Category Archives: Economy

Don’t Fear Higher Interest Rates

Here’s some weekly commentary from Brian Wesbury of First Trust 

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

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

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

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

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

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

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

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

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

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

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

 

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Consuming doesn’t produce wealth, production does.

Our favorite economist, Brian Wesbury of First Trust just published and article discussing the Christmas shopping season and “Consumer Fundamentals.”  We changed his headline because there is something fundamentally more important in his comments, and it’s this:  consuming doesn’t make people wealthy, producing does.  No one ever got rich by sitting around consuming; people producing stuff is what makes communities, nations and cultures rich.

Now on to Brian’s commentary on the economy:

Now that Black Friday has come and gone and Cyber Monday is upon us, you’re going to hear a blizzard of numbers and reports about the US consumer. So far, these numbers show blowout on-line sales and a mild decline in foot traffic at brick-and-mortar stores. Both are better than expected given the ongoing transformation of the retail sector.

But Black Friday isn’t all that it used to be. Sales are starting earlier in November and have become more spread out over the full Christmas shopping season, so the facts and figures we hear about sales over the past several days are not quite as important as they were in previous years. Add to that the fact that this year’s shopping season is longer than usual due to an early Thanksgiving holiday.

But all this focus on the consumer is a mistake. It’s backward thinking. We think the supply side – innovators, entrepreneurs, and workers, combined – generates the material wealth that makes consumer demand possible in the first place. The reason we produce is so we can consume. Consuming doesn’t produce wealth, production does.

Either way, we expect very good sales for November and December combined. Payrolls are up 2 million from a year ago. Meanwhile, total earnings by workers (excluding irregular bonuses/commissions as well as fringe benefits) are up 4.1%.

Some will dismiss the growth as “the rich getting richer,” but the facts say otherwise. Usual weekly earnings for full-time workers at the bottom 10% are up 4.6% versus a year ago; earnings for those at the bottom 25% are up 5.3% from a year ago. By contrast, usual weekly earnings for the median worker are up 3.9% while earnings for those at the top 25% and top 10% are up less than 2%.

Yes, that’s right, incomes are growing faster at the bottom of the income spectrum than at the top. A higher economic tide is lifting all boats and helping those with the smallest boats the most. This is not a recipe for stagnating sales.

And so the voices of pessimism have had to pivot their story lately. Just a short while ago, they were still saying the economy really wasn’t improving at all. Now some are saying it’s a consumer debt-fueled bubble.

It is true that total household debt is at a new record high. But debts relative to assets are much lower than before the Great Recession. Debts were 19.4% of household assets when Lehman Brothers went bust; now they’re 13.7%, one of the lowest levels in the past generation. Meanwhile, for the past four years the financial obligations ratio – debt payments plus the cost of car leases, rents, and other monthly payments relative to incomes – has been hovering near the lowest levels since the early 1980s.

Yes, auto and student loan delinquencies are rising. But total serious (90+ day) delinquencies, including not only autos and student loans, but also mortgages, home equity loans, and credit cards are down 61% from the peak in 2010.

The bottom line is that investors should be less worried about consumer debt today than at any time in recent decades. Some think this could change if the Fed continues to raise interest rates, while selling off its bond portfolio. But interest rates are still well below normal levels and the U.S. banking system is sitting on trillions in excess reserves.

The US economy is less leveraged and looking better in recent quarters than it has in years. And better tax and regulatory policies are on the way. The Plow Horse is picking up its pace and consumer spending is in great shape.

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The Economy is Accelerating

Economic commentary from Brian Wesbury, Chief Economist at First Trust

The Economy is Accelerating

We’ve called it a “Plow Horse” economy, which was our metaphor invented to counter forecasters who said slow growth meant a recession was on its way. A Plow Horse is always slow, but that slowness hides underlying strength – it was never going to slip and fall. Now, the economy is accelerating.

Halfway through the fourth quarter, monthly data releases show real GDP growing at a 3%+ annual rate. If that holds, it would make for three consecutive quarters of growth at 3% or higher. Believe it or not, the last time that happened was 2004.

Last week saw retail sales, industrial production, and housing starts all come in better than expected for October, the latter two substantially better.

And while retail sales grew “just” 0.2% in October, that came on the back of a 1.9% surge in September. Overall sales, and those excluding volatile components like autos, gas and building materials, all signal a robust consumer.

Meanwhile factory output surged 1.3% in October, tying the second highest monthly gain since 2010. Production at factories is now up 2.5% from a year ago, and accelerating. By contrast, factory production was down 0.1% in the year ending October 2016 and unchanged in the year ending October 2015. The current revival is not due to the volatile auto sector, where output of motor vehicles is down 5.9% from a year ago while the production of auto parts is down 0.3%.

The last piece of last week’s good economic news was on home building: housing starts surged after a storm-related lull in September. Single-family starts, which are more stable than multi-family starts – and add more per unit to GDP – tied the highest level since 2007. Housing completions hit the highest level since 2008.

As a result of all this data, the Atlanta Fed’s “GDP Now” model says real GDP is growing at a 3.4% annual rate in Q4. The New York Fed’s “Nowcast” says 3.8%.

Of course, if we get anything close to those numbers, some analysts will claim the fourth quarter is just a hurricane-related rebound. But the conventional wisdom has been way too bearish for years, and Q3 is likely to be revised up to a 3.4% growth rate from the original estimate of 3.0%. Put it all together, and things are looking up. It’s no longer a Plow Horse economy. In fact, after years of smothering the growth potential of amazing new technologies, the government is finally getting out of the way.

The Obama and Bush regulatory State is being dismantled piece by piece, and spending growth has slowed relative to GDP. Tax cuts are moving through Congress. These positive developments have monetary velocity – the speed at which money moves through the economy – picking up. “Animal spirits” are stirring. We don’t have a cute name for it, but growth is accelerating.

This reduction in the burden of government would be easier, and much more focused on growth, if Republicans had fixed the budget scorekeeping process when they first had the chance back in 2015, or even in the mid-1990s, after having gained control of both the House and Senate.

Instead, they took a cowardly pass. As a result, when assessing the “cost” of tax cuts, Congress still ignores the positive economic effects of tax cuts on growth. Oddly, while refusing to “score” better GDP growth, we understand the budget scorekeepers assume tax cuts lead to higher interest rates, which add to the cost of the tax cuts. In effect, the scorekeepers will use dynamic models to count the negative effects of tax cuts on the overall economy, but not the positive ones!

This kind of rigged scoring system is why the current tax proposals don’t cut tax rates on dividends or capital gains, and why some of the tax cuts are temporary. It’s also why the top tax rate on regular income for the highest earners is likely to end up near the current tax rate of 39.6%.

We were never satisfied with Plow Horse growth, but we always thought it showed the power of innovation. The power of new technology caused the economy to grow since 2009, despite the burden of big government.

Now with better policies, growth is on the rise. We haven’t fixed enough problems to get 3% real growth in every quarter, and maybe not even as the average growth rate over time. That would probably take some major changes to entitlement spending programs. But the recent improvement is hard to miss and signals that entrepreneurship is alive and well in the United States.

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Can We Afford a Tax Cut?

 

Taxes Image

 

Our favorite economist, Brian Wesbury of First Trust says “yes.”:

Congress took a big step last week toward enacting some sort of tax cuts and tax reform.

That big step was the US Senate passing a budget resolution creating the room for ten years of tax cuts totaling $1.5 trillion with a simple majority vote. This procedure means there is no need to break a filibuster by getting to 60 votes.

So right about now is when self-styled “deficit hawks” will start to squawk. They will claim the federal government simply can’t afford to boost the federal debt, which already exceeds $20 trillion, with no end in sight.

Let’s put aside the issue that between 2009-12 many of these deficit hawks were supporting new spending, when annual federal deficits were $1 trillion plus. Let’s just take them at their word that they don’t think any policy that increases the deficit can be good for the economy.

One problem with their argument is that the $1.5 trillion is an increase in projected deficits over a span of ten years, not a definite increase in the debt. If tax reform focuses on cutting marginal tax rates, particularly on overtaxed corporate capital and personal incomes, and can thereby generate faster economic growth, the actual loss of revenue could be substantially less than $1.5 trillion or maybe nothing at all.

The estimate of a $1.5 trillion revenue loss is based on “static” scoring, which means the budget scorekeepers on Capitol Hill make the ridiculous assumption that changes in tax policy can’t affect the growth rate of the overall economy. Just a 1 percentage point increase in the average economic growth rate over the next ten years would reduce the deficit by $2.7 trillion, easily offsetting the supposed cost of the tax cut.

Another problem for the deficit hawks is that despite a record high federal debt, the servicing cost of the debt is still low relative to both the size of the economy and federal revenue.

Late last week, we got final numbers for Fiscal Year 2017 and net interest on the national debt was $263 billion – that’s just 1.4% of fiscal year GDP. To put that in perspective, that’s lower than it ever was from 1974 to 2002. The peak during that era was 3.2% of GDP in 1991. The lowest point since 1974 was 1.2% in 2015, not far from where we are today.

The same is true for interest relative to federal revenue, which was 7.9% in Fiscal Year 2017, lower than any year from 1974 to 2013. The high point during that era was 18.4% in 1991 and the recent low was 6.9% in 2015. Again, we’re still pretty close to the recent low.

Yes, interest rates should move up in the years to come, but it will take several years to rollover the debt at higher interest-rate levels. Even if interest rates went to 4% across the entire yield curve, the interest burden would remain below historical peak levels relative to GDP and tax revenue.

The US certainly has serious long-term fiscal challenges. The US government has over-promised future generations of retirees and should ratchet back these spending promises to encourage work, saving, and investment. Meanwhile, we need the US Treasury Department to issue longer-dated maturities like 50-year and 100-year debt to lock-in low interest rates for longer.

However, the absence of these changes should not be an obstacle to boosting economic growth by cutting tax rates and reforming the tax code. Plow Horse economic growth is certainly better than no growth at all, but turning the economy into a thoroughbred would make it easier to handle our long-term budget challenges, not harder.

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Foreign markets are soaring

The US markets are reaching new highs daily and many investors are happy with the returns their portfolios have generated.  According to the Wall Street Journal the S&P 500 is up 13.9% year-to-date.

 But some foreign markets are doing even better.

For example, the Hang Seng (Hong Kong) index is up 29.4%.

Chile is up 28%

Brazil up 27.3%

South Korea up 22.1%

Italy up 16.4%

Taiwan up 15.8%

Singapore up 14.7%

As part of our asset allocation strategy we always include a foreign component in our diversified portfolios.  Over long periods of time international diversification has had a positive effect on portfolio performance.  That’s because the US economy is mature.  It’s harder to generate the kind of economic growth that smaller, newer, and less developed economies can generate.

There is, however, a level of risk as well as reward to global diversification.  It’s said that when the US catches a cold, foreign markets get pneumonia.

The U.K. market is up only 5.8% this year, Shanghai +9.1%, Mexico +9.5%, Japan +9.6% and France +10.3%.  It’s difficult for the average investor to do the research to pick and choose their own foreign stocks.  So it’s even more important when investing overseas to use experienced portfolio managers with years of experience and an established track record.

We have done the research and we choose the best mutual funds with experienced managers to give our clients exposure to foreign markets.

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Monday Morning Outlook

Our favorite economist Brian Wesbury on the Economy:

GDP Growth Looking Good 

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 10/16/2017
Next week, government statisticians will release the first estimate for third quarter real GDP growth. In spite of hurricanes, and continued negativity by conventional wisdom, we expect 2.8% growth.

If we’re right about the third quarter, real GDP will be up 2.2% from a year ago, which is exactly equal to the growth rate since the beginning of this recovery back in 2009. Looking at these four-quarter or eight-year growth rates, many people argue that the economy is still stuck in the mud.

But, we think looking in the rearview mirror misses positive developments. The economy hasn’t turned into a thoroughbred, but the plowing is easier. Regulations are being reduced, federal employment growth has slowed (even declined) and monetary policy remains extremely loose with some evidence that a more friendly business environment is lifting monetary velocity.

Early signs suggest solid near 3% growth in the fourth quarter as well. Put it all together and we may be seeing an acceleration toward the 2.5 – 3.0% range for underlying trend economic growth. Less government interference frees up entrepreneurship and productivity growth powered by new technology. Yes, the Fed is starting to normalize policy and, yes, Congress can’t seem to legislate itself out of a paper bag, but fiscal and monetary policy together are still pointing toward a good environment for growth.

Here’s how we get to 2.8% for Q3.

Consumption: Automakers reported car and light truck sales rose at a 7.6% annual rate in Q3. “Real” (inflation-adjusted) retail sales outside the auto sector grew at a 2% rate, and growth in services was moderate. Our models suggest real personal consumption of goods and services, combined, grew at a 2.3% annual rate in Q3, contributing 1.6 points to the real GDP growth rate (2.3 times the consumption share of GDP, which is 69%, equals 1.6).

Business Investment: Looks like another quarter of growth in overall business investment in Q3, with investment in equipment growing at about a 9% annual rate, investment in intellectual property growing at a trend rate of 5%, but with commercial constriction declining for the first time this year. Combined, it looks like they grew at a 4.9% rate, which should add 0.6 points to the real GDP growth. (4.9 times the 13% business investment share of GDP equals 0.6).

Home Building: Home building was likely hurt by the major storms in Q3 and should bounce back in the fourth quarter and remain on an upward trend for at least the next couple of years. In the meantime, we anticipate a drop at a 2.6% annual rate in Q3, which would subtract from the real GDP growth rate. (-2.6 times the home building share of GDP, which is 4%, equals -0.1).

Government: Military spending was up in Q3 but public construction projects were soft for the quarter. On net, we’re estimating that real government purchases were down at a 1.2% annual rate in Q3, which would subtract 0.2 points from the real GDP growth rate. (1.2 times the government purchase share of GDP, which is 17%, equals -0.2).

Trade: At this point, we only have trade data through August. Based on what we’ve seen so far, it looks like net exports should subtract 0.2 points from the real GDP growth rate in Q3.

Inventories: We have even less information on inventories than we do on trade, but what we have so far suggests companies are stocking shelves and showrooms at a much faster pace in Q3 than they were in Q2, which should add 1.1 points to the real GDP growth rate.

More data this week – on industrial production, durable goods, trade deficits, and inventories – could change our forecast. But, for now, we get an estimate of 2.8%. Not bad at all.

I like the way he puts it: The economy hasn’t turned into a thoroughbred, but the plowing is easier.

 

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Time To Drain The Fed Swamp

The Panic of 2008 is widely misunderstood.  Part of this is due to the fact that financial issues are complicated.  How many people, after all, know what “mark to market accounting” is?  Part of it is due to politics.  Government policies encouraged home ownership by lowering lending standards, leading to NINA (“No Income No Assets”) loans.  At one time home prices were rising so fast that people believed that no matter what they paid for a house they could always sell it for more.

A thought-provoking article by Brian Wesbury of First Trust expands on this issue.

 Time To Drain The Fed Swamp

The Panic of 2008 was damaging in more ways than people think. Yes, there were dramatic losses for investors and homeowners, but these markets have recovered. What hasn’t gone back to normal is the size and scope of Washington DC, especially the Federal Reserve. It’s time for that to change.

D.C. institutions got away with blaming the crisis on the private sector, and used this narrative to grow their influence, budgets, and size. They also created the narrative that government saved the US economy, but that is highly questionable.

Without going too much in depth, one thing no one talks about is that Fannie Mae and Freddie Mac, at the direction of HUD, were forced to buy subprime loans in order to meet politically-driven, social policy objectives. In 2007, they owned 76% of all subprime paper (See Peter Wallison: Hidden in Plain Sight).

At the same time, the real reason the crisis spread so rapidly and expanded so greatly was not derivatives, but mark-to-market accounting.

It wasn’t government that saved the economy. Quantitative Easing was started in September 2008. TARP was passed on October 3, 2008. Yet, for the next five months markets continued to implode, the economy plummeted and private money did not flow to private banks.

On March 9, 2009, with the announcement that insanely rigid mark-to-market accounting rules would be changed, the markets stopped falling, the economy turned toward growth and private investors started investing in banks. All this happened immediately when the accounting rule was changed. No longer could these crazy rules wipe out bank capital by marking down asset values despite little to no change in cash flows. Changing this rule was the key to recovery, not QE, TARP or “stress tests.”

The Fed, and supporters of government intervention, ignore all these facts. They never address them. Why? First, institutions protect themselves even if it’s at the expense of the truth. Second, human nature doesn’t like to admit mistakes. Third, Washington DC always uses crises to grow. Admitting that their policies haven’t worked would lead to a smaller government with less power.

The Fed has become massive. Its balance sheet is nearly 25% of GDP. Never before has it been this large. And yet, the economy has grown relatively slowly. Back in the 1980s and 1990s, with a much smaller Fed balance sheet, the economy grew far more rapidly.

So how do you drain the Fed? By not appointing anyone that is already waiting in D.C.’s revolving door of career elites. We need someone willing to challenge Fed and D.C. orthodoxy. If we had our pick to fill the chair and vice chair positions (with Stanley Fischer announcing his departure) we would be focused on the likes of John Taylor, Peter Wallison, or Bill Isaac.

They would bring new blood to the Fed and hold it to account for its mistakes. It’s time for the Fed to own up and stop defending the nonsensical story that government, and not entrepreneurs, saved the US economy. Ben Bernanke and Janet Yellen have never fracked a well or written an App. We need a government that is willing to support the private sector and stop acting as if the “swamp” itself creates wealth.

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Recovery of Emerging Markets

The MSCI Emerging Markets Index, up 28.09%, is the best performing major index year-to-date – better than the DASDAQ, better than the S&P 500, better than the DJIA.  That’s an amazing reversal.

Emerging Markets have lagged the other major indexes over the last decade.

  • 2.21% for 3 years (vs. 9.57% for the S&P 500)
  • 5.56% for 5 years (vs. 14.36% for the S&P 500)
  • 2.76% for 10 years (vs. 7.61% for the S&P 500)

Why do we mention this?  A well diversified portfolio often includes an allocation to Emerging Markets.  Emerging Markets represent the economies of countries that have grown more rapidly than mature economies like the US and Europe.

Countries in the index include Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, and the United Arab Emirates.  Some of these countries have economic problems but economic growth in countries like India, China, and Mexico are higher than in the U.S.

Between 2003 and 2007 Emerging Markets grew 375% while the S&P 500 only advanced 85%.  As a result of the economic crisis of 2008, Emerging Markets suffered major losses.  It is possible that these economies may now have moved past that economic shock and may be poised to resume the kind of growth that they have exhibited in the past.  Portfolios that include an allocation to Emerging Markets can benefit from this recovery.

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Hurricane Economics

With with the cleanup beginning from the effects of Hurricane Harvey and Hurricane Irma threatening the East Coast, We wanted to share the commentary of Brain Wesbury, Chief Economist at First Trust.

The hits keep coming. Hurricane Harvey left destruction in its wake, and now, Hurricane Irma has Florida in its sights.

It’s been five years since Hurricane Sandy, nine years since Ike and twelve years since Katrina. As with all major weather events, personal tragedy, pain, suffering, and loss are left in their wake. We have prayed, and continue to pray, for those affected. But at the same time, in our job as economists we look toward rebuilding and economic restoration. This is where investors often make two different mistakes about how these massive weather events will affect the economy and markets.

Some might think that, as did Nouriel Roubini after Katrina, the damage itself will cause a recession. Others take the opposite tack and think rebuilding efforts might actually help the economy. Neither are correct. By themselves, the storms will not push the economy off its Plow Horse path.

In the face of disasters we should all be thankful for the (mostly) free markets that help the U.S. respond. These markets allow accumulated wealth and know-how to focus on recovery. The losses will never be fully replaced, but the sheer size and flexibility of the U.S.’s capitalist system allows resources to be shifted and directed toward recovery. The price system makes this happen. While some think no profit should be made from a disaster, it is those profits which allow overall “economic” recovery to occur in relatively quick order.

Some estimate that damage from Harvey could be close to the $108 billion estimate for Katrina (2005), certainly above the $75 billion cost of Hurricane Sandy (2012).

Neither of these previous storms caused a recession, and at the same time, the data show no real acceleration in growth either. Real GDP grew 4.9% at an annual rate in the first quarter of 2006 after Katrina, but never accelerated above 3% in the first two quarters after Sandy. For six and nine month periods before and after these storms, growth rates were similar. In other words, it’s hard to separate the impact of Katrina or Sandy from normal statistical noise. The U.S. grew over 4% annualized in Q1 2005 and in Q3 2014, with no major weather impact.

But even if the bump in real GDP growth in the first quarter of 2006 was due to Katrina, that doesn’t mean it was good news. It would be what Henry Hazlitt in his book “Economics in One Lesson” called the “fallacy of the broken window” – which we recommend all investors read.

Hazlitt told a story about a vandal who broke a shopkeeper’s window, which caused a glassmaker to get an additional order. But the shopkeeper was planning on eventually using that same money to buy a new suit, so the tailor lost an order. In other words, even though rebuilding appears to create new economic activity, fixing things that have been destroyed actually robs an economy over time of the benefits of growth. Repairing physical capital does not generate new wealth, it only replaces old wealth.

Before Harvey, the market consensus was that automakers would sell cars and light trucks at a 16.6 million annual rate in August. Instead, automakers reported late on Friday that they only sold at a 16.1 million rate. Harvey hit an area that represents about 5% of US auto demand and it did so for about 20% of August. This suggests Harvey cut roughly 1% off of August sales nationwide, or that autos would have sold at a 16.3 million annual pace in the absence of the storm.

Automakers should make those sales back up in the next few months. In addition, reports suggest the storms destroyed about 500,000 autos, which will also generate additional sales in the months ahead.

These sales might help make the GDP numbers look better late this year or early next year, but it just represents demand that would have eventually appeared elsewhere in other sectors.

The lesson is that these disasters, while a tragedy in so many ways, do not shift the fundamental path of the U.S. economy. Some think socialist economies can respond better, but this is not true; markets are the most efficient system for guiding resources to areas in need. Free people that get hit with a disaster will overcome and reach new highs, because that’s what people do when they’re free, disaster or not. Godspeed to all those affected directly, and to those helping in recovery.

Our clients and friends in Texas were spared from the worst effects of hurricane Harvey.  Pray for those who lost their lives, their homes and their possessions.  And we applaud those who selflessly came to the rescue of their neighbors.  This showed the best of America.

 

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Good News on the Economic Front

Our favorite economist, Brian Wesbury of First Trust has a new note out that we wanted to share.

While the Sunday morning talk shows discuss the number of Civil War monuments that can dance on the head of a pin…and a rare Eclipse grabs focus…investors might be shocked at how the economy has accelerated.

Although we still have more than a month left in the third quarter, and many more pieces of data to come, as of August 16th the Atlanta Fed’s “GDP Now” model, which tracks and estimates real GDP growth, says the economy is expanding at a 3.8% annual rate in Q3.  If correct, that would be the fastest pace for any quarter since 2014.

We usually take forecasts this early with a grain of salt.  After all, a lot can happen over the remainder of the quarter.  And, on some prior occasions, the Atlanta Fed has projected rapid growth for a quarter mid-way through, only to ratchet back the forecast by quarter-end to a more pedestrian Plow Horse growth rate near 2%.  But, in this particular case, we think the pick-up is real.  In fact, our own internal forecast suggests the exact same growth rate of 3.8%.

One thing more pessimistic analysts are focusing on is that “inventories” are adding about 1% to the third quarter growth rate.  It looks like businesses are stocking shelves at a more normal pace after the lull in the first half of the year.  Excluding this inventory boost, First Trust models have real GDP growing at a 2.4% annual rate in Q3, while the Atlanta Fed model has it at 2.8%.

It’s hard to remember that the original report for Q1 real GDP was less than 1% growth.  That report worried many investors, and doom and gloom stories abounded.  But the foundation for continued economic growth remains in place.

It’s true that the US is unlikely to see tax cuts or real tax reform (or both!) anytime this year.  And this will make sustaining GDP growth at a 3.8% rate very difficult.  But we expect favorable changes in tax policy by early next year.  All that said, the best news is any threat of growth-harming tax hikes remains virtually nil.

Meanwhile, the one area of clear improvement in economic policy under President Trump has been regarding regulation.  The issuance of new rules that slow growth has basically stopped, while harmful old rules are getting rolled back or being reviewed for reform.  This alone can help push growth up by ¼ to ½ percentage point on an annual basis.

In addition, monetary policy remains very loose.  Short-term interest rates are still well below “normal” and there are over $2 trillion in excess reserves in the banking system.  We still expect another rate hike this year, and it seems clear that the Fed will begin slowly reducing the size of its bloated balance sheet.  Assuming the Fed starts balance sheet normalization on October 1st, their $4.4 trillion-dollar balance sheet would shrink by a measly 0.7% by year-end.  This takes the Fed from running a super-easy monetary policy to a very, very easy monetary policy.  In other words, any threat from tight money is remote.

Trade protectionism was the biggest threat to the economy as the new Trump Administration took office, but so far, there’s been a great deal more rhetoric than action on this front.  We remain confident that President Trump realizes a true lurch into protectionist policies would risk a drop in the stock market and would make it harder to meet his goal of faster economic growth.  Protectionist promises are much easier to break (or just ignore), when the unemployment rate is moving toward 4%.  Instead, expect the president to pivot toward trying to get better enforcement of intellectual property rights from China and an open market in oil and gas exports.

We constantly warn investors that one quarter, or one month, of economic data is meaningless.  So far, the Plow Horse has not morphed into a thoroughbred.  However, good news tends to lead to more good news and momentum is building.

Better economic growth means better profit growth and better profit growth will help push stocks higher.  Our 2017 end-of-year forecast of 2,700 for the S&P 500 and 23,500 for the Dow Jones Industrial Average remains in place.  Risks to growth remain low, and the chance of an acceleration remains positive as third quarter data is suggesting.

 

 

 

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