a year ago.

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Implications:  New orders for durable goods declined for the third consecutive month in February, falling 1.4%. However, the details reveal more promising underlying currents than the headline suggests. The drop in new orders was mainly due to a 5.4% drop in transportation equipment – particularly a 28.6% drop in commercial aircraft. Transportation is a notoriously volatile category month to month, so we prefer to focus on orders excluding transportation for a better check on the broader economy. Orders excluding transportation continue to rise, up 0.8% in February and 6.0% in the past year, the largest annual gain since 2022. The increase in these orders was led by primary metals (+2.2%), industrial machinery (+1.5%), and fabricated metal products (+0.5%).  The only category outside transportation to decline in February was once again electrical equipment.  However, orders for electrical equipment are still up a healthy 5.0% in the past year.  Note that both primary metals and computers & electronic products have had strong growth recently, with each experiencing double-digit annualized growth in the past three months.  Particularly, primary metals are up at a 25.4% rate in that time frame.  Arguably the most important number in today’s release is core shipments – a key input for business investment in the calculation of GDP – which rose 0.9% in February.  If unchanged in March, core shipments would rise at a 5.3% annualized rate in Q1 versus the Q4 average.  Business investment has shown strength recently as core shipments have consistently risen since mid-2025, which is a good sign for manufacturing headed into the economic shake-up of the Iran War. The investment momentum could also be evidence of Trump Administration’s push for manufacturing reshoring beginning to take hold.  However, for the Administration’s goals to fully materialize, it will have to translate into a much-needed resurgence in payrolls in that sector in the year ahead.

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Implications:  After expanding at the fastest pace in over three years last month, the service sector expanded once again in March, albeit at a slower pace, as the ISM Services Index declined to 54.0 from 56.1. Underlying activity in the sector continues to show strength, as the decline was driven largely by uncertainty surrounding the war in Iran.  Looking at the details, thirteen out of the eighteen major service industries reported growth in March, while three reported contraction and two remained unchanged.  The major measures of activity were mixed.  After climbing for five consecutive months, the business activity index declined to 53.9 from 59.9.  Meanwhile, the new orders index once again jumped to 60.6, reaching the highest level in more than three years.  Both the business activity index and the new orders index have expanded in at least ten out of the last twelve months.  Survey comments paint a picture of both headwinds and tailwinds for service companies which briefly benefitted from a reduction in tariffs from the Supreme Court ruling in mid-February, but now face increased economic uncertainty surrounding the Middle East. As a result, companies which started to increase hiring efforts at the start of the year brought hiring efforts to a halt in March. After the three months of expansion, the employment index fell into contractionary territory in March, declining to 45.2 from 51.8, although breadth in the decline was limited, as only six industries reported a decline in employment versus five that reported growth. Unfortunately, the highest reading of any index was once again the prices index, which jumped to 70.7 in March, the highest level since October 2022. Though the index remains elevated, it is still well below the worst we saw during the COVID supply-chain disruptions, when the index reached the low 80s.  While the ongoing war in Iran is expected to affect input prices in the short-term, we will continue to monitor the M2 money supply – which has grown very slowly over the last 3+ years – for whether these signals turn into long-term inflationary pressure.

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Implications: Good headlines, tepid details.  A month ago some analysts and investors got scared about a decline in jobs and increase in the unemployment rate in February.  Instead, we said it was “not a reason to panic,” that we were not in recession, and the factors dragging down jobs in February – weather and a temporary nurses’ strike – should reverse in March.  And that’s exactly what happened.  Nonfarm payrolls rose 178,000 in March, the largest gain for any month since 2024.  Excluding government as well as health care & education (which are often driven by government policies), payrolls rose 95,000 in March, also the most in more than a year.  Better, these gains happened at the same time the federal government (excluding the Post Office and Census) declined 16,000, bringing the total drop since January 2025 to 346,000, the steepest since at least 1990.  Meanwhile, the unemployment rate declined to 4.3% in March from 4.4% in February.  Unfortunately, the details for March were not nearly as strong as the headlines and we should expect much smaller payroll gains in the months ahead.  Civilian employment, an alternative measure of jobs that includes small-business start-ups, declined 64,000 in March; the reason the unemployment rate declined was because the labor force (people who are either working or looking for work) declined 396,000.  And in spite of the gain in payrolls, total private-sector hours worked declined 0.2% in March, as the average worker with a job worked fewer hours.   In addition, average hourly earnings rose a mediocre 0.2%, widely lagging what is expected to be a spike in consumer prices for March due to the Iran War.  That 0.2% gain means average hourly earnings are up only 3.5% from a year ago, the smallest increase for a twelve-month period since 2021.  Cutting through the volatility, in the past year private-sector payrolls are up 42,000 per month and we think that’s probably close to a “new normal” for an economy in which, for better or for worse, immigration laws are being strictly enforced and net immigration is likely near zero.

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In 2024, Republicans swept the White House, Senate, and House, which let them make the Trump tax cuts permanent.  But the clock is ticking on their congressional majorities.

At this point, we think the odds are very high that the Democrats win back the House in the mid-term election in November.  Compared to how they did in 2024, the Democrats only have to gain three seats to take back the House.  Historically, the party not in control of the White House – this cycle, the Democrats – have gained at least three House seats in eighteen of the twenty mid-term cycles since the end of World War II.

The Democrats are polling much better than they did in 2024, when the GOP won the national House vote by 2.7 percentage points.  Today the Democrats are up in the “generic” House polling average by 6.0 points, according the RealClearPolitics.  A swing of 8.7 points against the Republicans should generate a loss of about 25 House seats.  However, keep in mind that in the 2018 midterms the generic ballot showed the Democrats up by 12%+ at one point and they won by a smaller 8.4 point margin, so there’s still time for the GOP to improve.

Yes, mid-cycle changes in district lines around the country could slightly favor the Republicans, but not enough to make up for a loss of 25 seats.  Many Republicans had been hoping a Supreme Court case heard last year would give them more options for redistricting.  But it now looks like that decision will arrive too late to help much in 2026, even though it should help them substantially in 2028. For this year, unless the polls improve for the GOP, changes in district lines might help hold their losses to about 20 seats.

However, Republican prospects look much better for keeping control of the Senate.  The last time these same states were in play was 2020, a year when President Biden beat Trump by about 4.4 points in the popular vote.  In other words, even if this cycle is bad for the GOP, it won’t be much worse than the last time these same seats were up for grabs.

Yes, the Republicans have to defend most of the seats up for grabs this year, but of the twenty-two they have to defend, twenty are in what we would describe as “Red” states, where it will be tough for the Democrats to flip even one of these seats and they might end up flipping zero. That leaves only two “Purple”-state Republican seats that are vulnerable: North Carolina and Maine.

In North Carolina, the Republican is retiring and the Democrats have the inside track.  But in Maine the Republican incumbent, Susan Collins, is running again and she has a proven track record of winning in years that are bad for the GOP nationally, like in 2008 and 2020, as well as doing much better than the polls suggest in each of her past three races.

As a result, we think the most likely outcome is a divided Congress with the Democrats running the House but the GOP still in control of the Senate.

What will this mean for policy? Starting in January 2027, every bill that reaches the president’s desk is going to have to be at least a little bipartisan to get there.  We think spending deals will be cut in Congress, but, like in so many other arenas, President Trump will push the legal limits and we expect him to exercise “impoundment” powers that haven’t been used since the early 1970s.  This will lead to a legal fight about how much leeway presidents have to refuse to spend money appropriated by Congress.

In turn, if Trump wins that fight, all future presidents will have greater authority to reduce spending.  It would be a “one-way” ratchet, and future presidential candidates could run on their willingness to stand athwart Congress yelling “stop spending so much.”  If so, we think the American people would have more options to get our long-term fiscal house in order.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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In this week’s edition of “Three on Thursday,” we look at the Federal Reserve’s financials through year-end 2025. Back in 2008, the Federal Reserve (the “Fed”) embarked on a novel experiment in monetary policy by transitioning from a “scarce reserve” system to one characterized by “abundant reserves.” In addition to inflation, this experiment has resulted in some other developments that are worrisome. For deeper insights, click on the link below.

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Implications: The trade deficit took a break from its recent stretch of volatility in February, widening slightly to $57.3 billion after narrowing sharply in January.  Despite the small movement in the deficit, there was plenty of activity behind the scenes: exports rose by $12.6 billion, which was fully offset by a $15.2 billion increase in imports. Keep in mind that a large chunk of the rise in exports came from nonmonetary gold – a category not included in GDP calculations – which will dampen exports’ contribution to Q1 GDP. We like to focus on total volume of trade, exports plus imports, as it shows the extent of business and consumer interaction across the border. That measure rose by $27.8 billion in February, the largest increase in thirteen months, but is up only 0.9% (or $5.8 billion) from a year ago.  While total trade volumes have seen little change over the past year, the mix has improved for domestic producers, with exports rising 12.2% and imports falling 7.1% over the past year.  Meanwhile, the landscape of global trade continues to evolve. China, once the dominant exporter to the U.S., has slipped to a fourth place behind Mexico, Canada, and now Taiwan, with exports to the U.S. down 45.4% in the first two months of 2026 compared to the same period last year.  Accelerated demand for high tech equipment to fuel the massive AI investment is clear in the data with imports from Taiwan up 97.7% over the same period.  Also in today’s report, the dollar value of U.S. petroleum exports once again exceeded imports, marking the 48th consecutive month of America being a net exporter of petroleum products.  Keep in mind petroleum products include refined products like gasoline, diesel, and propane – all of which the U.S. exports in large volumes. When looking at crude oil alone however, the U.S. remains a net importer, largely due to domestic refinement capabilities. In other news this morning, initial jobless claims declined 9,000 last week to 202,000, while continuing claims rose 25,000 to 1.841 million.  We’re estimating Friday’s official labor report will show a nonfarm payroll gain of 76,000 with the unemployment rate remaining steady at 4.4%.  Keep in mind this report falls on Good Friday, and along with many other companies in the US, First Trust will be closed in observance of this sacred day. We will release our analysis of the jobs numbers, along with data on ISM Services, on Monday after Easter.

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Implications: Activity in the manufacturing sector surprised to the upside for the third month in a row in March, while the prices index signaled that inflation pressures remain stubbornly high.  The good news is the 52.7 level registered in March marks the first time the ISM Manufacturing Index has been in expansion territory for three consecutive months since 2022. While we remain cautious given last year’s head-fake (where the index briefly rose above 50 in January and February), the recent strength is a welcome development for an industry that has faced an army of headwinds in recent years.  Looking at the details, growth broadened slightly in March, with thirteen out of the eighteen major manufacturing categories reporting growth (versus twelve in February), while three reported contraction, and two reported no change.  The major measures of activity were mixed: the index for new orders declined to 53.5 from 55.8, while the production index increased to 55.1 from 53.5, but both remain in solid expansion territory, signaling growth.  It’s important to remember that order books have been very weak since 2023, and manufacturers had to rely on their order backlogs to keep production going.  The great news is that backlogs started growing again 2026, with the index sitting at 54.4 in March – now the third consecutive month in expansion territory – when before it had contracted for 39 straight months going back to September 2022.  Despite signs of improving demand, it has not been enough to meaningfully change hiring efforts in the manufacturing industry.  The employment index ticked down to 48.7 in March, signaling contraction, now for the 30th consecutive month.  The even worse news was a sustained pickup in pricing pressures, with the prices index jumping to 78.3 in March from 70.5 in February – markedly higher than the 59.0 level registered two months ago in January. With the ongoing war in Iran and the recent Supreme Court ruling against much of the Trump’s Administration tariffs, we expect volatility to continue for this category in the months ahead.   In other news this morning, construction spending declined 0.3% in January, as drops in homebuilding and manufacturing construction fully offset a large increase for highway & street projects.  In other manufacturing news, the Kansas City Fed Manufacturing Index – a measure of factory sentiment in that region – rose to 11 in March from a reading of 5 in February, the highest level since mid-2022.  Meanwhile, the Chicago Purchasing Managers Index (PMI) – where readings above 50 signal growth – declined to 52.8 in March from 57.7 in February, signaling slower growth than the previous month.

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