This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
The Fed Audit
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 04/01/2024
Several years ago some politicians started demanding that the Federal Reserve get audited. We think the idea has some merits but also some drawbacks, as well.
One problem with the Fed is that it doesn’t have a hard limit on its own spending. For example, let’s say the Fed wanted to hire a bunch of extra staff to write papers on climate change, income inequality, gun control, or other “political hot button” issues of the day that don’t really have a direct relationship with monetary policy or the Fed’s mission. Our understanding is that there’s nothing to stop the Fed from doing so, as long as it claims some relationship to monetary policy, no matter how tenuous.
And even if the appointed leaders at the Federal Reserve Board object, there are still twelve regional reserve banks around the country that could do so, and their leaders are not appointed by the president or confirmed by the Senate. In fact, the Chicago Federal Reserve Bank already has staff dedicated to researching topics that impact the “greater good” and “community development.”
Depending on the party in power, auditing the Fed could lead Congress to mandate more or less of these endeavors, and at the same time put more political pressure on the Fed to tilt monetary policy in a way that politicians see as favorable toward themselves, which would mean less Fed independence. History shows clearly that less central bank independence correlates closely with higher inflation and less currency stability.
What we would suggest is a law that limits the Fed to activities that directly, not indirectly, impact monetary policy. Those areas can be measured with an accounting audit by an outside firm, which the Fed already does. Last week the Fed released its audited financial statements for 2023 and they were…. interesting.
Most prominently, the Fed lost $114 billion last year. This is the first time the Fed has ever run an annual loss and the loss is a direct consequence of the Financial Panic of 2008 when the Fed started paying banks to hold reserves.
Prior to that change, the Fed did not pay banks to hold reserves, meanwhile earning interest on the securities in its portfolio (mostly Treasury bills). But after the change, when the Fed was holding rates close to zero, it still ran surpluses. When the Fed held rates low, it contributed an average of more than $75 billion annually to government revenue.
But holding rates too low creates distortions in financial markets and rates had to go higher. In order to “normalize” rates, the Fed now pays banks 5.4% on their excess reserves. The result is that the Fed paid private banks $281 billion in 2023.
But the Fed earns less than that on its bond portfolio. To repeat, it lost $114 billion in 2023 and has a total accumulated deficit of $133.3 billion since 2022. The Fed calls these accumulated losses a “deferred asset” because it expects to return to profitability in the future.
These kinds of losses should invite political oversight. Does the Fed just borrow more from the Treasury (the taxpayer) to meet payroll? If so, there is already a reason to doubt its independence from the political side of government. Rather than audit the Fed, which is already done, laws which require more transparency and a more focused mission, would be productive. The Fed has become too political. That should change.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Welcome to State-Run Capitalism
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 03/25/2024
We’ve mentioned this before, but it bears repeating. It seems that investors pay as close attention to what the government is doing, as they do to actual business news. We don’t think investors are wrong to do this, but it’s only because government has become so big.
The US has moved from a simple Keynesian-type model to what we call “State-Run Capitalism.” When the economy turns soft, a typical “Keynesian” (demand-side) response would be to boost the budget deficit or print more money.
Now, the government is running permanent, and very large, deficits and using its budget to fund semiconductors, EVs, solar and wind energy generation, as well as redistributing more money to immigrants and students who are in debt. This all smells and looks like central planning…or State-Run Capitalism.
At the same time, because the Fed is now using an abundant reserve monetary policy, it has taken the financial system out of the process of determining short-term interest rates. Banks no longer need to trade excess reserves, so the federal funds rate has no real market. The Fed just makes that rate up.
So, here we sit in 2024, and a Wall Street Journal economics reporter, Greg Ip, just wrote a piece titled “The Economy is Great…”. We don’t think that’s really true, but real GDP did grow more than 3% last year and job growth has been robust.
A typical Keynesian response to this, the one most people were taught in economics class, would be for the government to run a surplus, or at least substantially shrink the deficit, and the Fed to be at least slightly worried about over-heating the economy.
Instead, Congress just pushed through a $1.2 trillion spending bill with a deficit that will approach $1.6 trillion, and the Fed announced that it was likely to cut rates three times in 2024.
What the heck? Why? Especially with inflation reports so far in 2024 coming in hot. The Cleveland Fed median price index is up 4.6% from 12 months ago, “supercore” CPI is up 4.3% over 12 months, and nearly 7% annualized over the past three months. With inflation this high, and the economy “great,” no traditional Keynesian would support these policies.
We don’t blame investors for reading the tea leaves and realizing that all this stimulus is probably good for the markets in the short run. Lower rates mean more growth and higher price-earnings ratios. The market seemingly (and perhaps correctly) has decided that the Fed, and the Federal Government, can manage the economy to keep stocks up.
But all of this will come with a price. No centrally-managed economy has been permanently made to go only one way. It can look good for a time, but eventually the sheer size of the government and the mishandling of monetary policy catches up. On a smaller scale, the US tried this in the 1970s, and the result was stagflation. Russia, Venezuela, and a host of other countries have all failed.
But it doesn’t happen overnight. More importantly, because the Fed has separated the growth of the money supply and the level of interest rates, rate cuts may not mean what many people think they do. Yes, rates may come down this year, but the money supply has contracted in the past year. A contraction in the money supply is never a good sign.
We still expect a recession this year. The US will have an irresponsible deficit, but it will be slightly less irresponsible than it was last year. Add in a decline of M2, and the morphine pumped into the system over the past few years has worn off.
If the Fed is cutting rates because it is an election year, and if the government is spending money in an effort to entice some voters to see it as personally beneficial to vote for big government, it’s a recipe for lousy economic outcomes.
When the government pushes money in directions that are politically beneficial, they are often not efficient in a true economic sense. This means less growth and more inflation. We are very worried about stagflation in the years ahead.
Between now, and whenever that is, the market may completely ignore it. And, investors will think the government has found a recipe for permanent prosperity. But after thousands of years of trying, and never making it happen, we bet against even this new version of State-Run Capitalism.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
Focused on the Fed
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 03/18/2024
The Fed meets this week, which means investors and analysts will be sifting through Wednesday’s FOMC statement, updated economic projections, the “dot plots,” and Powell’s press conference searching for any signal – real or imagined – about what our central bank will do next. In particular, the market is on tenterhooks about when rate cuts will start, how fast those rate cuts will come, or if the Fed will simply hit the “pause” button on the prospect of rate cuts until deep into 2024.
We think this obsession with the Federal Reserve is unhealthy. Instead of an obsession with slight policy shifts out of Washington, DC, we think investors need to be focused on more important matters, like the process of innovation, entrepreneurial risk-taking, and corporate profits. In the end, it’s these factors that will drive stock market valuations the most, not the vagaries of the short-term interest rate target by the mandarins of money.
Things have changed a great deal since the last Fed meeting on January 31. Back then, the futures market expected about six rate cuts of 25 basis points each this year, with the first cut coming in March. As of Friday’s close, the market was expecting only three rate cuts this year, with the first one coming in either June or July.
No wonder the shift in rate expectations given recent reports on inflation. The two CPI reports since then show consumer prices up at a 4.6% annual rate in the first two months this year. And no, this was not food and energy; “core” prices, which exclude those two volatile categories were also up at a 4.6% annual rate so far this year.
Even worse for the Fed is that the newly made-up slice of the CPI that the Fed and others call the “Super Core” measure of inflation, which includes services only (no goods) but also excludes food, energy, and housing rents, rose 0.8% in January and 0.5% in February. That’s a growth rate of 8.2% annualized so far this year. Notice how you used to hear a lot about this measure a year or so ago when it was indicating lower inflation and now few dare speak its name when it shows inflation re-accelerating! Meanwhile, overall producer prices are up 5.4% so far this year and “core” producer prices are up at a 4.5% annual rate.
None of these figures are remotely close to the 2.0% inflation goal the Fed claims it’s still targeting.
The problem for the Fed is that there are signs that the economy may be slowing. Although retail sales rose 0.6% in February, after factoring in downward revisions to prior months, retail sales rose a tepid 0.1%. “Core” sales, which exclude volatile categories such as autos, building materials, and gas stations — and is a crucial measure for estimating GDP — increased by 0.1% in February, but was revised significantly lower for previous months, down 0.5%. If unchanged in March these sales will be down at a 0.7% annual rate in Q1 versus Q4, which would be the first quarterly decline since the COVID lockdowns.
Industrial production rose a tepid 0.1% in February but that follows declines of 0.3% and 0.5% in December and January, respectively. We like to follow manufacturing output excluding the auto sector (which is volatile) and that is down 0.9% from a year ago. Not a good sign.
As always, we will be watching the press conference following Wednesday’s meeting for any mention of the Fed looking more closely at the money supply, but we won’t get our hopes up. The M2 measure of money is down 2.0% in the past year, which would not be good for the economy if these figures are accurate and if they continue.
Another key issue is whether the Fed will publicly abandon it’s 2.0% target to make it easier on themselves to achieve their goal. We think that will happen eventually, but that’s several years from now, not soon. The Fed likely thinks it would lose credibility if it announced a higher target for inflation, and could send long-term interest rates spiraling upward; that’s not a risk the Fed would take, particularly in an election year.
Our advice to investors: listen to and watch the Fed but don’t obsess about it. The changes in monetary policy from meeting to meeting don’t matter nearly as much as the productive capacity of the American people.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Is the Job Market Really That Strong?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 03/11/2024
If you only look at the headlines about the monthly payroll report, the job market has looked surprisingly strong in recent months. Nonfarm payrolls rose 275,000 in February, beating the consensus expected 200,000 as well as the average of 229,000 per month in the past year.
But a deeper look at the data makes it look about as fishy as week-old sushi. Now, we’re not alleging some sort of “Deep State” conspiracy, we’ll leave that to others. But reviewing the report in its entirety show the job market is not nearly as strong as the top line payroll readings suggest.
For example, look at the revisions. Payrolls in December and January were revised down by a total of 167,000 (the largest monthly downgrade for any non-shutdown months since late 2008), meaning February was just 108,000 above the original January level. And it was even worse in the private sector, where payroll gains were a paltry 19,000 for the month after netting out revisions for prior months.
What’s odd about these downward revisions is that they seem to happen pretty darn often of late. In 2023, for example, the regular two-month revision process reduced the initial monthly report by 30,000, on average. That ain’t chump change. In the past few decades, negative revisions like this have normally been associated with recessions or the immediate aftermath of recessions.
It's also important to follow civilian employment, an alternative measure of jobs that includes small-business start-ups. On a monthly basis, these figures are volatile, and are affected by estimates of the size of the total population, so take them with a grain of salt. But the trend is important and isn’t anywhere as strong as payrolls. While payrolls are up 2.7 million in the past year, civilian employment is up 0.7 million and the unemployment rate has risen to 3.9%. Moreover, the gain in civilian employment in the past year has all come in part-time work, with a slight loss for full-time jobs.
There may be solid technical reasons for this large gap. The figures are generated by two different surveys (one for employers, the other for households), and maybe the massive influx in immigrants, even if largely illegal, is finding its way into payroll expansion (perhaps with illegal hiring or false documents) in a way not being picked up by the civilian survey. We’re guessing many recent immigrants are not eager to answer surveys sent by the Labor Department.
Notably, among those who do answer the survey, civilian employment among the native-born population is down around 900,000 from a year ago – the first drop since the onset of COVID – versus an increase of about 1.5 million among the foreign-born.
Only time will tell the true underlying health of the labor market. There is no clear signal we’re in a recession, but the patient isn’t looking well. What is clear, is that economic risks abound, and a soft landing is far from guaranteed.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Is a Debt Spiral Already Here
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 03/04/2024
Washington DC continues to spend much more than it gets in revenue. In the Calendar Year of 2023, the federal government spent $6.3 trillion, but only collected $4.5 trillion in taxes. This $1.8 trillion gap drove the national debt to $34 trillion in December 2023. And it is only going higher.
One problem with these budget numbers is that government accountants, rightly or wrongly, lowered spending in 2023 by about $300 billion after the Supreme Court struck down a large part of President Biden’s proposal to forgive student loans. That legal decision didn’t change the government’s cash flow last year in any significant way, but it did let the Department of Education “write up” the value of its loan portfolio by about $300 billion. This, they counted as “negative spending,” which then reduced the official budget deficit. So, while the reported deficit in 2023 was $1.8 trillion, the Treasury needed to borrow more than $2 trillion to make ends meet.
The high levels of borrowing are causing some investors to fear some sort of imminent and unprecedented snowballing of federal debt. Continual borrowing will lead to skyrocketing interest rates (and higher interest payments), which will lead to severe problems in the financial system.
In particular, they note that since June 2023, when the debt ceiling was suspended, total Treasury debt outstanding has gone up by nearly $3 trillion. That includes a total of $874 billion in the second quarter of 2023, $835 billion in the third quarter, and $834 billion in the fourth quarter. Other than 2020-21, during COVID lockdowns, the debt has never gone up this rapidly, not even in 2008-2009.
But it’s important to remember that the debt does not go up at a steady rate during the course of the year. In 2023, during March and April, the federal government received a surge in tax receipts, which temporarily reduced the amount of debt outstanding. We think this will happen again this year, particularly because the S&P 500 went up 24% last year and the federal government is therefore likely to reap lots of non-withheld revenue.
As a result, the Congressional Budget Office estimates that individual income tax payments will be up 13.4% this year and the budget deficit will come in at roughly $1.5 trillion versus $1.7 trillion in Fiscal Year 2023. On that score, we are not as optimistic. Even as we write this, Congress is debating foreign aid measures that, whether you like the underlying policy or not, will, by themselves, boost the deficit.
And while the cost of servicing the debt is going up, the interest measure that matters is the net interest on the debt relative to GDP. In other words, what matters is how much of our national income is needed to service the debt. That measure, while climbing and a problem, is still below the average of roughly 3% of GDP it was back in the 1980s-90s.
However, because we think interest rates will remain higher than government accountants think, the carrying cost of our debt will move higher.
The bottom line is that federal government spending is way too high and most politicians do not seem to care. There are those who look at these numbers and assume some kind of imminent crisis, when what we see is a slow, but unavoidable decay in our underlying potential to grow. New technologies are raising productivity, but a huge government acts like a ball and chain on those benefits.
For now, the markets are ignoring this, and assume a soft landing with lower interest rates. But the more economic growth is undermined, the less likely this outcome.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Watching the Fed
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 02/26/2024
Every day this week, investors will get data on the economy. New home sales today, then capital investment, GDP, consumer incomes and spending, manufacturing, and auto sales are on the list. All of this will feed into the outlook for what the Federal Reserve might do with interest rates this year.
Pretty much everyone expects the Fed to cut rates this year, but expectations have changed. A month ago, the futures market was pricing in five or six twenty-five basis point (bps) rate cuts in 2024 (125 - 150 bps in total); now the market is pricing in three or four (75 - 100 bps total). Two relatively strong employment reports and an upside surprise with Q4 GDP data caused some rethinking, but this could be reversed just as easily.
While all these data points matter, we will be watching another release very closely, as well, one that few investors pay attention to and the Fed itself either doesn’t care about or is doing a great job pretending it doesn’t care about: tomorrow afternoon’s report on the growth of the money supply, or lack thereof, the M2 measure of money, in particular.
That measure of money, in spite of QE, did not soar during the Great Recession and Financial Crisis of 2008-09, and therefore did not cause inflation. The main reason is that though the Fed did trillions in QE, through heavy-handed regulation, banks were forced to boost reserves.
But 2020-21 was different. Banks were paid to push the money into the economy (remember PPP loans?) and M2 skyrocketed 40.7%. This led to the surge in inflation that followed in 2021-22. Since then, M2 has actually declined 3.2% in 2022-23, taking the steam out of inflation, but so far hasn’t affected economic growth.
But in the last two months of 2023, M2 started growing at a moderate pace again, up at a 4.1% annualized rate. If the Fed keeps it up, not just for one month but as a trend, that would be good news and might even reduce the risk of a recession later this year.
While we watch M2, others have been eyeing the relationship between long and short interest rates. In October 2022, the 3-month Treasury yield rose above the 10-year yield, and has stayed there. This is called an “inverted yield curve” and historically signals that the Fed is tight and a recession is often on the way.
But in an “abundant reserve” monetary policy, higher short term interest rates no longer signal “tight” reserves. In fact, with reserves so abundant, the Federal Funds Rate is no longer determined in a market, but is actually set at the whim of the Fed. Technically, this is price fixing.
So, the yield curve doesn’t mean what it once did. Longer term bond yields now are hugely affected by what investors think the Fed might do with rates, rather than how those rates reflect underlying economic trends. The Fed has convinced itself and the markets, that it can move rates up and down with the economic data perfectly, but this is hubris. The Fed has held interest rates below inflation roughly 80% of the time since 2009, leading to distortions in markets and the banking system.
Having said that, with short-term rates no longer excessively low, and the money supply down in the past 18 months, we believe the economy is starting to falter.
Retail sales have declined in three of the past four months. Manufacturing production, excluding the auto sector has declined four months in a row. Meanwhile, home building got hammered, with both housing starts (-14.8%) and completions (-8.1%) dropping sharply while new home sales are down 5.3% in the past four months.
We advise watching the path of M2 to tell how much additional faltering it will do in the year ahead.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
January Stagflation
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 02/20/2024
A key economic mistake people make is thinking growth leads inflation. One reason they do that is because inflation is a monetary phenomenon. When money is too easy, first growth rises, and then inflation rises with a longer lag due to excess dollars in the system. This process reverses when money is tight, first growth slows, then with a longer lag inflation does too.
That makes 2023 an anomaly. The economy has remained resilient, but year-over-year consumer price inflation has moderated from a peak of 9.1% in mid-2022 to 3.4% in December 2023.
One theory is that the high inflation was all due to economic bottlenecks and supply constraints during COVID, so the end of lockdowns and the process of getting back to normal has expanded supply, leading to both faster growth and lower inflation. There’s no doubt that the imposition of lockdowns and then the re-opening from those lockdowns had “supply-side” effects – first negative, then positive – and are consistent with this explanation.
But it’s a flawed explanation. If supply constraints and their loosening were the key drivers of inflation, we would expect pandemic driven inflation to be followed by outright deflation as the economy reopened and returned to normal. That clearly hasn’t happened, and inflation remains stubbornly high.
Instead, we believe monetary policy played the key role. The M2 measure of the money supply soared 41% in 2020-21, the fastest since World War II. This measure of the money supply then declined 3.2% in 2022-23, the largest two-year drop since the Great Depression. These swings in M2, the relative sizes of the swings (larger up than down), and the long lags between shifts in M2 and inflation do a much better job explaining the inflation pattern of the past few years.
The problem with this theory of “monetary dominance” is that classical liberals like Milton Friedman and the Austrians would expect economic growth to take a hit before inflation were brought back down to normal. And yet Real GDP grew 3.1% in 2023, which is above the 2.0% long-term trend.
So what gives? Our belief is that the US injected so much money, so rapidly, that the economy couldn’t absorb it instantaneously. So, now, what we have seen is that even though M2 has declined, we still haven’t absorbed all the money that was added. Some call it excess savings, we call it excess M2.
But the US has finally absorbed the excess money, and fiscal stimulus is waning as well. And guess what? Recent reports for January show an economy that may be weakening faster than most investors realize. Retail sales fell 0.8% for the month and have declined in three of the past four months. Manufacturing production fell 0.5% in January and manufacturing excluding the auto sector (the auto sector is volatile) has declined four months in a row.
Meanwhile, home building got hammered in January, with both housing starts (-14.8%) and completions (-8.1%) dropping sharply. It’s possible that colder than normal January temperatures were a factor, as well as unusually high precipitation, but the drop in starts was in every major region of the country, the drop in completions happened in most regions (except for the West), and while weather was bad, quantitative measures of national heating requirements were not unusually high in January.
We’ve had bad weather before – and apocalyptic weather reports are clearly clickbait for some in the news media – but housing starts in January were the second lowest for any month since mid-2020, during the onset of COVID when lockdowns still prevailed in much of the country. In other words, we see these data potentially signaling broader economic weakness, consistent with the drop in retail sales and decline in manufacturing production in January.
And yet inflation was also a problem in January, with both consumer and producer prices rising 0.3%, faster than the consensus expected and inconsistent with the Federal Reserve’s 2.0% target inflation.
A weakening US economy with inflation remaining (temporarily) stubbornly high would be consistent with the monetary dominance story of inflation’s rise and fall and would also be a problem for the stock market. Using our Capitalized Profits Model, with a 10-year Treasury yield at about 4.25%, economy-wide corporate profits would need to rise 30%+ to justify an S&P 500 at 5,000. But there’s no way profits (ex-Fed), which are already high relative to GDP would surge that much higher in a soft economy. The current consensus puts profit growth at roughly 10% this year.
Time will tell if the weakness in January becomes more widespread. On the surface, the job market still looks fine, with payrolls up more than 300,000 in both December and January. But the labor market can be a lagging indicator.
Unprecedented policies during COVID have created noise in the data. But underneath it all, we still believe Milton Friedman had it right. A decline in money will lead to recession, and then a decline in inflation.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
CBO’s Rosy Scenario
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 02/12/2024
Last week the Congressional Budget Office set out new projections for budget deficits and debt in the decade ahead, and they weren’t quite as bad as they looked last year. The CBO now projects a deficit of 6.4% of GDP in 2033 versus a prior forecast of 7.3%. Total accumulated debt by 2033 is now forecasted to be 114% of GDP versus 119%. None of this is “good” news – deficits and debt would still be too high – but it is “less bad.”
The problem is that the CBO’s assumptions are way too rosy. In particular, it assumes the end of many of the tax cuts enacted in 2017 without any negative effects on the economy. Fat chance! More likely, growth would slow and revenue would come in low, meaning bigger budget deficits.
But it will also be tough to hit the CBO’s revenue projections if we keep the 2017 tax cuts fully in place. The CBO is forecasting “real” (inflation-adjusted) economic growth of about 2.0% per year, on average for the decade ahead, the same growth we’ve experienced since the end of 2000 (before the 2001 recession) and since the end of 2019 (the business cycle peak prior to COVID). If we tax that economy at lower rates than CBO projects it’ll yield less revenue than CBO projects, as well.
The bottom line is that no matter what candidates say this year on the campaign trails in their races for the White House, Senate, and House, both parties are going to have to find ways to limit deficits in the years ahead. If we get a GOP sweep – which we believe would result in a continuation of the 2017 tax cuts (and on which we put 35% odds, up from 30% last November) – we expect measures to fight the deficit to include curbs on “green energy” subsidies, more tariffs, and Medicaid reform.
If the Democrats sweep (20% odds) then we think a wide range of tax hikes will be on the table, including raising the top income tax rate (now 37%) back to 39.6%, raising the top long-term capital gains and dividends tax rates (now 20%) to at least 24%, reducing estate tax exemptions, raising the standard corporate tax rate (now 21%) to 35%, and possibly introducing a carbon tax, which the Clinton Administration very briefly considered in 1993. Back then, both Senators from Nebraska were Democrats, which helped keep President Clinton away from a carbon tax; now the Democrats get very little support from energy-intensive states.
But in a world where the current House majority is razor thin and some election maps are still being redrawn, it shouldn’t shock anyone if we end up with “mixed government” in 2025-26, with the GOP holding at least one of the White House, Senate, and House, and the Democrats holding at least one, as well. We’d put the odds on that at about 40-45%, at present.
With mixed government, expect some brutal political fights. Does anyone think a Speaker Hakeem Jeffries would simply rollover for a Republican president and accept a full extension of the 2017 tax cuts, or anything close? Why wouldn’t a Republican president test the Supreme Court by “impounding” (refusing to spend) money appropriated by Congress, which hasn’t happened since the early 1970s? The bottom line is that for all the fighting, mixed government scenarios would likely generate no entitlement reforms and little deficit reduction, leaving plenty of time for the bond vigilantes to sharpen their knives.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Labor Market Not Adding Up
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 02/05/2024
On the surface, there’s much to like about the job market. But when you get into the details, it’s not quite as strong and some things don’t add up. Here’s what to like.
The establishment survey answered by a sample of businesses showed that nonfarm payrolls increased 353,000 in January, easily beating the consensus expected 185,000, the largest gain in a year, and coming in higher than the forecast from every economics group (that filed a forecast with Bloomberg). Meanwhile, payroll gains were revised up by 126,000 for November and December, bringing the net gain, including revisions, to 479,000. In the past year, payrolls are up 2.9 million or 244,000 per month.
We like to follow payrolls excluding government (because it's not the private sector), education & health (because it rises for structural and demographic reasons, and usually doesn’t decline even in recession years), and leisure & hospitality (which is still recovering from COVID Lockdowns). That “core” measure of payrolls rose 194,000 in January, which is the best month since mid-2022.
That same payroll survey showed that average hourly earnings – cash earnings, excluding irregular bonuses/commissions and fringe benefits – rose 0.6% in January and are up 4.5% versus a year ago. The Federal Reserve might not like that – the odds implied by the futures market that the Fed will cut rates by the end of the May 1 meeting went down substantially – but it is good news for workers and means wage growth per hour is out-stripping inflation.
Meanwhile, the survey that samples US households showed that the unemployment rate remained at 3.7%.
But here are the details and figures that make us wary about just accepting all the good news at face value.
First, the same payroll survey showing strong job growth is showing a concerning drop in the number of hours per worker. Workers in the private sector worked an average of 34.6 hours per week in January 2023; this January they were down to 34.1. Average weekly hours haven’t been this low since March 2020, with the onset of COVID.
As a result, even though total jobs are up 1.9% in the past year, total hours worked are up only 0.3%. To put this in perspective, a 0.3% increase in private-sector jobs in the past year would have meant private payroll gains of 33,000 per month, not the 194,000 per month we experienced. (A 0.3% gain in jobs is what would have happened if businesses had hired workers to fill the extra hours they needed but kept the number of hours per worker the same.)
Second, the household survey measure of employment hasn’t been rising nearly as fast as payrolls, which is something that has happened in the past prior to recessions. As we noted earlier, nonfarm payrolls (which includes government workers) are up 244,000 per month in the past year. But the household survey (smoothed for recent population adjustments) is up only 101,000 per month in the past year. That’s a very large gap by historic standards.
Another issue is the oddity of having payroll growth of 244,000 per month in the past year while the unemployment rate has been so low. Since February 2001, right before the 2001 recession, payrolls have grown at an average pace of 91,000 per month. Since February 2020, right before COVID, payrolls have grown at an average pace of 115,000 per month. Those longer-term averages make sense given a growing population in the context of an aging workforce.
But how then can we have payroll growth so much faster in the past year, particularly when the unemployment rate is already so low? Usually job growth gets slower when the jobless rate is near bottom.
One theory can explain this, however: that the US economy has been temporarily boosted by having the government run a larger budget deficit, including the effects of the CHIPS Act, infrastructure bill, and the Inflation Reduction Act. But that artificial boost should soon come to an end. And when it does job growth should slow sharply, as well.
A strong job market is a good thing, but it doesn’t mean a recession can’t start soon. Payrolls are up 1.9% in the past year. But they were up the same in the year ending in January 1990 and a recession started mid-year. They were up 1.3% in the year ending January 2001 and a recession started in Spring 2001. The flu starts when you’re feeling good and it’s normal for a recession, like the flu, to come when the economy looks fine.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
A Stock Market Conundrum
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 01/29/2024
The economy is still growing. Real GDP rose at a solid 3.3% annual rate in the fourth quarter, and consumer spending was strong in December meaning the first quarter is off to a good start. New home sales came in above expectations and initial jobless claims remain low, although orders for durable goods came in low due to weak demand for aircraft.
All eyes are now on Friday’s jobs report, which we expect to show a gain of about 170,000 while the unemployment rate holds steady. But the strength in employment seems fragile. If we exclude job gains in government, health & education (which are largely funded by government), and leisure & hospitality (still recovering from lockdowns), job growth looks exceptionally weak. In the last seven months of 2023, payrolls excluding those categories rose only 3,000 per month, the kind of weakness we might expect before a recession. In other words, much of recent growth is fueled by government deficits.
Meanwhile the stock market continues to rally, with the S&P 500 closing at a new record high last Thursday. That’s great, but we aren’t exactly sure what the market sees.
If the economy remains healthy and keeps growing, it’s very hard to imagine the Federal Reserve cutting short-term interest rates by the 125-150 basis points the markets appear to expect. In turn, less rate cutting than the market expects should be a headwind for equities in 2024.
What would get the Fed to cut rates by 125-150 bps? Either a sharp drop in inflation or a decline in economic growth. While lower inflation is good, can a sharp drop happen without a weak economy? Either way, we don’t think the stock market would like that outcome because they would likely signal lower corporate profits.
This is all consistent with our Capitalized Profits Model, which still says stocks are overvalued. That model uses economy-wide profits from the GDP accounts (excluding profits or losses by the Fed) and discounts them by the 10-year Treasury yield. Using the level of profits in the third quarter (we won’t get Q4 numbers for profits until the end of March) and a 10-year yield of 4% (which was its yield before rate cut expectations started to evaporate), suggests the S&P 500 would be fairly valued at about 3,900, well below recent highs.
What would it take to suggest that recent stock prices are appropriate? A 10-year yield of 3.2% would do it. So would a 30% increase in profits. But a 3.2% yield would probably be accompanied by lower profits and a 30% surge in profits would likely be accompanied by a much higher 10-year yield, so fair value is even further away than it seems.
The only way out of this conundrum is if Artificial Intelligence and other new and rapidly advancing technologies provide a miraculous boost to productivity. This could keep growth strong, or even accelerate it, while bringing inflation down. In other words, profits up and interest rates down.
While this could happen, it would take a miracle. And while expecting miracles worked for San Francisco fans, we still think investors should remain cautious. The monetary and fiscal stimulus that made COVID lockdowns seem like a bump in the economic road are wearing off.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Slower Growth in Q4, But No Recession
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 01/22/2024
The economy slowed substantially in the last quarter of 2023 from the rapid pace of the third quarter, but, as we explain below, still expanded at a moderate rate. Some will take this week’s Real GDP report to confirm their prior view the recession is simply not in the cards for the US economy, but we still think a recession is more likely than not.
Why do we still think a recession is coming? Because monetary policy is tight whether you like to use the yield curve, the “real” (inflation-adjusted) federal fuds rate, or the M2 measure of money to assess the stance of policy from the Federal Reserve.
Why hasn’t a recession happened yet? Because monetary policy works with long and variable lags and a surge in the budget deficit in 2023 temporarily postponed the economic day of reckoning. We are right now living through a reckless Keynesian experiment with massive deficit spending relative to low unemployment, with the government having devised programs to temporarily boost GDP in the short run. But this government spending isn’t lifting long-term growth; it’s stealing from future growth.
In the meantime, higher short-term interest rates mean businesses have the ability to lock in healthy nominal returns on cash with minimal risk. In turn, this should lead to a reduction in risk-taking and business investment.
In the meantime, we estimate that Real GDP expanded at a moderate 2.1% annual rate in the fourth quarter, mostly accounted for by an increase in consumer spending.
Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector rose at a modest 1.3% annual rate in Q4 while auto sales declined at a 3.6% rate. However, it looks like real services, which makes up most of consumer spending, should be up at a moderate 2.4% pace. Putting it all together, we estimate that real consumer spending on goods and services, combined, increased at a 2.2% rate, adding 1.5 points to the real GDP growth rate (2.2 times the consumption share of GDP, which is 68%, equals 1.5).
Business Investment: We estimate a 1.8% growth rate for business investment, with gains in intellectual property leading the way, while commercial construction declined. A 1.8% growth rate would add 0.2 points to real GDP growth. (1.8 times the 13% business investment share of GDP equals 0.2).
Home Building: Residential construction is showing some resilience in spite of some lingering pain from higher mortgage rates. Home building looks like it grew at a 2.6% rate, which would add 0.1 points to real GDP growth. (2.6 times the 4% residential construction share of GDP equals 0.1).
Government: Only direct government purchases of goods and services (not transfer payments) count when calculating GDP. We estimate these purchases – which represent a 17% share of GDP – were up at a 1.7% rate in Q4, which would add 0.3 points to the GDP growth rate (1.7 times the 17% government purchase share of GDP equals 0.3).
Trade: Looks like the trade deficit shrank in Q4, as both exports and imports declined but imports declined faster. In government accounting, a drop in the trade deficit means faster growth, even if exports and imports both declined. We’re projecting net exports will add 0.3 points to real GDP growth.
Inventories: Inventory accumulation looks like it slowed down in Q4, meaning inventories generally went up, but at a slower pace than in Q3. That translates into what we estimate will be a 0.3 point drag on the growth rate of real GDP. When a recession hits, we expect inventory declines to play a significant role in the drop in GDP.
Add it all up, and we get a 2.1% annual real GDP growth rate for the fourth quarter. If we are right about a recession, this number is likely to go to zero or below sometime in first half of 2024.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Budgets And Governing
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 01/16/2024
The leaders of the House and Senate have come up with a new budget deal, and many people aren’t happy. It still needs passing by January 19th, or else the government, evidently, may shutdown. We doubt that this will happen, but the fight over government spending seems to drag on year after year after year.
It’s not hard to understand why. Non-defense spending by the federal government (including entitlements like Social Security) has climbed dramatically.
In other words, non-defense spending now consumes more than twice as much GDP every year as it did 60 years ago. It’s share of GDP is up 45% from just before the Great Recession, and it’s up 24% from the year before COVID. Government continues to take more and more of what the private sector produces, and it is heading for annual deficits of about $2 trillion.
The Great Recession and COVID were one off-events. Yet somehow, government spending never returned to pre-crisis levels following either. And because politicians have not been punished at the ballots for such unconstrained spending – or the resulting deficits – they have had little incentive to alter course.
This is why budget battles have turned consistently ugly in recent years. Repeated threats to not raise the debt ceiling or shut down the government because a budget can’t be agreed on have become commonplace. An ever- changing mix of politicians who want to see spending controlled face heavy pressure from every direction that they must go along to get along. But they still fight. And fight they should.
Total debt has ballooned at the same time the Fed lifted artificially low interest rates to fight the inflation that poor policies created, causing net interest expenses to skyrocket. In 2020, the net interest expense was $332.6 billion. In the past twelve months, it has totaled $730.4 billion. The Congressional Budget Office expects net interest expenses to rise to above $1 trillion per year after 2028. Lunacy.
While many think all the US has to do is raise tax rates, history suggests eliminating deficits this way is virtually impossible. The last period the budget was balanced was between 1998 and 2001. During those years, tax receipts averaged an all-time record of 19.4% of GDP, while total spending averaged just 18%.
This was the tail end of a miraculous period in modern US history. Starting with Ronald Reagan, and continuing through Bill Clinton, government spending fell as a share of GDP. The less government spends, the more there is left for private sector growth. Economic growth boomed, and that growth boosted tax receipts.
When spending gets too high, economic growth slows, as do tax receipts. Last year, the CBO’s budget forecast overestimated tax receipts by 11%, and underestimated spending by 9%. The bigger government gets, the more likely this happens year after year.
Back in the 1980s and 1990s, when the US was cutting spending, real GDP grew an average of 3.2% per year. In the past two years, in spite of historically large Keynesian deficits, real GDP has averaged just 1.7%.
We understand that the make-up of Congress creates difficulties for those who want to cut spending. But calling them names and accusing them of not being able to govern perpetuates the problem. Out of control spending, and huge deficits as far as the eye can see, are the real failure in governance.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Low Quality Growth
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 01/08/2024
Last Friday’s jobs report showed nonfarm payrolls up 216,000 in December, beating the consensus expected 175,000. Many are arguing that this was a huge number proving that the economy is not going into recession. But digging deeper into the data brings some doubt. In fact, it looks like the US is seeing low quality growth.
For example, yes, nonfarm payrolls came in better than expected in December, but not after adjusting for downward revisions of 71,000 to prior months. These downward revisions have now happened in ten out of the eleven past months. Over the past three months, private payrolls have increased a moderate 115,000 per month, tying for the slowest three-month pace of job gains since the COVID reopening started back in 2020.
What’s more, average hours worked by employees also fell by 0.2% in December. Despite more workers, we worked less in December than we did the month before, which is a headwind to growth. Losing 0.2% total hours of work is the equivalent to losing 228,000 jobs.
More importantly, the kind of jobs being added are of lower quality than we want. In 2023, nearly half of all jobs added were in the government and health care (which is heavily funded by government). Compare this to 2015 - 2019 (before COVID) when these two sectors accounted for a fifth of new jobs added.
Where else is the quality of growth low? Construction. Many people are talking about onshoring as manufacturing comes back to the US. Manufacturing facility construction is up 59.1% from a year ago and up 123.5% from two years ago. But this isn’t all private money. The government is funding many new projects, with the CHIPS Act and Inflation Reduction Act, artificially boosting spending in areas like manufacturing construction. But this deficit spending can’t last forever.
Real (inflation-adjusted) government purchases, which feed directly into the GDP numbers, are up 4.8% in the past year versus an average of 1.0% in the past twenty years. Meanwhile, recent government programs have been structured to multiply private-sector investment in politically-favored sectors, like “clean energy.” That, in turn, helped prop up economic performance last year – pushing out a recession that had looked likely to arrive at some point in 2023. But it’s low-quality growth that comes at a price. In order to spend on government favored projects, we must tax profitable entities in other areas. This redistribution does not add to growth, it just shifts it from one sector to another.
In fiscal year 2023, the U.S. government spent over $6.1 trillion dollars and ran a budget deficit of nearly $1.7 trillion dollars. That is fiscal madness. And it understates the true spending because the government was credited with a $333 billion “negative outlay” when the Supreme Court struck down President Biden’s plan to forgive student loans. Strip that out, and government spending in fiscal year 2023 represented roughly 24.0% of GDP. An incredibly high number for peacetime, especially for an economy that wasn’t in recession and had an unemployment rate below 4.0%.
It's only a matter of time before low quality growth stalls out. There are consequences to taking short term gains rather than fixing structural problems. Just ask California, Illinois, or New York.
In the meantime, the Federal Reserve is tasked with navigating treacherous terrain. Inflation is moderating but is still too high. The Fed’s choice to move from a scarce reserve system to a system of abundant reserves makes battling inflation that much tougher. And they are navigating with blinders on, willfully ignoring changes to the M2 money supply, down 3.0% in the past year.
We haven’t lost faith in the U.S. economy. Far from it. But we need to take an honest view on the sustainability of the current growth. For the sake of future progress, the government needs to stop digging the hole deeper and face issues head on. We will never beat China by trying to be like China. Government can never create wealth in the long run.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
The Housing Outlook: 2024
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 01/02/2024
Just because we still think the economy is headed for a recession, doesn’t mean we think the housing market is going to get killed.
The housing market was a mixed bag in 2023: housing starts and existing home sales were weak, while new home sales and home prices rose, in spite of the highest mortgage rates in twenty years. This year we expect modest gains almost all around: modest gains in housing starts, modest gains in sales, and modest gains in prices.
A recession, by itself, would have a negative effect on housing. But there are so many other factors affecting housing that we think the sector would weather the economic storm.
In terms of construction, builders started fewer homes in 2023 than in 2022, which was already down from the COVID peak in 2021. But builders have been consistently building too few homes since the bursting of the housing bubble about fifteen years ago. As a result, we expect a turnaround in 2024. However, the gains should be concentrated in single-family homes; the number of multi-family homes (think apartments and condos) under construction is at an all-time high already.
In terms of sales, it would be hard for the existing home market to get any worse in 2024. Sales have been handcuffed in 2022-23, for two reasons. First, temporary indigestion as mortgage rates rose. Second, homeowners who borrowed money at rock-bottom mortgage rates in 2020-21 have been very reluctant to sell. Who in their right mind would give up a mortgage with a fixed rate of something like 2.75% locked in for fifteen or even thirty years?
But with each passing year a gradually smaller share of homeowners will be locked in with those rock-bottom mortgage rates. Some of them will move anyhow, for one reason or another. In addition, mortgage rates should be lower this year than in 2023, helping boost sales among some prospective buyers and sellers.
Meanwhile, new home sales were up in 2023 and should continue to grow in 2024. Lower mortgage rates should help a little, as will the construction of more single-family homes.
The biggest surprise in the housing market last year was that prices increased consistently after falling in the second half of 2022. Through the first ten months of 2023, the national Case-Shiller index and the FHFA index were both up roughly 6.0%. We think the continued resilience of home prices largely reflects a lack of supply. However, a faster pace of construction in 2024 should put a ceiling on price gains in the year ahead.
The business cycle hasn’t been normal since COVID hit in 2020. COVID led to a massive surge in government stimulus, both monetary and fiscal, to fight widespread and overly draconian shutdowns. That was followed by tighter money in 2022-23, although government spending has continued to gush. Meanwhile, in certain ways, housing is still recovering from the housing bust that followed the bubble that peaked before the Financial Crisis in 2008-09.
Put it all together and we have a recipe for general improvement in housing even as the rest of the US economy slows down.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
A Mild Recession and S&P 4,500
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 12/26/2023
Very early this year our economics team got a pleasant surprise: Consensus Economics, which collects forecasts from roughly 200 economists around the world, rated us the most accurate forecasters of the United States for 2022, based on our forecasts for GDP and CPI. Unfortunately, we don’t expect a repeat award for 2023.
For 2022, we saw inflation and continued moderate growth. We were right. This past year, in 2023, we anticipated economic weakness late in the year, and put our S&P 500 target at 3,900. Instead, the economy remained resilient and stocks rallied much more than we thought. As we said a year ago: “if it turns out that Chairman Powell and the Federal Reserve have engineered a soft landing – no recession in 2023 and with the market ending 2023 confident of not having a recession in 2024 – then stocks should rally substantially in 2023 and easily beat our S&P 500 target of 3,900.” Today, that’s what most stock market investors are thinking: a soft landing has been achieved and they should therefore be optimistic about the future.
But we don’t think the economy is out of the woods yet. The consensus among economists is now that the economy will continue to grow in 2024, with a soft landing and no recession. We think that’s too bullish and see a mild recession with a -0.5% real GDP print on the way for 2024.
The yield curve has been inverted for more than a year and is likely to remain so well into 2024 and the M2 measure of the money supply is down 3.3% from a year ago, while commercial & industrial loans have also declined. Commercial construction has been temporarily and artificially supported by government subsidies in the past couple of years and should soon start faltering. Payrolls have grown very fast in the past year even with an unusually low unemployment rate, suggesting that businesses have over-hired.
Meanwhile, consumer spending looks set to slow. Government payouts, rent and student loan moratoriums, and temporary tax cuts during COVID led to bloated overall savings for many consumers. In turn, they could relax in 2022-23 and save a smaller part of their ongoing earnings than they normally would. But the artificial boost from these government actions is likely to finally run out in 2024, which suggests to us consumer spending will moderate significantly in 2024.
It's also important to realize how much the federal budget deficit expanded last year. The official deficit was about $1.7 trillion in FY 2023 but would have been $2.0 trillion if it hadn’t been for the Supreme Court striking down much of President Biden’s plan to forgive student loans. But that Court decision didn’t change the government’s cash flow; the Education Department just wrote up the value of its loan portfolio. In other words, the underlying cash flow situation for the federal government was no different than if we had run a deficit of $2.0 trillion, or about 7.4% of GDP. For last year, in FY 2022, excluding the student loan scoring, the deficit was about 4.0% of GDP. That’s a huge one-year spike in the deficit, which temporarily lifted spending.
But this won’t continue. The budget deficit won’t grow again in 2024, given the rally in stocks in 2023, big tax payments are likely due, which takes away this temporary stimulus.
What will happen to inflation? We think it keeps heading down in 2024 and may even finish the year at, or perhaps even temporarily below, the Federal Reserve’s 2.0% target. However, if we do hit 2.0% don’t expect to stay there for long. The Fed is likely to cut rates about as aggressively as the futures market now projects, about 150 basis points in 2024. And, unless the money supply keeps falling, inflation is likely to move back up in 2025 (and beyond); above the Fed’s 2.0% target.
What does this mean for stocks? The good news for stocks is that if the economy is weaker than expected and inflation keeps heading down, long-term interest rates will tend to decline, as well. That’s important because our Capitalized Profits Model takes nationwide profits from the GDP report and discounts them by the 10-year US Treasury yield, to calculate fair value.
If we use a 10-year Treasury yield of 3.50% the model says the S&P 500 is fairly valued, with current profits, at about 4,450. In other words, for the first time in many years, the US stock market is very close to fair value. And, the path of both profits and 10-year Treasury yields, in the next year, is uncertain.
We expect profits to be weaker than the consensus expects in 2024, and with Fed rate cuts of 150 basis points, the 10-year to end the year around 3.5%. Putting this all together, including the fact that the S&P 500 closed on Friday at 4,754, we think it finishes 2024 at 4,500, or lower.
Remember, this is not a trading model, and it doesn’t mean investors should run out and sell all their stocks, it just means investors need to be selective. The past few years have been the most difficult time to forecast in our careers. The US economy has never gone through COVID lockdowns before, plus a reopening, along with such massive peacetime fiscal and monetary stimulus. We understand many think we can do all this with little, or no, significant impact on the economy. We don’t believe this conventional wisdom. 2024 will be a tough year.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Greedy Innkeeper or Generous Capitalist?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 12/18/2023
The Bible story of the virgin birth is at the center of much of the holiday cheer this time of year. The book of Luke tells us that Mary and Joseph traveled to Bethlehem because Caesar Augustus decreed a census should be taken. Mary gave birth after arriving in Bethlehem and placed baby Jesus in a manger because there was “no room for them in the inn.”
Some people think Mary and Joseph were mistreated by a greedy innkeeper, who only cared about profits and decided the couple was not “worth” his normal accommodations. This version of the story (narrative) has been repeated many times in plays, skits, and sermons. It fits an anti-capitalist mentality that paints business owners as greedy, or even evil.
It persists even though the Bible records no complaints and there was apparently no charge for the stable. It may be the stable was the only place available. Bethlehem was over-crowded with people forced to return to their ancestral home for a census – ordered by the Romans – for the purpose of levying taxes. If there was a problem, it was due to unintended consequences of government policy. In this narrative, the government caused the problem.
The innkeeper was generous to a fault – a hero even. He was over-booked, but he charitably offered his stable, a facility he built with unknowing foresight. The innkeeper was willing and able to offer this facility even as government officials, who ordered and administered the census, slept in their own beds with little care for the well-being of those who had to travel regardless of their difficult life circumstances.
If you must find “evil” in either of these narratives, remember that evil is ultimately perpetrated by individuals, not the institutions in which they operate. And this is why it’s important to favor economic and political systems that limit the use and abuse of power over others. In the story of baby Jesus, a government law that requires innkeepers to always have extra rooms, or to take in anyone who asks, would “fix” the problem.
But these laws would also have unintended consequences. Fewer investors would back hotels because the cost of the regulations would reduce returns on investment. A hotel big enough to handle the rare census would be way too big in normal times. Even a bed and breakfast would face the potential of being sued. There would be fewer hotel rooms, prices would rise, and innkeepers would once again be called greedy. And if history is our guide, government would chastise them for price-gouging and then try to regulate prices.
This does not mean free markets are perfect or create utopia; they aren’t and they don’t. But businesses can’t force you to buy a service or product. You have a choice – even if it’s not exactly what you want. And good business people try to make you happy in creative and industrious ways.
Government doesn’t always care. In fact, if you happen to live in North Korea or Cuba, and are not happy about the way things are going, you can’t leave. And just in case you try, armed guards will help you think things through.
This is why the Framers of the US Constitution made sure there were “checks and balances” in our system of government. These checks and balances don’t always lead to good outcomes; we can think of many times when some wanted to ignore these safeguards. But, over time, the checks and balances help prevent the kinds of despotism we’ve seen develop elsewhere.
Neither free market capitalism, nor the checks and balances of the Constitution are the equivalent of having a true Savior. But they should give us all hope that the future will be brighter than many seem to think.
(We’ve published a version of this same Monday Morning Outlook during Christmas week, each year, since 2009.)
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
What Should the Fed Do? How About Nothing?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 12/11/2023
For the first time in roughly fifteen years, interest rates in the United States are about right. In economics, we call it the “neutral” or “natural” rate. The Taylor Rule says rates should be higher, and our model that uses nominal GDP growth (real GDP plus inflation) says the same thing. But both these models rely on data that is still distorted by COVID.
A simpler approach is to assume interest rates should be “Inflation Plus.” If we judge current inflation using an average of the Cleveland Median CPI (up 5.3% from a year ago) and overall total CPI (up 3.2% from a year ago) we get 4.2%. “Plus 1%” says rates should be roughly 5.2%. And that’s almost exactly where the federal funds rate is today.
This is a big change. Between 2008 and today, the Federal Reserve held the funds rate below inflation roughly 83% of the time. These excessively low rates have created problems.
Banks have hundreds of billions of dollars of mark-to-market losses and government-funded green new deal projects are facing serious problems because they are not profitable at current neutral interest rates. In other words, holding rates down artificially, like the Fed did for years, may make things look OK, but it can’t last forever.
At the same time, the Fed grew the M2 measure of money so rapidly in 2020-21 that inflation was easy to see coming. But now the M2 measure of money is contracting. So, with money contracting and interest rates near normal, it seems appropriate to pause. Especially given the fact that tighter money seems to be helping inflation come back down from its post COVID spike.
But it is certainly not time to claim victory and return to an environment of artificially low rates. That would risk repeating the 1970s, when Arthur Burns cut rates before eradicating inflation. If, as we suspect, the US economy enters recession in 2024, the political pressure on the Fed to cut rates and restart QE will be intense. But it would be a big mistake unless inflation continues to fall and thereby reduce the “neutral” interest rate. All it would do is continue the mistakes of the past fifteen years.
One interesting thing we have observed is how much bank regulators, Fed members, and Treasury officials have shifted their thinking. Back in 2008, Hank Paulson, Ben Bernanke and Sheila Bair religiously adhered to mark-to-market (MTM) accounting. We still blame this accounting convention for the financial panic that ensued. But that panic was used to justify growing the Fed’s balance sheet by trillions of dollars with QE and supporting TARP, which grew the size of the federal government.
These policies were supposed to make the US financial system safer, but they didn’t. Because the Fed became so powerful and flooded the banking system with deposits (at artificially low rates), bank balance sheets now have an estimated $675 billion in losses on them.
Interestingly (and thankfully) banks don’t have to mark these assets to market anymore. It would wipe out almost a third of bank capital. But what happened to all these MTM believers? Did they only believe in MTM accounting when they could blame it on banks? Now that it is clear the Fed’s policies caused the losses, are they trying to avoid blame?
The bottom line is that those who think the Fed can just manage its way out this easily, cutting rates to offset the pain of recession (or avoid one entirely), may not be correct. Many seem to have submitted to “state-run capitalism.” But history shows it has never really worked. The Fed is likely to “do nothing” this week and holding that position in 2024 might not be a bad thing.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Disinflation, Not Deflation
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 12/04/2023
New home prices are much lower than a year ago. The average price of a new home sold in October was 10.4% lower, while the median price was down 17.6%.
Records on new home prices go back all the way to the Kennedy Administration and never before has the median new home price dropped so much in twelve months, even during the bursting of the housing bubble in 2007-11. Is this a signal that monetary policy has become excruciatingly tight, that deflation – an outright and generalized drop in consumer prices – is about to grip the US economy?
Hardly.
In fact, deflation doesn’t even have a grip on the housing market. New home prices only include the prices for the new homes sold each month, which in the past year has averaged about 55,000 per month. That’s out of a total housing stock of about 145 million homes. In other words, new home prices reflect what’s going on each month with only about 0.04% of all homes.
Another big problem with just looking at prices for new homes sold is that those sold in October 2023 might be very different in size and quality than the new homes sold a year ago. Mortgage rates are higher, so many new home buyers are cropping their appetites, buying smaller homes to reduce their projected future mortgage payments. And builders are reacting to this, building smaller, less expensive homes. As a result, the average and median prices are falling, but not the price per square foot.
Better gauges of national home prices include the Case-Shiller index and the FHFA index, which are designed to adjust for the quality of homes. They also attempt to track the sales price of the same homes over time. These two indexes show home prices up 3.9% and 6.0% in the past year, respectively. In other words, no deflation. Home prices are not really falling.
And, when politics gets involved with economic data, confusion is often the result. When you hear that “inflation is falling” what that means is that prices are still rising, just not as fast as they were a year ago. The PCE price index, the Fed’s favorite measure for inflation, is up 3.0% in the past year versus a gain of 6.3% in the year ending in October 2022. Core PCE prices, which exclude food and energy, are up 3.5% in the past year versus a gain of 5.3% in the year ending in October 2022.
We expect this process to continue, with consumer prices climbing, but at a slower pace. Yes, they might fall in a particular month when energy prices drop, but even in those months core prices will continue to rise.
It’s important to remember that although the M2 measure of the money supply is down 4.5% from the peak in July 2022, that follows the surge of 40% that preceded it. That huge increase is still wending its way into the economy, and it would be crazy to try to take all that money back out. That would cause a massive deflationary problem. As a result, the general price level is permanently higher than the path it was on pre-COVID.
The bottom line is that the stance of monetary policy is tight enough to keep bringing inflation down in 2024. But don’t expect it to stay there so long that general prices start consistently falling. At present, the futures market is pricing in a drop in short-term interest rates of about 1.25 percentage points. We think the rate cuts will be steeper, the front edge of a shift in policy that will eventually cause an echo of the 2021-23 inflation problem in the years ahead. Unfortunately, like the 1970s.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Argentina: Is the Pendulum Swinging, Again?
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 11/27/2023
When Argentina entered the 20th Century, its prospects looked bright. On a per person basis, its economy was on par with Canada and Sweden and about two-thirds of the United States.
This all changed in 1946 when the country elected Juan Peron to the presidency. Peron launched plans to foster social justice through economic redistribution. The government sector grew rapidly (spending and money printing) and very high inflation (300%+) became the norm. Standards of living plummeted.
Without a change in policies, inflation could not be eradicated. Then, in the 1990s, Argentina tried a currency board arrangement where each Argentine peso was backed by one American dollar. Like the old-fashioned gold standard before the creation of the Federal Reserve, each unit of Argentine currency was backed by something that held its value. That currency board system worked for about a decade, bringing inflation down to US levels and spurring a decade of solid economic growth.
However, it broke down in 2001-02, largely because government spending never really subsided. When the government couldn’t print new money, it borrowed. Investors (correctly) thought politicians would abandon the currency board and let the value of the peso fall at the first sign of economic trouble. And that’s exactly what happened.
Now Argentina finds itself with another lost decade of growth and hyper-inflation. Recently, Argentina’s per person GDP stood less than 20% of US levels, and below even Russia.
But last month brought a political earthquake: the presidential election was won in a landslide by Javier Milei, a libertarian economist, and an unbridled and outspoken critic of socialism and supporter of free-market capitalism.
Milei wants to end the Argentine peso and central bank completely and just use the US dollar as the country’s currency. That way, re-introducing the peso would be very hard, so Argentines could be confident the government wouldn’t devalue again. He wants to slash government spending, including spending on the social safety net and get rid of lots of government agencies.
Unfortunately, he has his work cut out for him. Although he’s popular with voters he doesn’t come from a political party with widespread support in the legislative branch. As a result, it remains to be seen how much Milei can accomplish.
And yet this isn’t the only big shift at the polls in recent months, with voters in New Zealand and the Netherlands swinging toward leaders seeking some major changes.
The long historic battle between those who support wealth creation and those who support wealth redistribution, continues. The pendulum is starting to swing. We think much of this recent pattern is due to voters getting fed up with governments that are too big. Even the election of Geert Wilders in the Netherlands, ostensibly about immigration has a big government component, due to taxpayer-funded resources that, right or wrong, voters think recent immigrants’ demand.
When governments are already very large, and inflation rises while growth suffers, it’s harder for the left to make bigger government appealing to voters, and easier for the right to make trimming government look attractive.
The pendulum is swinging toward smaller government. If leaders fulfill this desire, investors around the globe will have reason to cheer. While Argentina has followed a different rhythm than many Western countries, the elections of Margaret Thatcher and Ronald Reagan changed the direction of global economic growth. Is it happening again?
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Consumer Spending Set for Slower Growth
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 11/20/2023
Now that we’re about to enter the Christmas shopping season, expect even more focus than usual on the consumer over the next several weeks.
We are supply-siders and so usually cringe when we hear analysts and investors dwell on consumption as if it were the ultimate arbiter of economic growth. Ultimately the economy depends on production, which, in turn, hinges on entrepreneurship and innovation, the labor supply, as well as the health of cultural institutions like property rights and freedom of contract.
The government can affect these factors by raising or reducing tax rates, increasing or lowering spending, and adding or cutting regulations. Meanwhile, monetary policy can lead to temporary deviations from these long-run factors, with a policy that raises or reduces inflation.
On top of all this, the wild policy response to COVID – with enormous government checks sent directly to bank accounts – left consumers with more purchasing power than they’d normally have, given output. In turn, that has meant following the consumer is one way to gauge the extra inflationary impulse still remaining in the US economy, as well as the timing of the onset of the tighter monetary policy – the M2 measure of the money supply has dropped 4.4% – that the Federal Reserve began implementing last year.
In the year ending in September, “real” (inflation-adjusted) consumer spending is up 2.4%, no different than the growth rate in the ten years immediately prior to the onset of COVID. However, there are multiple reasons to believe that growth rate should soon decline.
First, much of the increase in spending in the past year has been driven by increases in jobs. Total payrolls are up 243,000 per month in the last year, which is unusually fast given an unemployment rate below 4.0%. A slowdown in job growth should limit the growth in consumer purchasing power.
Meanwhile, consumers have been eating into the excess saving they were able to accumulate during COVID, back when the government was passing out checks with reckless abandon. Immediately prior to COVID, in February 2020, US consumers, in the aggregate, were accumulating savings at a $1.28 trillion annual rate. That’s personal income, minus taxes, minus consumer spending. By contrast, in September 2023, consumers were saving at a $690 billion annual rate.
For the time being, accumulating savings at a slower rate makes sense; the government showered consumers with checks during COVID and so they got used to not having to save for themselves. But eventually we expect that old pace of saving to reassert itself. Even if it takes two years to do so, an increase in the pace of saving back to $1.28 trillion per year should trim consumer spending by about 1.5 percentage points per year. That alone could take a pace of real consumer spending growth of 2.4% per year down to less than 1.0% per year. Ouch!
Then there are student loan payments that have finally re-started. By itself, that’s unlikely to be a major issue; we estimate the effect at about 0.2% of consumer spending. But it should be a small headwind.
None of this means that consumer spending has to plummet anytime soon. But we don’t need consumer spending to drop in order to have a recession. That’s what happened in 2001, for example, when real consumer spending rose a respectable 2.0%, while the unemployment rate rose almost two percentage points, as well.
Some economists are already taking a victory lap because they didn’t forecast a recession and a recession hasn’t started yet. But we think they’re declaring victory too early. Some of them say that we never should have been worried about a recession while inflation fell because the surge in inflation was due to supply-chain issues, and then the reduction in inflation has been due to fixing those issues.
The problem with their theory is that they ignore the link between the surge in the money supply in 2020-21 and the inflation that followed, as well as the drop in money and the reduction in inflation this year. They think it’s a coincidence, but we think they’re going to get a rude awakening in the year ahead.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
The Election Outlook is a Tax Outlook
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 11/13/2023
We’re now less than a year away from a presidential election and control of the White House, Senate, and House are all up for grabs. One of the biggest issues facing the winners is going to be how to handle the federal budget.
As we set out a couple of months ago, the US is currently running the most reckless budget in the history of the country. Never before has the deficit soared so quickly to such a high level when the US is still at peace and not in recession.
No wonder Moody’s just announced it was downgrading the outlook for US debt to “negative” from “stable.” They claim it’s because of political “polarization” on top of the deficit itself, but that seems odd. Moody’s makes it sound like we’d be better off if no one on Capitol Hill cared at all about the deficit, because then our institutions wouldn’t be polarized! The way we see it, thank goodness there are some politicians focused on the deficit, even if that’s what’s causing more polarization.
For the presidency, we think 2024 is likely to be a rerun of 2020, Biden versus Trump, although retiring Senator Joe Manchin may throw a monkey-wrench into the election if he can find a Republican to run with. At this point, we think Trump would be a slight favorite; but will face constant challenge given how much of the electorate dislikes him. Meanwhile, the House of Representatives is likely (but not definitely) going to go to the party that wins the White House.
The Senate is an easier call, with the GOP in excellent political position to win for fundamental reasons. At present the GOP has 49 seats. But Republicans don’t have to defend any seats in blue (Democratic) states and only have to defend one seat in a purple state, Florida, which is very unlikely to suddenly lurch back toward the Democrats, given the recent popularity of Republican governance in that particular state. In other words, we do not see a route for the Democrats to win any seats now held by the GOP.
However, there are multiple seats where the Democrats are vulnerable. Now that Joe Manchin is retiring, it’s extremely likely that the GOP picks up West Virginia with popular Governor Jim Justice having thrown his hat in the ring. Republicans are also favored to knock off an incumbent Democrat in Ohio, plus have a shot in Montana as well as in Arizona, and Nevada.
In turn, the election will have a major influence on what happens to the Trump tax cuts originally enacted in 2017 and which are set to expire at the end of 2025. We think the odds of a GOP sweep are about 30%, which would probably result in a full extension of those tax cuts and the GOP pushing through substantial reforms to Medicaid as well as major budget cuts outside of national defense. If the Democrats sweep – we put those odds at about 20% – look for substantial tax hikes, on individuals and businesses, alike, and not just on the “rich.”
That leaves a 50% chance of mixed government, in which case expect modest tax hikes, with a slightly higher top rate for individuals, a slightly higher rate on companies, but with lots of talk and little action on cutting government down to size. And without spending cuts, expect negative outlooks to turn into outright and deserved downgrades in the years ahead.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Government Is Too Darn Big
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 11/06/2023
Two weeks ago, the yield on the 10-year Treasury Note was hovering around 5%, and the S&P 500 was in contraction territory, down over 10%. But last week, the 10-year yield dipped to 4.6%, while the S&P 500 saw a 6% gain. This market volatility is attributed to changing sentiments: 1) There was a belief that the Federal Reserve had lost control, but now, 2) it seems the Fed has achieved a "soft landing," bringing a semblance of stability.
While this may hold some truth, we remain cautious. If we step back and look at the US economy from a distance, things don’t really look so great. Our worries have roots all the way back in 2008, when the Fed altered its approach to monetary policy. The Fed shifted from a "scarce reserve" model to an "abundant reserve" model when it initiated Quantitative Easing, fundamentally changing how interest rates are determined.
In the past, banks occasionally lacked the reserves they were legally required to hold, prompting them to borrow from other banks with excess reserves through their federal funds trading desks, thus determining the federal funds rate through an active market. Today, banks are flush with trillions of excess reserves, eliminating the need for borrowing and lending reserves. Consequently, the federal funds trading desk has become obsolete.
So…if banks are not creating a market for federal funds, were does the rate come from? The answer: the Fed just makes it up. Literally makes it up. And, over the past fifteen years, the Fed has held the funds rate below inflation 83% of the time.
The last time the Fed kept rates artificially low was in the 1970s. The result was inflation, but even more importantly, banks and Savings & Loans lent at rates lower than they should have. The ultimate result was the dramatic downfall of the S&L industry, along with many banks, as the losses incurred from offering high interest rates to depositors while getting low rates from borrowers steadily eroded their capital.
Today, US commercial banks carry an estimated $650 billion loss in their “held to maturity” assets…but they don’t have to mark them to market. Just imagine if this was 2008 and Treasury Secretary Hank Paulson, Fed Chair Ben Bernanke and FDIC Chair Sheila Bair were in charge. They would have insisted on mark-to-market and we would need TARP 2.0 to bail out the banking system.
What the Fed will do is pay these private banks and other institutions roughly $300 billion this year just to hold reserves. Without this payment from the Fed to the banks, profits would be much lower and the losses on their books would be more painful.
The point we are making is that the Fed has made a mess of the banking system. While we've averted major crises thus far, it's the taxpayers who ultimately bear the burden. The $300 billion the Fed pays to banks doesn't appear out of thin air, and unless interest rates decrease significantly, these losses will accumulate. Why isn’t Elizabeth Warren fuming over this?
Like the 1970s and 1980s – because we don’t have mark-to-market accounting on these held-to-maturity assets – the banks can eventually earn their way out of this abyss. So, this doesn’t mean the economy will suffer, other than the fact that banks have less ability to make new loans.
This is exacerbated by the Fed engineering a decline in the M2 measure of money, which has fallen by 3.6% in the past year, the most substantial drop since the Great Depression.
Some of this decline is because since 2008 the Treasury Department has started holding a great deal of cash in its checking account at the Fed. For decades it held just $5 billion as a cash management tool. This number soared after QE started, and as of November 1, 2023, the Treasury General Account (TGA) at the Fed held $820 billion. This money is part of the Fed’s balance sheet, but does not count as M2. So, when the Treasury borrows from, or taxes the private sector, and then puts that money aside in its own TGA, it will lower M2. In other words, the Treasury has helped engineer a decline in M2. The Treasury could use this $820 billion to reduce debt, but it hasn’t, and taxpayers will pay roughly $40 billion per year in interest, just so the Treasury/Fed can hold this cash.
This new method of managing monetary policy appears fraught with risks. Instead of stabilizing banks, it has introduced instability, proved costly to taxpayers, and contributed to the worst inflation since the 1970s.
We aren’t saying that the economy can’t survive, but the idea that everything will turn out perfectly seems like wishful thinking. The government has expanded significantly since 2008, with federal government spending growing from 19% of GDP in 2007 to 25% last year, and the Fed's balance sheet has expanded from 6% of GDP in 2007 to 33% of GDP.
It's evident that we no longer operate in a free-market capitalist system. While government involvement in the economy is not new, it has reached unprecedented levels.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
It’s the Same Bear Market
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 10/30/2023
The S&P 500 closed at 4,117 on Friday, more than 10% below its recent peak in late July. Some are saying it’s a brand-new bear market for stocks. In this view there was a bear market in 2022, a bull market from October 2022 through July this year, and a new bear market that started in August.
We don’t think this is the appropriate way to look at things. This is not a new bear market. Instead, it’s the same bear market. We had a bear market in 2022, a temporary rally, and then the bear market reasserted itself.
The driving forces behind the ongoing bear market have not changed. Federal policy of easy money and extremely loose fiscal policy during COVID kept a serious recession at bay. That is basically over now. The M2 measure of money is down 3.6% in the past twelve months. Second, the massive episodes of COVID-era government spending/stimulus had to eventually wear off, which is revealing lots of malinvestment and now generating economic headwinds.
We think much of the headwinds from these shifts are still in front of us. Yes, the economy grew at a rapid pace in the third quarter but that includes contributions from consumer spending and inventory accumulation that were unsustainably hot. Meanwhile, business investment should slow as companies can earn robust returns by hoarding cash with little to no credit risk. Speaking of interest rates, they are now above inflation across the yield curve. The artificial boost from artificially low rates is gone.
This is why we remain bearish. At the end of last year we forecast that the S&P 500 would finish 2023 at 3,900 and we haven’t budged since, remaining bearish throughout the rally that took the S&P 500 all the way up to 4,600 this summer.
It hasn’t been easy taking this position. Equities tend to trend upward over long periods of time, as the real economy and profits tend to grow, and the price level rises, as well. We still believe the US future is relatively bright: entrepreneurs are still creating and innovating, and artificial intelligence shows great promise. We are also hopeful that sometime in the next few decades there will be major technology breakthrough in the energy sector. Our natural tendency is toward bullishness.
Clearly, we are not “permabulls” and never have been. From 2009, all the way through 2021 we remained bullish. We didn’t run with the herd of other forecasters worried that the world had come to an end in 2008. And, while we are bearish today, we don’t think it’s the end of the world now.
Eventually, stock prices will reflect fair value. More importantly, we expect the political pendulum to swing back toward the center. Big government directed economies eventually suffer…then recover when policy shifts back.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
Growth Surge in Q3 Masks Weak Trend
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 10/23/2023
We still think a recession is coming, but it definitely didn’t start in the third quarter. Instead, as we set out below, it looks like real GDP expanded at a 4.7% annual rate. If we are right about that number, that would be the fastest pace of growth for any quarter since 2014, with the exception of the re-openings from COVID in 2020-21.
Keep in mind, though that even with growth that fast, the growth rate since the end of 2019 – the pre-COVID peak – would be only 1.9% per year, reflecting an underlying trend that is still slow.
Why do we still think a recession is coming? Because after the surge in money creation in 2020-21, monetary policy started getting tight in 2022. In the past year the M2 measure of the money supply is down 3.7%. Meanwhile the yield curve (we like to compare the 10-year Treasury yield to the target federal funds rate) has been inverted since late 2022 and is likely to stay that way for at least the next several months.
Higher short-term interest rates mean businesses have the ability to lock in healthy nominal returns on cash with minimal risk. In turn, this should lead to a reduction in risk-taking and business investment.
Meanwhile, jobs are still expanding rapidly. Payrolls are up 2.1% in the past year. During the economic expansion that happened before COVID (mid-2009 through early 2020), a pace that fast (2.1% or more) only happened when the unemployment rate was about 5.5%, which meant plenty of workers still available for hire. Now it’s happening when the unemployment rate is less than 4.0%. This suggests employers are out over their skis and vulnerable to any softness in demand.
The bottom line is that the economy grew rapidly in Q3 but Q4 and beyond are likely to be much slower.
Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector rose at a 3.7% annual rate in Q3 while it looks like real services, which makes up most of consumer spending, should be up at about a 4.0% pace. The one weak spot was autos and light trucks, which declined at a 2.5% rate. Putting it all together, we estimate that real consumer spending on goods and services, combined, increased at a strong 4.1% rate, adding 2.8 points to the real GDP growth rate (4.1 times the consumption share of GDP, which is 68%, equals 2.8).
Business Investment: We estimate a 4.5% growth rate for business investment, with gains in intellectual property and equipment leading the way while commercial construction was roughly unchanged. A 4.5% growth rate would add 0.6 points to real GDP growth. (4.5 times the 14% business investment share of GDP equals 0.6).
Home Building: Residential construction is showing some resilience in spite of some lingering pain from higher mortgage rates. Home building looks like it grew at a 7.5% rate, which would add 0.3 points from real GDP growth. (7.5 times the 4% residential construction share of GDP equals 0.3).
Government: Only direct government purchases of goods and services (not transfer payments) count when calculating GDP. We estimate these purchases – which represent a 17% share of GDP – were up at a 1.8% rate in Q3, which would add 0.3 points to the GDP growth rate (1.8 times the 17% government purchase share of GDP equals 0.3).
Trade: Looks like the trade deficit shrank in Q3, as exports expended rapidly in spite of foreign economic weakness. We’re projecting net exports will add 0.5 points to real GDP growth.
Inventories: Inventories look like they grew a little bit faster in Q3 than in Q2, suggesting they’ll add about 0.2 points to the growth rate of real GDP. When a recession hits, we expect inventory declines to play a significant role in the drop in GDP.
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is 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.
First Trust Advisors L.P., is not affiliated with Dowd Financial Group, Inc., and Grove Point Financial, LLC or its subsidiaries.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to hold, purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. Performance of an index is not illustrative of any particular investment and performance figures quoted are historical. It is not possible to invest directly in an index.
