Drip Drip Drip

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 7/31/2019


The Fed cut short-term interest rates by 25 basis points today, moving the range for the federal funds rate down to 2.00 - 2.25%. It also announced it will stop reducing its balance sheet in August, two months earlier than previously planned.

It made these moves despite better-than-expected economic data since the last meeting in June, as well as Chairman Powell's assessment at the press conference that our economic performance is "reasonably good" and the outlook is "good," as well. The Federal Reserve still claims it's "data dependent," but no one should believe it.

We don't think today's rate cut was needed, and would prefer that they continue to shrink the balance sheet. Nominal GDP is up 4.0% in the past year, and is up at a 5.0% annual rate in the past two years. Both figures stand well above the Federal Reserve's target for short-term rates. On policy, we agree with Esther George and Eric Rosengren, bank presidents for Kansas City and Boston, respectively, who dissented stating they preferred no change in rates at today's meeting.

We think cutting rates by 25 basis points was the worst possible policy outcome. If the Fed was determined to cut rates, it should have committed further – by 50 basis points or more – to tell businesses and consumers considering big-ticket purchases the Fed is planning for one-and-done. By cutting rates only 25 basis points and leaving alive expectations of further gradual cuts at coming meetings – drip, drip, drip – the Fed has created an incentive to postpone economic activity. Powell said the Fed wasn't committed to a series of rate cuts, but didn't give markets a reason to believe it. After all, at the June meeting the median interest rate projection from the Fed was for rates to remain unchanged through year-end.

The Fed's statement justified the rate cut based on "global developments" and "muted inflation." At the press conference, Powell referred to the European Union and China as points of global concern. But US monetary policy is not the tool to address these problems. Powell also suggested the Fed is concerned with a "downward slide" into lower inflation expectations. It is true that the Fed's favorite inflation measure, the PCE deflator, is up only 1.4% from a year ago. However, it's up at a 2.2% annual rate in the past three months. This is not an environment where deflation seems like much of a risk.

Putting aside whether the Fed is doing the right thing, we think the Fed is likely to reduce rates by another 25 basis points in September. In for a penny, in for a pound. The current environment remains bullish for equities, which were cheap even without rate cuts. In the meantime, holders of long-term bonds will eventually come to regret policies that mean a faster pace of inflation over the long run.

Solid GDP Report

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 7/29/2019


A cottage industry has sprung up in the past decade with the sole focus of discrediting any good news on the economy. When President Obama was in office, the attacks mostly came from the right. With President Trump in Office, the attacks mostly come from the left. Since March 2009, regardless of who was in office, we have stridently argued that this recovery has legs. The result? We have been attacked from both sides of the political aisle.

The latest debate is over real (inflation-adjusted) GDP, which grew at a better than expected 2.1% annual rate in Q2. Some say it showed soft spots from the trade war and weak business investment.

It's true that net exports (exports minus imports) trimmed the Q2 real GDP growth rate by 0.65 percentage points. But that follows the Q1 boost to growth of 0.73 points. In the past year, trade has subtracted an average of 0.58 points each quarter. For comparison, we saw larger drags from net exports in 2010, 2014, and 2015, all years without "trade wars." Our conclusion: this is statistical noise.

That leaves real business fixed investment, which declined at a 0.6% annual rate in Q2, the first drop since 2016. Many have taken this as proof that tax cuts and deregulation didn't work.

But the Q2 decline was almost entirely due to a drop in brick and mortar investment (what economists call "structures"). In the age of the Internet, software and computers are replacing brick and mortar. We buy airline tickets online, not in an office. Blockbuster was replaced by Netflix. You don't need to leave the comfort of your home, the stores come to you. As a result, investment in structures has slowed in recent years while investments in technology and equipment have continued to rise. Strip out structures, and real fixed investment rose at a 1.9% annual rate in Q2 2019.

More importantly, business investment ex-structures has clearly picked up under the Trump Administration compared to Obama's second term.

Why only use the final four years of the Obama Presidency? Because the first four years were driven by a V-shaped recovery from the Panic of 2008. His second term illustrates the impact of tax hikes and more business regulation.

Real business investment, excluding structures, grew at a 3.8% annualized rate between Q4 2012 and Q4 2016, but accelerated to a 5.9% annualized rate since Trump took office. Real Investment in software and R&D grew at a 5.5% annualized rate in the final four years of the Obama Administration versus 7.5% since the start of 2017. Tax cuts and deregulation have indeed boosted "animal spirits."

In addition, Core GDP – combining personal consumption, business investment, and home building – grew at a very solid 3.2% annual rate in Q2. Meanwhile, profit reports are widely beating expectations. The economy is much stronger than conventional wisdom thinks and has been since 2009.

Temporary Tepid Growth for Q2

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 7/22/2019


This Friday, the government will release its initial estimate of real GDP growth in the second quarter, and the headline is likely to look soft. At present, we're projecting an initial report of growth at a 1.8% annual rate.

If our projection holds true, we're sure pessimistic analysts and investors will latch onto the slowdown from the 3.1% growth rate for the first quarter, implying that we're back to slower Plow Horse growth for good. They will argue nothing has substantially changed since Trump took office, despite tax cuts and deregulation.

It's true that an annualized growth rate of 1.8% would be the slowest pace since the first quarter of 2017. But, as we will explain below, growth in the second quarter was likely held down temporarily by businesses returning to a more sustainable pace of inventory accumulation following the rapid pace of inventory building in the second half of 2018 and first quarter of this year. Excluding inventories – focusing on what economists call final sales – we estimate that real GDP grew at a 3.1% annual rate in Q2.

We also like to follow what we call "core GDP," which is real growth in personal consumption, business investment, and home building, combined. Core GDP looks like it grew at a 4.1% annual rate in the second quarter, the fastest pace in a year. In other words, while the economy may not be booming like the mid-1980s or late-1990s, the underlying trend remains quite healthy, and certainly much better than the Plow Horse period from mid-2009 through early 2017.

Here's how we get to our 1.8% real growth forecast for Q2:

Consumption: Automakers say car and light truck sales grew at a 2.8% annual rate in Q2 while "real" (inflation-adjusted) retail sales outside the auto sector grew at a 3.9% rate. Combined with some less up-to-date figures on consumer spending on services, real personal consumption (goods and services combined) looks to have grown at a 4.0% annual rate, contributing 2.7 points to the real GDP growth rate (4.0 times the consumption share of GDP, which is 68%, equals 2.7).

Business Investment: Reports on durable goods shipments and construction suggest all three components of business investment – equipment, commercial construction, and intellectual property – rose in the first quarter. A combined growth rate of 5.1% adds 0.7 points to real GDP growth. (5.1 times the 14% business investment share of GDP equals 0.7).

Home Building: After five straight quarters of contraction, it looks like home building – a combination of new housing as well as improvements – increased at a 2.6% annual rate in Q2. Expect more gains in the quarters ahead as home builders are still constructing too few homes given population growth and the scrappage of older homes. In the meantime, a 2.6% pace translates into a boost of 0.1 point to real GDP growth. (2.6 times the 4% residential construction share of GDP equals 0.1).

Government: Looks like a relatively large 2.3% increase in real public-sector purchases in Q2, which would add 0.4 points to the real GDP growth rate. (2.3 times the government purchase share of GDP, which is 17%, equals 0.4).

Trade: Net exports' effect on GDP has been very volatile in the past year, probably because of companies front-running - and then living with - tariffs and (hopefully) temporary trade barriers. Net exports added 0.9 points to the GDP growth rate in Q1, but should subtract an almost equal 0.8 points in Q2.

Inventories: Inventories are a potential wild-card, because we are still waiting on data on what businesses did with their shelves and showrooms in June. We get a report on inventories on Thursday, the day before the GDP report arrives, which may change our final GDP forecast. In the meantime, it looks like the pace of inventory accumulation got back to more normal levels in Q2, which should temporarily subtract 1.3 points from real GDP growth.

Add it all up, and we get 1.8% annualized real GDP growth. Don't let this tepid headline number spoil your day; the trend remains strong where it matters most, and prospects are bright for the US economy.

Here's to a Summer of Clear Skies and Clear Goals →

June 27, 2019

The beaches are filling up and the days are getting longer, giving you space to take a breath, reflect on your progress and set new goals. You’ll also want to take stock of any recent life changes that may affect your estate plan, benefits and insurance and adjust as needed.

Summer 2019 Market Closures

Thursday, July 4: Independence Day
Monday, September 2: Labor Day

Mark Your Calendar

Friday, August 2: Observe Information Security Day – update your passwords for all online accounts to keep your personal information secure.

Planning To-Do's

Conduct a midyear checkup: Look back on your to-do list progress, make sure your retirement plan is on track, determine if your emergency fund is adequate, and establish a regular savings plan you can stick to each month.

Register with SSA.gov: Check your earnings history for accuracy and review your expected benefits. If you’re close to retirement age, discuss with your advisor when and how you should file to maximize your benefits.

Update your estate plan: Check the beneficiaries of your IRAs, insurance policies, trusts and any other accounts, and update information that is no longer relevant. Ensure your plan protects you and your family in the case of an unexpected event.

Assess insurance needs: Periodically review and update coverage to help ensure proper protection.

Adjust as life changes: Speak with your advisor about major life changes you’ve experienced and how your financial plan could be affected. These changes include marriages, births, deaths, divorces, a sudden windfall and more.

Plan a family meeting: Use the opportunity to talk about “big” things, like your philanthropic legacy, as well as simpler things – like the menu for the next holiday dinner.

Never stop learning: Websites like EdX and Coursera offer free online classes in a range of topics.

Talk with your advisor to help ensure you don't miss any important financial planning dates this summer.

Read more

This Crazy Rate Cut →

The narrative that the U.S. economy is in trouble – some say teetering on the edge of recession - has become so powerful and persuasive that few investors give it a second thought. So of course, they believe, the Fed should cut interest rates. We haven’t seen anything like it since the Fed was hiking rates in the deflationary late- ‘90s. Those rate hikes, which were totally unwarranted, ended up causing a recession.

Read more

Money: A Love Story →

There are moments in your clients’ lives when they realize money can indeed buy happiness. It’s the joy they feel when they get the unexpected bonus at work. Or the cash in their hands when they sell a car. Or the pleasure when a stock they took a risk on quickly doubles or triples in value. Money delivers a rush. The way they feel at those times is a physiological response to money. That’s because when they think about money, it can exert a neurological effect on their brains so seductive that it literally matches what happens to their bodies when they think about love or sex—some of their most primal of urges. It’s no wonder, then, that research from behavioral economists and neuroscientists confirms it can be difficult to remain rational when it comes to investing behavior. Clients are seeking that rush, time and time again.My field of study, physiology, sheds fascinating light on how the body deals with these seductive effects. Let’s investigate why evolution hard wires clients to react emotionally rather than rationally when it comes to money, and how they, as investors, can tame their inner beast and resist the allure of quick profits from the next cryptocurrency.

Read more

Trade War Hysterics

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Dep. Chief Economist

Strider Elass – Senior Economist

Since hitting new all-time highs two weeks ago, the S&P 500 has fallen about 2.2% as trade negotiations with China hit a snag.  Last week, the US announced new tariffs on Chinese imports.  This morning, China announced new tariffs on some US goods. Many fear a widening trade war.

Don’t get us wrong.  We want free trade, and we understand the dangers of trade wars and tariffs (which are just taxes on consumers).  At the same time, we think trade deficits themselves are not a reason for trade wars.  We all run personal trade deficits with the local grocery store and benefit from that.  Even if the entire world went to zero tariffs, the US would almost certainly still run trade deficits, even with China.

But today, the trade deficit with China is partly due to the fact that China has higher tariffs on imports than the US does – working to eliminate these lopsided tariffs is worthwhile.

In 1980, China was an impoverished nation.  Then it began adopting tools of capitalism – property rights, markets, free prices and wages.  Chinese businesses started to import the West’s technology, and growth accelerated.

Initially, China didn’t have to worry about intellectual property.  When you replace oxen with a tractor, all you have to do is buy the tractor, not reinvent the internal combustion engine.  But China has now picked, and benefited from, the lowest hanging fruit.  So, China decided to steal the R&D of firms located abroad.  Some estimates of this collective theft run into the hundreds of billions of dollars.

That’s why normal free market and free trade principles don’t neatly apply to China.  

Remember President Reagan’s old story supporting free trade?  “We’re in the same boat with our trading partners,” Reagan said.  “If one partner shoots a hole in the boat, does it make sense for the other one to shoot another hole in the boat?”  The obvious answer is that it doesn’t, and so our own protectionism would hurt us.

But China hasn’t just shot a hole in the boat, they’ve become pirates.  If Tony Soprano and his cronies robbed your house, would free market principles require you to trade with them to buy those items back?  Of course not!  

It’s true tariff increases will not help the US economy.  But $100 billion of tariffs spread over $14 trillion of consumer spending is not a recession inducing drag.  It’s true some business, like soybean farmers, are hurt.  But the status quo means accepting hundreds of billions in theft from companies that are at the leading edge of future growth.

Either way, if tariffs nick our economy, China’s gets hammered.  Last year we exported $180 billion in goods and services to China, which is 0.9% of our GDP.  Meanwhile, China exported $559 billion to the US, which is 4.6% of their economy.  We have enormous economic leverage that they simply can’t match.

An extended US-China trade battle means US companies will shift supply chains out of China and toward places like Singapore, Vietnam, Mexico, or “Made in the USA.”  If that happens, the Chinese economy is hurt for decades.                        

Anyone can invent a scenario where some sort of SmootHawley-like global trade war happens.  Realistically, though, that appears very unlikely.  We’re not the only advanced country China’s piracy has victimized, and China may realize it’s more isolated than it thought.  In the end, China wants to trade with the West, not North Korea, Russia, and Venezuela.  China needs the West.  And all these trade war hysterics just aren’t warranted. 

Click HERE     
 
 

Opinion: What to tell a new graduate about investing in stocks

Published: May 9, 2019 2:58 p.m. ET

Success with money and investments requires humility, self-awareness, and a few good friends

By Vitaliy Katsenelson, Columnist

College graduation ceremonies this time of year remind me of my own graduation from the University of Colorado in 1997.

I felt completely lost, with no idea what to do next. Now, more than 20 years later, I can offer some experience-based advice about investing and how to go about it realistically. Here’s what I would tell my younger self and his generation:

1. Find yourself. Investing is like a piece of tight clothing: Just because it fits and looks good on someone else doesn’t mean it’s a good fit for you. Your investment strategy has to fit your personality; it has to wrap around your biases and life experiences. You’ll only discover your strategy, the one that fits your personality, when you start putting real money to work.

2. Just do it. The best way to learn about investing is by doing. Don’t create paper portfolios. Take as much money as you can afford to lose (because you may lose it), and invest it. The most difficult part of investing is staying rational when you get punched in the face by the markets. Understanding the emotions that losses and gains evoke in you and dealing with them is incredibly valuable.

Don’t focus on building a properly diversified portfolio. Your initial focus should be stock analysis, not portfolio construction. You simply won’t have enough time to do the deep research necessary to build a diversified portfolio of 15 to 25 stocks. At this point in your career, depth is more important than breadth.

3. Invest, don’t gamble. Do the analysis with the diligence and care that you would bring to investing your parents’ retirement savings. Document your research. Imagine you are working as an analyst at a mutual fund and writing a pitch for a stock to a portfolio manager. You’ll learn a lot from documenting and writing up your research. This will keep you rational.

Browse investment writeups on ValueInvestorsClub.com. This website was started by Joel Greenblatt — a terrific investor who wrote “The Little Book That Beats the Market” and “You Can Be a Stock Market Genius” (both highly recommended). This is where you can learn what the depth and rigor of your research needs to be. Writeups here are posted by diehard value investors, not academics, who put their money where their mouths are.

4. Start with what you know.  What stocks do you analyze first? Recently I was asked this question by a fellow who had undergraduate and graduate degrees in aerospace engineering. What do you think my answer was? I said “You probably know more than most people your age about the aerospace industry. Create a map of the industry and then learn about each company in the industry.” It is easier to start analyzing something you already understand.

5. Learn to say ‘I don’t know’. You cannot be expert in everything. Someone who has an answer for everything probably knows very little. Saying “I don’t know” requires honesty and self-confidence, and it opens doors for learning.

6. Make investment friends. My life over the last 20 years has been enriched by having great investment friends around me. Today my investment friends are really just my friends, with whom I share and debate stocks, though we also talk about family, kids, and such.

Investing doesn’t have to be a solitary, sterile journey; in fact it should not be one. Every investor, without exception, will go through a period where he or she feels like a complete idiot — the market will do this to you at times (trust me on this). Surround yourself with loyal, humble investment friends who can give you support, and who are smarter than you, so you’ll always be learning from them.

7. Read. These books have been helpful to me:

•  “Fooled by Randomness”, by Nassim Taleb, which will make you deeply appreciate the role randomness plays in investing.

• “The Essays of Warren Buffett” — Buffett’s annual reports edited into a book by Lawrence Cunningham.

• “Poor Charlie’s Almanac”, to understand the second half of Berkshire Hathaway BRK.A, -2.26% BRK.B, +0.00%  — Warren Buffett’s partner, Charlie Munger.

•  “Basic Economics”,  by Thomas Sowell, which has taught me more about economics than all my economics classes combined.

• “Margin of Safety”, by Seth Klarman — one of the most brilliant investors of our time. Though the book is out of print, you can find it online if you’re resourceful.

• “The Most Important Thing Illuminated”, by Howard Marks, which is filled with Klarman-like wisdom.

• The “Little Book” series: The process of writing one of these books made me appreciate the series even more that I did already. These books are typically written by investors who often have taken their “big” books (as I did) and simplified and condensed them into smaller, more accessible works. This process of simplification and condensation forces you to keep what matters the most. My two favorite books in is series are “The Little Book of Behavioral Investing”, by James Montier, and “The Little Book That Builds Wealth”, by Pat Dorsey.

• “Reminiscences of a Stock Operator”, written in 1923 by Edwin Lefevre, tells from a first-person perspective the fictionalized tale of the early years of the great trader Jesse Livermore. It is rumored that this book was actually written by Jesse Livermore and edited by Lefevre.

This book provides a great introspective look inside a trader’s mind and teaches many behavioral and common-sense lessons. My favorite edition is the one annotated by my friend Jon Markman. His annotations are like a book within a book; they take you behind the scenes of Lefevre’s story and give important insights into the key characters and the backdrop of that interesting time period.

I don’t want to end with empty platitudes, but I’d be remiss if I didn’t stress the importance of having an unstoppable, insatiable thirst for knowledge. Learning doesn’t cease when you graduate; it continues and never stops. As I look at my investment role models, all them, without exception, have that quality. If you don’t have that thirst, cut your losses and find another career or hobby. A value investor needs to have a growth mindset.

5 Signs That This Market Will Push Even Higher [VIDEO]

While it’s never easy to watch stocks fall, CIO Larry Adam sees any current weakness in the market as a potential buying opportunity.

May 7, 2019

Click HERE to watch video

In the video above, Chief Investment Officer Larry Adam discusses five factors pointing to continued stock market growth:

  1. The economy is accelerating.

  2. The Fed has put interest rate increases on hold.

  3. Earnings are better than expected, and estimates for future quarters are being revised higher.

  4. Dividends have remained healthy and have reached a record high.

  5. The U.S. market continues to de-equitize, meaning fewer companies are trading publicly.

 

Recorded April 25, 2019 with Larry Adam, CFA, CFP®, CIMA®.

The Big Picture and the Fed

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Dep. Chief Economist

Strider Elass – Senior Economist

you take a long hike up a mountain, there’s plenty to appreciate along the way. But, sometimes, you just have to stop and enjoy the view. With that in mind, let’s forget about the April employment report – which saw a combination of very fast payroll growth and moderate wage growth – and think about where the labor market stands in general.

Nonfarm payrolls have grown by 2.6 million in the past year, well ahead of the roughly 2.0 million jobs the consensus was forecasting a year ago.

Due to the rapid job creation, the unemployment rate has dropped to 3.6%, the lowest level since 1969. Some analysts claim the jobless rate is being artificially suppressed by lower labor force participation, but participation is higher now than it was in the late 1960s, when 3.6% was considered full employment.

Regardless, the labor force is up 1.4 million from a year ago, and the labor force participation rate has been essentially flat since late 2013. And that’s in spite of an aging population.

The unemployment rate for those with less than a high school degree has averaged 5.6% in the past twelve months, the lowest on record, and well below the previous cycle low of 6.3% reached during the internet boom two decades ago

The Hispanic unemployment rate has averaged 4.6% in the past year, while the Black unemployment rate has averaged 6.4%, both also record lows.

Meanwhile, wage growth has accelerated. Average hourly earnings are up 3.2% from a year ago, versus the gain of 2.8% in the year ending in April 2018, and 2.5% in the year ending in April 2017. And the gains in wages are not just tilted toward the rich. Among full-time workers age 25+, usual weekly earnings are up 3.5% for those in the middle of the income spectrum. But wages are up 4.9% for workers at the bottom 10% of earners, while up 1.7% for those at the top 10% of income earners. A rising tide is lifting all boats.

Some observers are claiming we should discount strong job creation because workers are taking multiple jobs. But, in the past year, multiple job holders have been just 5.0% of the total number of employed workers; that’s lower than at any point during the 2001-07 expansion, or during the previous longest recovery on record during the 1990s. Meanwhile, part-time jobs are down since the expansion started, meaning, on net, full-time jobs account for all the job creation during the expansion.

What’s interesting is that President Trump, Vice President Pence and NEC Chief Larry Kudlow all think things could be even better if the Fed hadn’t raised interest rates. President Trump, in fact, is calling for a 1% interest rate cut. This puts the Administration at odds with Fed Chair Jerome Powell, who thinks interest rates are at appropriate levels.

We don’t disagree with the theory behind the thinking of Trump, Pence and Kudlow who say faster economic growth, by itself, doesn’t have to cause higher inflation. A "permanent" supply-side boost to "real" growth from deregulation and marginal tax rate cuts is not inflationary. In fact, as we’ve previously written, the growth potential of the US economy has accelerated. Productivity (output per hour) is up 2.4% in the past year, deep into this recovery, when normally productivity growth should slow.

But "nominal" GDP (real growth plus inflation) is still up 4.8% at an annual rate in the past two years, and is set to equal, or exceed, that in the year ahead. If we think of nominal GDP as the average growth rate of all businesses in the economy, then a federal funds rate of 2.375% is not holding anyone back. Even projects with a below-average return could justify borrowing, which is a recipe for disaster – what Ludwig von Mises called "mal-investment" – when people push investment into areas that are unsustainable at normal interest rates. Remember the housing bubble?

That’s why we want Powell and the Fed to resist calls to cut rates. The Fed is not tight. Interest rates are not discouraging investment. If anything, the Trump administration should work to cut government spending, which has grown so large it’s crowding out private sector growth.

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/5/6/the-big-picture-and-the-fed

Consensus forecasts come from Bloomberg. 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.