Will Russian Sanctions Lead China to Sell US Debt?

March 8, 2022 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

March 7, 2022

Russia’s invasion of Ukraine led western nations to impose the most draconian economic sanctions in the modern era. The Russian stock and bond markets have collapsed, along with Russia’s currency, the ruble.

Many investors fear that China, which has always wanted control of Taiwan, will use the mayhem of the moment to take it. Obviously, this would create even more uncertainty and mayhem, but China is more involved in global finance than Russia. The West’s response to Russia has not gone unnoticed, but many fear that even if China doesn’t invade, it may preemptively sell its roughly $1.1 trillion in US government debt to avoid financial retaliation. The fear is that this will cause US interest rates to soar and the US economy to suffer.

We think this fear is unwarranted. Yes, inflation and Fed tightening are likely to push up rates in the next few years. This is what the markets should focus on, not a Chinese sell-off of US Treasury debt, which would have little impact.

First, total US debt is roughly $30 trillion. If China sold all its debt, it is only 3.6% of all outstanding US debt. A shock to the system maybe, on the day it happens, but just a temporary shock, not a death blow.

Second, consider what’s happened to our budget deficit the last couple of years. Right before COVID, the Congressional Budget Office estimated that the baseline deficits for Fiscal Years 2020 and 2021, combined, would be a two-year total of $2.0 trillion. Instead, due to COVID and related shutdowns, the two-year deficit totaled $5.9 trillion. That’s $3.9 trillion in extra deficits over a two-year period. And the 10-year Treasury yield is essentially where it was right before COVID hit.

Third, the Federal Reserve shrunk its balance sheet by almost $700 billion (effectively selling debt securities) in 2018 and the first eight months of 2019. Guess what? Interest rates fell.

Fourth, even if rates were to rise, which looks likely no matter what China does, the US economy has rarely been as insensitive to interest rates as it is today. Due to underbuilding going back a decade, there are too few homes in the US. Even if mortgage rates go up, we need more new homes. Higher interest rates might mean a greater appetite for renting versus buying, but rental units have to be built, too. Meanwhile, auto sales are very low due to supply-chain issues. As those issues gradually get resolved, auto sales should increase even if interest rates go up.

Fifth, we anticipate another round of Quantitative Tightening starting mid-year that will eventually be more aggressive than it was in 2018-19, maybe reducing the balance sheet by $100 billion per month. If we’re right, that would mean one year of peak QT by the Fed is even more debt being sold than all the debt China owns. And yet, the 10-year yield is still 1.8%. We know the Quantitative Tightening isn’t an exact equivalent to China selling debt. But the comparison still puts the size of a potential China selloff in perspective.

Sixth, it’s important to remember that China didn’t buy our debt as a favor to the US; they bought our debt out of self-interest. Using Treasury debt to back up their currency makes people more willing to use the renminbi. If China’s government sells its Treasury debt, that appetite for the relative safety of the dollar won’t disappear and citizens in China could offset this sale by buying more dollar-denominated assets.

Seventh, and most important of all, we need to recognize that interest rates are a function of economic fundamentals and expectations about the future, not who is buying and selling how much Treasury debt on any particular day.

If China sells its Treasury debt, it’s going to end up getting dollars in return. What will it do with those dollars? Swap them for a different currency…let’s say Euros? Then whomever it swaps with will have the dollars. What will they do with those dollars? If China’s sales of bonds drive up rates, whoever gets the dollars would likely turn around and buy US bonds. The result? No fewer dollars or bonds in the world.

The US debt that China owns is more problematic for China than it is for the US. Moreover, if China sells US debt because it fears sanctions, then it will likely sell European debt as well. In the end, it’s not the US that has a problematic conundrum.

China invading Taiwan would be a horrible event. But the fear of China hurting our economy by selling our debt is overblown.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

3-7 / 2:00 pm Consumer Credit– Jan $24.5 Bil $20.7 Bil $18.9 Bil

3-8 / 7:30 am Int’l Trade Balance – Dec -$87.4 Bil -$87.4 Bil -$80.7 Bil

3-10 / 7:30 am Initial Claims – Mar 6 217K 215K 215K

7:30 am CPI – Feb +0.8% +0.7% +0.6%

7:30 am “Core” CPI – Feb +0.5% +0.5% +0.6%

3-11 / 9:00 am U. Mich Consumer Sentiment- Feb 61.3 62.8 62.8

The State of Ukraine, The Fed, & The Union

March 1, 2022 Tyler Goodrich

Please join Raymond James Chief Investment Officer Larry Adam and other thought leaders for an update on the situation in Ukraine, and a preview of what may come in Fed Chair Powell’s semi-annual testimony to Congress and President Biden’s State of the Union address. Joining him on the webinar will be:

Frank Kelly, Senior Political Strategist for DWS & Managing Partner of Fulcrum Macro Advisors LLC*
Tracey Manzi, Senior Investment Strategist
James Camp, Managing Director, Strategic Income, Eagle Asset Management**

* DWS & Fulcrum Macro Advisors, LLC is not affiliated with Raymond James

** An affiliate of Raymond James & Associates, Inc., and Raymond James Financial Services, Inc.

Click on the link below to register

https://raymondjames.zoom.us/webinar/register/WN_AwfxToTFQYOV3jGpynjz_w

Matt Goodrich, Financial Advisor

President, Goodrich and Associates, LLC

Branch Manager, Raymond James Financial Services

12 Bellwether Way, Suite 215 // Bellingham, WA 98225 // 360.671.0226
matt.goodrich@raymondjames.com // goodrichassociates.net

© 2022 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. © 2022 Raymond James Financial Services, Inc., member FINRA/SIPC. Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value.

All expressions of opinion reflect the judgment of the author(s) and are subject to change. Content provided herein is for informational purposes only. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Economic and market conditions are subject to change. Past performance may not be indicative of future results.

February Market Review

March 1, 2022 Tyler Goodrich

March 1, 2022

Dear Friends and Clients,

Investors have been on a bumpy ride as both domestic and emerging markets have seen continued volatility over the past few months. February was no exception with the broad-market S&P 500 dipping into its first 10% correction in almost two years as geopolitical tensions intensified. The last week of February brought the somber news of escalating conflict in Eastern Europe. I, along with many of you, hope for a peaceful resolution soon without further loss of life.

The world continues to watch this very fluid situation between Russia and Ukraine. While the conflict is troubling, investors need not overreact, advises Raymond James Chief Investment Officer Larry Adam. We’re likely to see the biggest financial impact in the form of increased prices on commodities produced in the region, namely oil, natural gas, wheat, palladium and aluminum.

The situation has added to macro uncertainty and impacted legislative priorities on Capitol Hill, says Ed Mills, Washington Policy Analyst. Generally speaking, defense considerations and supply chain security/domestic manufacturing capability have risen on the congressional to-do list. President Biden’s March 1 State of the Union address will inform the direction of the domestic agenda and potential policy changes.

Investors are factoring in tighter monetary policy. The Fed is expected to start raising short-term interest rates in March and begin reducing its balance sheet later this year. Compared to the start of previous tightening cycles, the U.S. economic outlook is a lot stronger, the labor market is a lot tighter, and inflation is substantially higher, notes Raymond James Chief Economist Scott Brown.

The crisis will weigh on a market already struggling with high inflation and the coming transition to tighter monetary policy, says Mike Gibbs, managing director of Equity Portfolio & Technical Strategy. Gibbs notes that despite elevated uncertainty, history shows that geopolitical events such as this often create a buying opportunity for long-term investors.

In the United States, a late rally helped the S&P 500 regain some of its earlier losses for the month. Let’s look at the longer-term numbers:

Higher commodity prices would weigh on global consumer spending, including in the U.S. Russia may be tempted to retaliate against aggressive sanctions by limiting energy exports to the European Union (EU), though Russia’s own economy would feel even more pain in this scenario. The crisis has raised the issue of energy security across Europe. It’s a good bet that European policymakers feel an urgency to reduce dependence on Russian oil and gas, which aligns with the EU’s climate agenda to move away from fossil fuels and toward renewable energy and electric vehicles.

Despite the conflict, losses were modest in Europe and the U.K. The region’s fourth quarter 2021 corporate earnings season came in slightly higher than expectations, although inflationary challenges have increased across much more than oil or gas prices. The conflict could also hinder wheat supply, as well as the global supply of palladium, which is needed for fuel cells, solar energy and electric vehicles.

Bottom line

Despite uncertainty, geopolitical conflicts tend to create buying opportunities for long-term equity investors, who may want to strategically add positions in select sectors (e.g., materials, energy and financials). Equity declines associated with previous conflicts typically are followed by higher markets six to 12 months later, analysis shows. We expect to see more market turbulence over the next several months. For now, equity valuations remain attractive and economic fundamentals remain strong in our view. Corrections can be uncomfortable, and I encourage long-term investors to stay patient.

I firmly believe a disciplined financial plan gives you the best chance of making progress toward your future goals. Thank you for your continued trust in me. Please feel free to reach out with any questions.

Sincerely,

Matt Goodrich, Financial Advisor

President, Goodrich & Associates, LLC

Branch Manager, RJFS

Investing involves risk, and investors may incur a profit or a loss. All expressions of opinion reflect the judgment of the authors and are subject to change. There is no assurance the trends mentioned will continue or that the forecasts discussed will be realized. Past performance may not be indicative of future results. Economic and market conditions are subject to change. The Dow Jones Industrial Average is an unmanaged index of 30 widely held stocks. The NASDAQ Composite Index is an unmanaged index of all common stocks listed on the NASDAQ National Stock Market. The S&P 500 is an unmanaged index of 500 widely held stocks. The MSCI EAFE (Europe, Australia, Far East) index is an unmanaged index that is generally considered representative of the international stock market. The Russell 2000 is an unmanaged index of small-cap securities. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. An investment cannot be made in these indexes. The performance mentioned does not include fees and charges, which would reduce an investor’s returns. Small-cap securities generally involve greater risks. International investing is subject to additional risks, such as currency fluctuations, different financial accounting standards by country, and possible political and economic risks. These risks may be greater in emerging markets. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Material prepared by Raymond James for use by its advisors.

Thoughts on Ukraine

February 28, 2022 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

February 28, 2022

They say the truth is the first casualty of war…so, here we are about one week into the Russian invasion of Ukraine and the fog of war is still very thick.

Over the past few weeks, it has been conventional wisdom that Russia would take parts of Ukraine (maybe all) and then things would settle down while the world awaited further actions. In the worst-case scenario, those moves could include closing the current 40-mile wide border between Poland and Lithuania, which could lead to direct NATO military involvement and a wider conflict.

So far, things haven’t unfolded as many thought they would. Supply-chain issues for the Russian military and formidable opposition are slowing Russia’s advance. In addition, more sanctions and military help from countries around the world have given many hope that hostilities end early with Russia falling well short of its goals.

If Russia is unable to take control of Ukraine or even forced to retreat, Vladimir Putin could be in more than just political trouble. His inner circle may not like risking access to their personal wealth on what they might believe is an ill-advised military adventure. For Putin, this is a huge incentive to continue his attack, and escalate. Nothing is totally clear.

What we are more confident about is what the conflict means for public policy. Policies designed to suppress US energy production are going to be tougher for the voting public to digest. The same is true for many European countries, with Germany now discussing building a natural gas reserve.

How about green energy? Many will keep pushing it, and those projects will continue, but it’s going to be tougher to curtail drilling, extraction, and pipelines for old-fashioned fossil fuels.

Meanwhile, Build Back Better, President Biden’s plan to raise spending and taxes for the next decade, looks even less likely than before. War means disruption and many will argue we should wait and see how the economy reacts to the conflict.

In addition, while the war will likely make global supply chain issues even more problematic and inflationary, the Federal Reserve is likely to pull back on tightening plans because of the potential economic upheaval. A rate hike of 50 basis points in March is unlikely.

Meanwhile, at least one polling average now shows the GOP ahead in the congressional generic ballot by 3.7 points over the Democrats. Comparing this to historical readings suggests the government will be politically divided in 2023. In turn, divided government reduces the odds of future tax hikes and spending increases.

In addition, while not related to Ukraine, we think the Supreme Court’s recent decision slapping down private-sector vaccine mandates by OSHA is a sign that it is willing to limit the power of bureaucrats. This is good news for growth.

Put it all together and we think the prospects for more bills that expand government are waning while the Court seems to be more wary of regulatory expansions, as well.

While war is hell and our prayers are with the Ukrainians, the direction of policy is moving toward the better.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

2-28 / 8:45 am Chicago PMI – Feb 62.3 64.3 56.3 65.2

3-1 / 9:00 am ISM Index – Feb 58.0 58.2 57.6

9:00 am Construction Spending – Dec -0.1% +0.6% +0.2%

afternoon Total Car/Truck Sales – Feb 14.5 Mil 14.2 Mil 15.0 Mil

afternoon Domestic Car/Truck Sales – Feb 11.3 Mil 10.9 Mil 11.7 Mil

3-3 / 7:30 am Initial Claims – Mar 2 225K 226K 232K

7:30 am Q4 Non-Farm Productivity +6.6% +6.9% +6.6%

7:30 am Q4 Unit Labor Costs +0.3% +1.4% +0.3%

7:30 am ISM Non Mfg Index – Feb 61.0 61.1 59.9

9:00 am Factory Orders – Dec +0.5% +1.5% -0.4%

3-4 / 7:30 am Non-Farm Payrolls – Feb 400K 380K 467K

7:30 am Private Payrolls – Feb 408K 350K 444K

7:30 am Manufacturing Payrolls – Feb 22K 23K 13K

7:30 am Unemployment Rate – Feb 3.9% 3.8% 4.0%

7:30 am Average Hourly Earnings – Feb +0.5% +0.4% +0.7%

7:30 am Average Weekly Hours – Feb 34.6 34.6 34.5

Initial Thoughts on Ukraine and the Markets

February 28, 2022 Tyler Goodrich

First Trust Economic Video Commentary

Brian S. Wesbury - Chief Econmist

February 24, 2022

Anything can happen in war, and our hearts go out to the people impacted by Russia's actions.

But we have to analyze what impact these events will have on the US economy and markets.

Click here for Brian Wesbury's initial thoughts

Russia and Ukraine – On The Edge

February 25, 2022 Tyler Goodrich

Raymond James Client Webinar

Larry Adam - Chief Investment Officer

February 24, 2022

Staying informed about current economic and financial market developments is key to successful financial planning. That’s why I’m sharing with you this webinar featuring Raymond James Chief Investment Officer Larry Adam, which was recorded on Thursday, February 24. It contains some great insights into the financial markets. I hope you find it as informative as I did.

Please feel free to get in touch if you’d like additional perspective or guidance. I’m always available to discuss any concerns or questions you may have about your portfolio or to explore how you may benefit from personalized financial planning.

Click on the link below to watch the webinar.

https://www.raymondjames.com/investment-strategy-client-call

Sticking to Our Targets, For Now

February 22, 2022 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

February 22, 2022

Late last year we unveiled our stock market forecast for 2022, projecting the S&P 500 would rise to 5,250 and the Dow Jones Industrials average would climb to 40,000. Since then, however, equities have dropped, with (now realized) fears about Russia invading Ukraine and the recognition that inflation is a more persistent problem than the Federal Reserve had previously let on, which means some combination of faster rate hikes or a higher ultimate peak for short-term interest rates, or both.

Reaching our year-end equity targets would now take a steeper climb than we previously thought: 20.7% for the S&P 500 and 17.4% for the DJIA, from Friday’s close. But we still like those targets and don’t see enough reason to change them.

As we wrote last week, Russia would likely invade Ukraine by soon after the Olympics ended, but that such an invasion is unlikely to change the long-term outlook for corporate profits. As a result, any drop in equities would end up being a buying opportunity.

Sure, the Biden Administration might try to exert pressure on Russia through economic and financial sanctions. But other countries, like China and Germany, have strong interests in continuing to exchange freely with Russia. Ultimately, right or wrong, we think the Biden Administration is more concerned about managing its image involving the Russia-Ukraine conflict, for purposes of domestic politics (like, not “appearing weak”), than trying to alter the outcome of the conflict itself.

Meanwhile, and for the time being, inflation is likely to be equities’ friend, not their foe. Companies with pricing power, commodities’ companies, and materials’ firms, in particular, should do well.

In addition, the message from our Capitalized Profits Model hasn’t changed, at least not yet. The cap profits model takes the government’s measure of profits from the GDP reports, discounted by the 10-year US Treasury note yield, to calculate fair value. Corporate profits for the third quarter were up 19.7% versus a year ago, up 21.2% versus the pre-COVID peak at the end of 2019, and at a record high.

The key question then becomes what discount rate should we use? If we use 1.90%, roughly the current 10- year Treasury yield, our model suggests the S&P 500 is still grossly undervalued. But, with the Fed about to embark on a series of rate hikes and inflation likely to keep running relatively hot, the 10-year yield is likely to keep rising, although with fits and starts.

So, to be cautious, we plug in some alternative higher long-term interest rates. Using third quarter profits, it would take a 10-year yield of about 3.00% for our model to show that the stock market is currently trading at fair value. And that assumes no further growth in profits. With a 10- year yield of 2.50% all it would take is profits 3% above the level in Q3 for our model to estimate fair value at 5,250, which is what we projected for the end of 2022.

The bottom line is that the winds of change are blowing hard in 2022: COVID is winding down, borders are in flux, and monetary policy is in for a major and long overdue shift. In spite of these changes, we think equities are likely to rebound from recent strife and work their way higher this year. The bull market in stocks won’t last forever. But, for now, it isn’t at an end.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

2-24 / 7:30 am Initial Claims – Feb 20 235K 237K 248K

7:30 am Q4 GDP Second Report 7.0% 7.1% 6.9%

7:30 am Q4 GDP Chain Price Index 6.9% 6.9% 6.9%

9:00 am New Home Sales – Jan 0.803 Mil 0.849 Mil 0.811 Mil

2-25 / 7:30 am Durable Goods – Dec +1.0% +2.3% -0.7%

7:30 am Durable Goods (Ex-Trans) – Dec +0.4% +0.2% +0.6%

7:30 am Personal Income – Jan -0.3% -1.0% +0.3%

7:30 am Personal Spending – Jan +1.6% +1.6% -0.6%

9:00 am U. Mich Consumer Sentiment- Feb 61.7 61.7 61.7

Russia and Rate Hikes

February 14, 2022 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

February 14, 2022

The financial markets have been on tenterhooks lately for two main reasons: Russia and rate hikes.

By the time you read this, Russian tanks may already be rolling across the Ukrainian border. If not, we think an invasion of eastern Ukraine will probably start soon after the Olympics, to avoid embarrassing China, which is a Russian ally (for now). Not invading at all after a big build-up of troops, arms, and equipment, would make it tough for Russia to bluff in the future. By contrast, re-incorporating more of Ukraine into Russia would seal for Vladimir Putin an esteemed place in Russian history.

An invasion would likely set off a flight to lower-risk assets, but we don’t think it changes the outlook for corporate profits over time, and so any downdraft in equities would be temporary and a buying opportunity.

Meanwhile, financial markets are also agonizing about how far and how fast the Fed will have to go to fight inflation. At the end of 2021, the futures market in federal funds was pricing in 75 basis points of rate hikes this year. Now the market is pricing in 150 - 175 bps.

Those hikes aren’t just warranted, they’re needed. Consumer prices are up 7.5% from a year ago, the fastest gain since the early 1980s. “Core” prices, which exclude food and energy, are up 6.0% from a year ago. And with the M2 measure of money up more than 40% since the start of COVID, there is plenty of inflation in the pipeline.

Given these data and the willingness of relatively dovish policymakers to consider rate hikes, we now think the Fed will raise rates 125 basis points this year. The most likely path would be a series of 25 bp rate hikes at the next four meetings, in March, May, June, and July, followed by a pause during election season, then one more hike in December. That makes five total in 2022.

Some analysts and investors think the Fed will go 50 in March. We’d love that! The Fed is way behind the inflation curve and needs to catch up. But we don’t yet think 50 will happen. Why? Because if the Fed is willing to go 50, it wouldn’t still be expanding the balance sheet. What would change our minds: if the Fed announces a sudden and early end to QE, then 50 becomes our base case for March.

The other open question is how forcefully the Fed will pursue Quantitative Tightening. The fastest pace of QT in the prior cycle was $50 billion per month. We think the Fed starts QT around mid-year, gets to a $50 billion monthly pace by year end, and eventually gets to a $75 - 100 billion pace range in 2023.

The key to remember, though, is that there’s a huge difference between the Fed becoming “less loose” versus “tight.” A tight Fed is still a long way off. For the moment, long-term investors think the Fed can wrestle inflation back under control with relative ease. The Fed calculates what the Treasury market expects inflation to average in the five-year period starting five years from now. It’s called “five-year forward inflation.” And that inflation forecast is still below 2.5%.

As a result, for 2022, we do not think higher short-term rates will immediately generate an equal reaction in longer-term yields. Longer-term yields should move up and will be a headwind for equities, but equities should also move higher as profit growth (for the time being) more than fully offsets that problem. The key issue is when investors realize the Fed can’t wrestle inflation down quickly and must push rates even higher. We think that’s 2023 and beyond.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

2-15 / 7:30 am PPI – Jan +0.5% +0.6% +0.2%

7:30 am “Core” PPI – Jan +0.4% +0.3% +0.5%

7:30 am Empire State Mfg Survey – Feb 12.0 20.0 -0.7

2-16 / 7:30 am Retail Sales – Dec +2.0% +2.5% -1.9%

7:30 am Retail Sales Ex-Auto – Dec +1.0% +1.1% -2.3%

7:30 am Import Prices – Jan +1.2% +0.6% -0.2%

7:30 am Export Prices – Jan +1.1% +1.0% -1.8%

8:15 am Industrial Production – Jan +0.5% +0.6% -0.1%

8:15 am Capacity Utilization – Jan 76.8% 76.9% 76.5%

9:00 am Business Inventories – Nov +2.1% +2.1% +1.4%

2-17 / 7:30 am Initial Claims – Feb 12 218K 225K 223K

7:30 am Housing Starts – Jan 1.696 Mil 1.690 Mil 1.702 Mil

7:30 am Philly Fed Survey – Feb 20.0 25.3 23.2

2-18 / 9:00 am Existing Home Sales – Jan 6.100 Mil 6.210 Mil 6.180 Mil

Not All That

February 7, 2022 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

February 7, 2022

Nothing is normal about the current business cycle; it really is unique. It started with a massive COVID-related lockdown, which caused the deepest and fastest recession on record. Then we had a recovery based on re-opening plus an unprecedented peacetime expansion in government spending. But rarely have we seen an economic report as misinterpreted as Friday’s jobs report.

The key headline that investors and analysts rejoiced about was the 467,000 increase in nonfarm payrolls, not only well above the consensus expected 125,000 but also well above the highest forecast from any economic group. And if that were the only piece of information in the entire report, it would make sense to celebrate.

But there are plenty of other key pieces of data in every jobs report. One of them is the number of hours worked and that part of the report was not strong at all. Average weekly hours per worker declined to 34.5 in January from 34.7 in December. As a result, the total number of hours worked fell 0.3%, the largest decline in almost a year.

If that 0.3% drop had come in the form of fewer jobs while the number of hours per worker didn’t change at all, private payrolls would have declined about 350,000 in January. Obviously, in that scenario, many of the investors and analysts who cheered Friday’s report would have been jeering, instead. And, yet, both situations have the same exact demand for total hours from workers by businesses across the US.

But what about the huge 709,000 upward revisions in payrolls in November and December? Usually we’re big fans of including revisions for prior months when assessing a payroll report. However, the January report every year is different. It’s the one time a year when those revisions should be ignored. Why? Because it’s the month when the Labor Department goes back and revises monthly seasonal adjustment factors for the whole calendar year. This year, November and December figures were revised up substantially, but all those gains came out of June and July, which were revised down.

But how about those stellar numbers from the other part of the employment report? Civilian employment, an alternative measure of jobs that includes small-business start-ups, rose almost 1.2 million in January, appearing to confirm the strength of the headline growth in payrolls. Meanwhile, it looked like the labor force (the number of people working or looking for work) grew almost 1.4 million.

However, once again, a statistical quirk was at work. Every January, the Labor Department inserts into the jobs report new Census Bureau estimates on the total size of the US population, which, in turn, affects the numbers on the labor force and employment. That population adjustment was responsible for all the increase in civilian employment and the labor force in January; without that quirk, Labor would have reported a 272,000 drop in civilian employment and a 137,000 decline in the labor force.

But what about the increase in wages? Average hourly earnings grew 0.7% in January. That’s certainly a rapid pace and very likely outpaced inflation in January. But these wages are up only 5.7% in the past year, which is almost certainly slower than inflation over the same twelve months and which is no reason to celebrate. We are not asserting the January jobs report was “bad” news, that the US is teetering on the edge of a recession, or that the Federal Reserve should call off its intention to raise short-term rates, stop Quantitative Easing, or start Quantitative Tightening.

Far from it. We expect continued job growth in the months ahead and a rebound in hours worked. The Fed was behind the inflation curve before Friday’s report and still is today. We still expect rate hikes starting in March – we think 25 basis points, although the futures market is pricing in a significant shot of 50 – as well as an end to QE in March and a start to QT around midyear.

But we’ve never been shy about bucking the conventional wisdom when we think it’s wrong and we’re not about to start: Friday’s jobs report was mediocre, not the very positive news most investors and analysts thought it was. We expect that the year or two ahead will have multiple occasions like this; both when we think the data are worse than others think, as well as when we think it’s better. We will tell you every time.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

2-7 / 2:00 pm Consumer Credit– Dec $21.9 Bil $21.8 Bil $40.0 Bil

2-8 / 7:30 am Int’l Trade Balance – Dec -$83.0 Bil -$83.4 Bil -$80.2 Bil

2-10 / 7:30 am Initial Claims – Feb 5 230K 235K 238K

7:30 am CPI – Jan +0.4% +0.5% +0.5%

7:30 am “Core” CPI – Jan +0.5% +0.5% +0.6%

2-11 / 9:00 am U. Mich Consumer Sentiment- Feb 67.3 69.0 67.2

January Market Review

February 1, 2022 Tyler Goodrich

February 1, 2022

Dear Friends and Clients,

Volatility was the trend for domestic and foreign equity markets in January, as well as the domestic bond market, albeit to a lesser extent. The broad-market S&P 500 flirted with a 10% pullback, for example. The ups and downs in the domestic equity indices stabilized briefly ahead of the Federal Reserve’s (Fed’s) meeting, which left short-term interest rates unchanged, but turned skittish shortly after Fed Chair Jerome Powell announced there was “quite a bit of room” to raise rates in the near future. The market seemed to have priced in three hikes this year but may have presumed the announcement meant the central bankers planned two more moves in response to inflationary pressures, explains Raymond James Chief Investment Officer Larry Adam.

Powell said that no decisions have been made as yet, but he could not rule out raising rates more aggressively if warranted. Chief Economist Scott Brown believes accelerated increases are not necessarily a foregone conclusion but notes that the labor market is tight, and inflation is well above the Fed’s long-term goal of 2%.

With uncertainty regarding inflation, economic slowing (though it remains at a healthy growth rate) and a Fed tightening cycle upon us, we may be in for several months of volatility before the market can resume its uptrend, notes Joey Madere, senior portfolio strategist, Equity Portfolio & Technical Strategy. Headwinds also include geopolitical tensions between Russia and Ukraine as well as uncertainty over the direction of U.S. policy. In Washington, D.C., the current focus appears to be on economic competition and China policy, which has the potential to boost next-generation technology and domestic manufacturing, adds Washington Policy Analyst Ed Mills.

Let’s look at the longer-term numbers:

As we close out the month, here are a few trends we’re keeping an eye on:

Sector roundup

We are also seeing slow progress toward a revised and targeted Build Back Better bill, which could direct additional federal funding toward energy and renewables, healthcare, and education, but the potential timeline for a final deal remains unclear.

Technology companies have borne the brunt of market weakness this year as higher interest rates put pressure on high valuations. While valuations remain relatively expensive, importantly, information technology demand remains strong and supportive of the sector’s backdrop.

Tension on the Russia-Ukraine border drove up natural gas prices in the European market as Russia deliberately curtailed its export volume. We believe that Russia’s aggressive strategy is partly economic and partly political. In the meantime, the U.S. and other exporters are bolstering supply. Concern about excessive dependence on Russian oil and gas will likely accelerate energy transition toward wind, solar and energy efficiency, notes Energy Analyst Pavel Molchanov.

Around the world

Almost all equity markets across Europe, Asia and the world’s other emerging economies saw losses in January. However, performance was best in the U.K. and select emerging markets in Latin America due to a range of strong commodity sector performances. A little over half of early corporate earnings season updates in Europe and Asia have been ahead of expectations, but both February and March will provide more detailed insights.

Unsurprisingly, the latest International Monetary Fund survey showed a reduction in 2022 economic growth expectations. While a number of emerging market central banks raised interest rates during January, the People’s Bank of China continued to soften monetary policy in an attempt to counter slowing Chinese growth levels. The European Central Bank will not change its formal negative interest rate policy for at least a few quarters, but the Bank of England is set to further raise its interest rates in February.

The bottom line

As we approach the two-year anniversary of this bull market where, historically, returns become more moderate, volatility increases and investors become more discerning (e.g., selectivity becomes critical), it is important that market participants remain patient, committed to their investment strategy and avoid any knee-jerk portfolio moves.

We have said in recent months that volatility and pullbacks are to be expected throughout 2022, although overall conditions are likely to remain healthy. And wider spreads coupled with higher Treasury yields translates to higher income opportunities for fixed income investors. Savvy investors may elect to thoughtfully add to their portfolios at opportune times. I’m here to provide you not only with insight, but with advice on how we can work to help manage the effects of – and capitalize upon – the markets’ movements.

I know that volatility can be unnerving but sticking to a financial plan has historically worked in favor of long-term investors, which is why I remain focused on helping you make progress toward your future goals. Thank you for your continued trust in me. Please feel free to reach out with any questions.

Sincerely,

Matt Goodrich, Financial Advisor

President, Goodrich & Associates, LLC

Branch Manager, RJFS

Investing involves risk and investors may incur a profit or a loss. All expressions of opinion reflect the judgment of the authors and are subject to change. There is no assurance the trends mentioned will continue or that the forecasts discussed will be realized. Past performance may not be indicative of future results. Economic and market conditions are subject to change. The Dow Jones Industrial Average is an unmanaged index of 30 widely held stocks. The NASDAQ Composite Index is an unmanaged index of all common stocks listed on the NASDAQ National Stock Market. The S&P 500 is an unmanaged index of 500 widely held stocks. The MSCI EAFE (Europe, Australia, Far East) index is an unmanaged index that is generally considered representative of the international stock market. The Russell 2000 is an unmanaged index of small-cap securities. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. An investment cannot be made in these indexes. The performance mentioned does not include fees and charges, which would reduce an investor’s returns. Small-cap securities generally involve greater risks. International investing is subject to additional risks, such as currency fluctuations, different financial accounting standards by country, and possible political and economic risks. These risks may be greater in emerging markets. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Material prepared by Raymond James for use by its advisors.

Rate Hikes Finally on the Way

January 31, 2022 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

January 31, 2022

The Federal Reserve’s policy statement from last week plus Jerome Powell’s post-meeting press conference made it abundantly clear it is ready to start raising short-term interest rates in March.

As of early this morning, the futures market for federal funds was pricing in five rate hikes (of 25 basis points each) in 2022. We think that many rate hikes are warranted; we’d even support more. The Fed is badly behind the inflation-fighting curve. The Consumer Prices Index rose 7.0% in 2021, the largest increase for any calendar year since 1981. Meanwhile, commodity prices continue to rise.

However, we’re still skeptical the Fed will move as aggressively as the financial markets are pricing in. If the Fed were really serious about the inflation fight, why didn’t it announce a sudden and early end to Quantitative Easing last week? Instead, the Fed maintained QE, which increases the size of its balance sheet, even as it released a set of “principles” for reducing the size of the balance sheet.

Think about how absurd the current situation is. Maintaining QE while signaling it will soon start Quantitative Tightening is like deciding to keep digging a hole deeper, even though you already know that in an hour you’re going to take all the dirt you dug up and use it to fill the same hole back in. Why not just stop digging now!

Either way, we think QT starts around mid-year and the Fed will be more aggressive about it than it was back in 2017-19, when the fastest pace of QT was about $50 billion per month. The best reason to implement a larger QT is that the Fed needs to counteract the excessive growth in the M2 measure of the money supply that is the root cause of higher inflation. Unfortunately, the Fed is still not focused on reducing M2 as a policy goal.

Instead, we think the Fed will pursue a robust pace of QT for other reasons. First, the Fed would use QT as a signal of its commitment to keep lifting rates, knowing that market conditions may, from time to time, make it temporarily tougher for the Fed to hike. Second, the Fed thinks selling off longer maturity securities could modestly lift long-term interest rates, creating more room for it to raise short-term rates without inverting the yield curve.

And third, if the Fed doesn’t substantially reduce the balance sheet, it could be a position in a few years where it’s paying large financial institutions around $100 billion per year. That’s what would happen if the banks are still holding $4 trillion in Fed reserves while short-term rates have hit 2.5%. No Fed chief wants to explain to Congress why it’s paying the biggest US banks $100 billion per year.

The bottom line is that the Fed has its work cut out for it. This won’t be a one-year job, or even two. Wrestling inflation back under control may take several years. The sooner the Fed focuses its attention on M2 and renews its respect for Milton Friedman the easier that job will be.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

1-31 / 9:00 am Chicago PMI – Jan 61.8 61.8 65.2 64.3

2-1 / 9:00 am ISM Index – Jan 57.5 58.0 58.8

9:00 am Construction Spending – Dec +0.6% +0.3% +0.4%

afternoon Total Car/Truck Sales – Jan 12.9 Mil 14.7 Mil 12.4 Mil

afternoon Domestic Car/Truck Sales – Jan 10.4 Mil 11.5 Mil 9.9 Mil

2-3 / 7:30 am Initial Claims – Jan 30 245K 250K 260K

7:30 am Q4 Non-Farm Productivity +3.3% +5.1% -5.2%

7:30 am Q4 Unit Labor Costs +1.0% +0.9% +9.6%

9:00 am ISM Non Mfg Index – Jan 59.5 60.1 62.3

9:00 am Factory Orders – Nov -0.4% -1.0% +1.6%

2-4 / 7:30 am Non-Farm Payrolls - Jan 150K 175K 199K

7:30 am Private Payrolls – Jan 113K 185K 211K

7:30 am Manufacturing Payrolls – Jan 23K 25K 3.9%

7:30 am Unemployment Rate – Jan 3.9% 3.8% +0.8%

7:30 am Average Hourly Earnings – Jan +0.5% +0.4% +0.6%

7:30 am Average Weekly Hours - Jan 34.7 34.7 34.7

The 2021 Finish: Fast Growth, High Inflation

January 24, 2022 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

January 24, 2022

When fourth quarter GDP data is released later this week, it will show that 2021 finished on a high note. Unfortunately, the high note included not only strong economic growth but also rapid inflation. This shouldn’t be a surprise; it’s what you get when you mix a huge surge in government spending with very loose monetary policy.

At present, we estimate that real GDP grew at a 5.7% annual rate in the fourth quarter. If we’re right, then real GDP grew 5.2% in 2021 (Q4/Q4), the fastest pace for any calendar year since the Reagan Boom in 1984. However, that rapid growth follows a 2.3% contraction in 2020. As a result, real GDP at the end of last year was up only 1.4% annualized versus the end of 2019 (the last quarter before COVID). That’s slower than the pre-COVID trend in economic growth, which means that in spite of the fastest growth in decades last year, the economy remains smaller than it would have been if COVID and all the related lockdowns hadn’t happened. Glass half-full, glass half empty.

The same can’t be said about inflation, which is clearly higher than the pre-COVID trend. We estimate that GDP prices rose at a 5.9% annual rate in the fourth quarter, which would bring the 2021 (Q4/Q4) increase to 5.6%, the highest inflation for any calendar year since 1981. That follows a moderate 1.5% gain in 2020.

Bear in mind that we get a report on Wednesday that will tell us about inventories and international trade in December, and those figures may change our projections a little. But, as of now, here’s how we get to our 5.7% real GDP growth forecast for the fourth quarter.

Consumption: Car and light truck sales fell at a 15.5% annual rate in Q4, largely due to continued supply-chain issues. However, “real” (inflation-adjusted) retail sales outside the auto sector rose at a 1.0% rate and it looks like real services spending should be up at a solid pace. Putting it all together, we estimate real consumer spending on goods and services, combined, increased at a moderate 2.0% annual rate, adding 1.4 points to the real GDP growth rate (2.0 times the consumption share of GDP, which is 69%, equals 1.4).

Business Investment: The fourth quarter should show slight growth in both business investment in equipment as well as commercial construction, while investment in intellectual property rose at a typically strong rate. Combined, business investment looks like it grew at a 5.3% annual rate, which would add 0.7 points to real GDP growth. (5.3 times the 13% business investment share of GDP equals 0.7).

Home Building: Residential construction looks like it slowed slightly in the fourth quarter. That’s not due to less demand – sales are trending higher and inventories remain very low – but instead reflects supply-chain issues and lingering problems finding willing workers. We estimate a contraction at a 4.3% annual rate in Q4, which would cut 0.2 points from real GDP growth. (-4.3 times the 5% residential construction share of GDP equals -0.2).

Government: Remember, only direct government purchases of goods and services (and not transfer payments like unemployment insurance) count when calculating GDP. We estimate federal purchases grew at a 1.1% annual rate in Q4, which would add 0.2 points to real GDP growth. (1.1 times the 18% government purchase share of GDP equals 0.2).

Trade: Imports and exports have both recovered but imports have recovered faster, which should result in a slightly larger trade deficit in Q4. At present, we’re projecting that the increase in imports relative to exports will subtract 0.1 points from real GDP growth in Q4.

Inventories: Inventories look like they finally started surging in Q4. Inventories are still very low, but they’re moving in the right direction. We estimate that the surge will add 3.7 points to real GDP growth.

Add it all up, and we get a 5.7% annualized real GDP growth for the fourth quarter. Look for continued growth in 2022, but not nearly as fast, as the artificial “sugar high” from excessive government spending runs its course.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

1-26 / 9:00 am New Home Sales – Dec 0.760 Mil 0.778 Mil 0.744 Mil

1-27 / 7:30 am Initial Claims – Jan 25 265K 230K 286K

7:30 am Q4 GDP Advance Report 5.3% 5.7% 2.3%

7:30 am Q4 GDP Chain Price Index 6.0% 5.9% 6.0%

7:30 am Durable Goods – Dec -0.6% -0.7% +2.6%

7:30 am Durable Goods (Ex-Trans) – Dec +0.4% +0.3% +0.9%

1-28 / 7:30 am Personal Income – Dec +0.5% +0.8% +0.4%

7:30 am Personal Spending – Dec -0.6% -0.4% +0.6%

9:00 am U. Mich Consumer Sentiment- Jan 68.8 69.5 68.8

Who Gets the Blame for Inflation

January 18, 2022 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

January 18, 2022

Consumer prices rose 7.0% in 2021, the largest increase for any calendar year since 1981. As a result, politicians across the political spectrum are working overtime to find someone to blame and attack.

Some politicians on the left are blaming “greedy” businesses for inflation. But we find this explanation completely ridiculous. Of course, businesses are greedy, in the sense that they’re run by people who are free to maximize their earnings!

But businesses are no greedier today than they were before COVID. In the ten years before COVID, the consumer price index increased at a 1.8% annual rate; in the twenty years before COVID, the CPI rose at a 2.1% annual rate. Both figures are a far cry from 7.0%.

Those blaming greedy businesses for higher inflation have no rational explanation for why businesses somehow missed all the opportunities to raise prices faster in previous decades but suddenly had a “eureka moment” and decided to do so in 2021. Under this economically illiterate theory, think of all the profits they’ve voluntarily foregone for decades.

Meanwhile, think about the rapid increase in workers’ pay in 2021, when average hourly earnings rose 4.7%. Did workers suddenly become greedier, too? Is all this greed contagious? Can we stop it by wearing masks? What does the CDC have to say?

But the political left is not alone in misunderstanding higher inflation. Some politicians on the right are saying the inflation is due to the huge surge in COVID-related government spending and budget deficits. Part of this is likely tactical: by blaming government spending and deficits, they can reduce the odds of passing the Biden Administration’s Build Back Better proposal, which they’d like to see defeated.

What they’re missing is that there is no consistent historical relationship between higher spending, larger deficits, and more inflation. Yes, inflation grew in the late 1960s after the introduction of the Great Society programs. But government spending also soared in the 1930s under Roosevelt’s New Deal, without a surge in inflation. Budget deficits soared in the early 1980s and inflation fell. The Panic of 2008 led to a surge in government spending and deficits and inflation remained tame.

So, if it’s not greed or government spending, by itself, then what is causing higher inflation? We think it’s loose monetary policy. The M2 measure of the money supply has soared since COVID started. That is the (not-so-secret) policy ingredient that has converted extra government spending and deficits into more inflation rather than higher interest rates.

That, in turn, makes it important to follow the path of monetary policy this year and beyond. In recent weeks, a number of Fed policymakers have hinted at rate hikes starting in March, including Mary Daly, the president of the San Francisco Fed and considered a dove. Rule of thumb: when the doves get hawkish and start hinting at rate hikes, it’s time to believe the hints.

The futures market in federal funds is pricing in four rate hikes this year. For now, we think the most likely policy path is three hikes – 25 basis points each: in March, June, and December, with a hiatus for the mid-term election season.

In addition, we think the Fed finishes up Quantitative Easing (QE) in March and starts Quantitative Tightening (QT) around mid-year. The easiest and most straightforward way for the Fed to do QT would be by selling Treasury and mortgage backed securities to the banks and having the banks buying them send their reserves back to the Fed. The Fed can then erase those reserves from its balance sheet. That would result in the Fed holding fewer bonds as assets while being liable for fewer reserves, reducing its overall balance sheet. Instead, the Fed will probably take a more complicated path of not rolling over some assets when they mature, which means the Fed will have to coordinate its operations with the Treasury Department.

The key to remember, though, is that a few rate hikes and some modest QT will still leave monetary policy too loose. “Real” (inflation-adjusted) short-term rates will still be negative while actual short rates remain well below the trend in nominal GDP growth (real GDP growth plus inflation).

The Fed has its work cut out for it. Its goal is to execute a reduction in inflation while sticking a soft-landing for the economy. A year from now, we’ll have a much better idea whether it can meet both these goals.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

1-18 / 7:30 am Empire State Mfg Survey – Jan 25.0 27.0 -0.7 31.9

1-19 / 7:30 am Housing Starts – Dec 1.650 Mil 1.682 Mil 1.679 Mil

1-20 / 7:30 am Initial Claims – Jan 15 225K 210K 230K

7:30 am Philly Fed Survey – Jan 19.0 20.0 15.4

9:00 am Existing Home Sales – Dec 6.430 Mil 6.550 Mil 6.460 Mil

Job Market Making Progress

January 17, 2022 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

January 10, 2022

Many analysts were disappointed by last Friday’s job report for December, but we think the headline masks an overall report that shows continued improvement in the labor market and a possible surge in small-business start-ups and entrepreneurship.

Nonfarm payrolls rose 199,000 in December versus a consensus expected 450,000. Payroll growth was revised up a combined 141,000 in October and November, which brought total growth to a still short, but respectable, 340,000. This was the fourth time in the last five months that payrolls missed consensus expectations.

However, even as payrolls have recently fallen short, civilian employment, an alternative measure of jobs, has been rising fast, including a gain of 651,000 in December and an increase of 1.09 million in November.

Over long periods of time, and after some revisions, the two surveys closely mirror each other, but in the short run they often deviate. Reading too much into one survey over the other, and every short-term gyration in the data, is a mistake. This is especially true when we account for COVID.

The design of the civilian employment survey makes it better able to capture small-business start-ups and we think that’s a potential reason for slow recent growth in payrolls: entrepreneurs are leaving established businesses (some of whom are supposed to fill out the payroll survey) and setting up their own shops (which can’t fill out the payroll survey because the Labor Department doesn’t know enough about them yet).

One possibility is that people who’ve been working from home feel less attached to large employers and are more willing to strike out on their own. Or maybe it’s a concern about some big company requiring vaccines that’s making some workers leave these employers. Only time will tell.

Either way, we think more small-business start-ups is a good sign for future job growth.

Overall, we think job growth will be strong in 2022. Payrolls rose 537,000 per month in 2021 (and should be revised up in the next couple of months). For 2022, we expect job growth of 325,000 - 350,000 per month, so that by late 2022 total jobs finally exceed the pre-COVID peak. Meanwhile the jobless rate should fall to 3.5%, where it was right before COVID.

Normally job growth this fast would be associated with very rapid real GDP growth, as well. But this is not a “normal” economy. Lockdowns have damaged supply chains severely and the government has grown substantially in the past couple of years, with federal spending setting peacetime records as a size of GDP. Add in the Federal Reserve and its money printing and demand surged. The regulatory state is growing faster, too. This increase in the size of government, even if some of it is (hopefully) temporary will come with a cost. And we think that means slower productivity growth (output per hour) in 2022.

Think about it from the perspective of many businesses, which have struggled to hire the workers they need. They have more of an incentive to keep their most marginal (lowest productivity) employees in the hopes of being able to eventually train them into future profitability. Business beggars can’t be choosers, and less selectivity will create a headwind for output per hour even as the labor market continues to heal.

In turn, that means profits should grow but not nearly as quickly as in 2021. We are still bullish, but we also know that no bull can run forever. And while some think some weak data signals the end, looking beneath the surface is important.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

1-12 / 7:30 am CPI – Dec +0.4% +0.5% +0.8%

7:30 am “Core” CPI – Dec +0.5% +0.4% +0.5%

1-13 / 7:30 am Initial Claims – Jan 9 200K 205K 207K

7:30 am PPI – Dec +0.4% +0.3% +0.7%

7:30 am “Core” PPI – Dec +0.5% +0.2% +0.7%

1-14 / 7:30 am Retail Sales – Dec 0.0% +0.3% +0.3%

7:30 am Retail Sales Ex-Auto – Dec +0.2% +0.3% +0.3%

7:30 am Import Prices – Dec +0.2% -0.3% +0.7%

7:30 am Export Prices – Dec +0.3% +0.3% +1.0%

8:15 am Industrial Production – Dec +0.2% +0.1% +0.5%

8:15 am Capacity Utilization – Dec 77.0% 76.8% 76.8%

9:00 am Business Inventories – Nov +1.3% +1.3% +1.2%

9:00 am U. Mich Consumer Sentiment- Jan 70.0 70.6 70.6

S&P 500 outpaces COVID-19 woes, soars more than 25% in 2021

January 5, 2022 Tyler Goodrich

Markets and Investing

January 03, 2022

The year ended on a high note for the Dow and S&P 500 despite economic challenges posed by the coronavirus and extreme weather events.

While the traditional end of year Santa Claus equity rally may not have been as pronounced as we typically see, it may have just come early. Thus far, we’ve seen both the Dow Jones Industrial Average and the S&P 500 notch new highs in December with underlying market sectors firmly in the green.

Despite the challenges posed by coronavirus variants and extreme weather events, 2021 saw the best economic growth since 1984, muted market volatility and the S&P 500 delivering a return of approximately 27% over the course of the year. Raymond James Chief Investment Officer Larry Adam expects inflation to peak by early next year, which should alleviate pressure on the Federal Reserve (Fed) in the upcoming tightening cycle and would be supportive of domestic equity markets overall. The situation remains fluid, but there’s general optimism that the global reopening will continue and inflationary pressure will subside. Both will be key factors for markets, economic growth and corporate earnings throughout 2022.

This year-end equity boon didn’t come easy. We saw some volatility amid faltering negotiations to advance President Biden’s Build Back Better legislation and rising geopolitical tensions between Russia and the Ukraine, which have the potential to escalate in the near term. We believe that U.S. lawmakers may eventually unlock a deal in the new year, says Washington Policy Analyst Ed Mills. However, investors can expect to see short-term economic headwinds emerge in the meantime, and consumer sectors may stumble as the monthly child tax credit payments are set to expire as well.

Energy policy

As negotiations in D.C. drag out, clean energy companies in the U.S. market may not be able to count on a decade-long extension of the wind and solar tax credits, a more generous electric vehicle tax credit, or new tax credits for low-carbon fuels and green hydrogen. These provisions may be revived in some form but that remains to be seen. This is a sharp contrast to the European Union climate policy, notes Energy Analyst Pavel Molchanov. For example, Germany’s new coalition government announced plans to phase out coal and mandate 80% renewables in the electricity mix by 2030.

Inflation and interest rates

The overall market feel has not changed a great deal. Inflation is rooted in select products/industries, yet interest rates remain subdued for a myriad of reasons that include inflation longevity doubts, global interest rate disparity, sovereign bias toward amassing debt levels and more complex demographic rationales.

The Fed began to taper the pace of its monthly asset purchases and financial markets seem to have priced in rate hikes sooner than later. The central bankers have stated hikes won’t occur until tapering is complete, most likely around May. Given that monetary policy has been so influential to equity markets post-credit crisis, the Fed’s hawkish pivot from ultra-lenient policy could come with more moderate returns and normal volatility/choppiness over the coming year, notes Joey Madere, Senior Portfolio Analyst, Equity Portfolio & Technical Strategy.

Around the world

Overseas markets faced similar challenges (e.g., a sharp rise in COVID-19 cases; higher gas prices; heightened inflationary pressures), yet European equity markets hit new 2021 highs during December. Corporate earnings growth for 2022 is anticipated to be above 10%, aided by a combination of general global export recovery and the current low level of both the euro and the pound against both the dollar and the Chinese yuan.

During 2021, over 40 global central banks raised interest rates, predominantly in the emerging markets, reflecting both economic recovery and higher inflation. With economic growth rates in China continuing to slow, we believe the world’s largest emerging market is more likely to reduce its interest rates further during 2022.

The bottom line

We expect normal volatility and pullbacks in the year ahead, along with continued sector rotation. Overall conditions are likely to remain healthy, and investors can use these periods to opportunistically and thoughtfully add vetted positions. If you have any questions about your financial plan, please reach out to your financial advisor.

Investing involves risk, and investors may incur a profit or a loss. All expressions of opinion reflect the judgment of the authors and are subject to change. There is no assurance the trends mentioned will continue or that the forecasts discussed will be realized. Past performance may not be indicative of future results. Economic and market conditions are subject to change. The Dow Jones Industrial Average is an unmanaged index of 30 widely held stocks. The NASDAQ Composite Index is an unmanaged index of all common stocks listed on the NASDAQ National Stock Market. The S&P 500 is an unmanaged index of 500 widely held stocks. The MSCI EAFE (Europe, Australia, Far East) index is an unmanaged index that is generally considered representative of the international stock market. The Russell 2000 is an unmanaged index of small cap securities. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. An investment cannot be made in these indexes. The performance mentioned does not include fees and charges, which would reduce an investor’s returns. Small cap securities generally involve greater risks. International investing is subject to additional risks, such as currency fluctuations, different financial accounting standards by country, and possible political and economic risks. These risks may be greater in emerging markets. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Welcome to 2022: The Winds of Change

January 3, 2022 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

January 3, 2022

Welcome to 2022! We can’t imagine a more transformative year for America. After two years of unprecedented government actions, the winds of change are blowing hard. The economy has been buffeted by short-term factors since 2020; this year, long term fundamentals should re-assert themselves as the most important drivers of economic and financial performance.

First, the obvious: COVID and COVID-related rules should have much less influence on our lives twelve months from now than they do today. Seems like everyone knows someone who has tested positive (vaccinated, or not). Cases are at record highs, but hospitalizations and deaths are not. This is good news.

Second, President Biden’s Build Back Better plan to increase entitlements and taxes seems mired in the DC muck. It’s still possible that a plan totaling something like $1.5 trillion or more gets passed. But we think that’s unlikely. More likely? Either nothing at all, or a much smaller bill. Put yourself in the shoes of relatively moderate Democrats in Congress – being forced to vote on tax hikes in an election year is difficult, and reluctance is going to grow every week as 2022 unfolds.

Third, the mid-term election in November could dramatically limit the ability of the Biden Administration to get much done in 2023-24. Given the history of mid-term elections as well the election returns in 2021 (gubernatorial and state legislative races in New Jersey and Virginia, as well some races elsewhere), the most likely possibilities seem to be either a GOP Wave or a GOP Tsunami. Either would mean no more tax hikes and that all legislation would have to be bipartisan to pass, which should mean lots of gridlock.

Fourth, look for an economic contest between waning fiscal “stimulus” packages, rising employment and healing supply chains. The excess demand from massive government spending will decline in 2022, while supply chains appear to be healing. Business inventories are finally rising again (they need to do so after falling dramatically in 2020 and earlier in 2021) and it’s hard to imagine chipmakers not ramping up production to meet enormous demand.

Fifth, the Federal Reserve has its work cut out for it. It’s most recent “dot plot” suggests three rate hikes this year (25 basis points each) and the futures market for federal funds agrees. The big question is whether Fed policymakers have the guts. Given that the Biden Administration is trying to pack the Fed with as many doves as they can appoint, we’d take the “under,” and think the Fed will probably raise rates only twice this year.

Sixth, it’s important to watch profits, which are at an all time high. Remember, some of the strength in corporate results of late is due to temporary and artificial government spending blowouts. Meanwhile, more jobs, lower unemployment, and lower participation could mean higher wages take a slice out of corporate earnings. We still expect profit growth of 10% or more in 2022, but this is well below what we saw in 2021.

And last, of course, are the wildcards: Will China invade Taiwan? Will Russia invade Ukraine? We think the former is very unlikely, with the possible exception of some tiny uninhabited islands off the coast of Taiwan. The latter? If your name isn’t Vladimir Putin, you don’t know the answer. Either of these could cause a temporary sell-off, but neither would change the fundamentals. The winds of change are still tailwinds.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

1-3 / 9:00 am Construction Spending – Nov +0.7% +0.7% +0.4% +0.2%

1-4 / 9:00 am ISM Index – Dec 60.2 60.3 61.1

afternoon Total Car/Truck Sales – Nov 13.1 Mil 12.0 Mil 12.9 Mil

afternoon Domestic Car/Truck Sales – Nov 10.7 Mil 9.5 Mil 10.4 Mil

1-6 / 7:30 am Initial Claims – Jan 1 199K 198K 198K

9:00 am ISM Non Mfg Index – Dec 67.0 67.6 69.1

9:00 am Factory Orders – Nov +1.5% +1.2% +1.3%

1-7 / 7:30 am Non-Farm Payrolls – Dec 400K 390K 210K

7:30 am Private Payrolls – Dec 370K 370K 235K

7:30 am Manufacturing Payrolls – Dec 33K 25K 31K

7:30 am Unemployment Rate – Dec 4.1% 4.0% 4.2%

7:30 am Average Hourly Earnings – Dec +0.4% +0.4% +0.3%

7:30 am Average Weekly Hours – Dec 34.8 34.8 34.8

2:00 pm Consumer Credit– Nov $22.5 Bil $22.0 Bil $16.9 Bil

Greedy Innkeeper or Generous Capitalist

December 30, 2021 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

December 23, 2021

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.)

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

12-30 / 7:30am Initial Claims – Dec 25 NA NA 205K

8:45am Chicago PMI – Dec 62.0 63.4 61.8

2022: Moderate GDP, Persistent Inflation

December 20, 2021 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

December 20, 2021

From 30,000 feet, the COVID lockdown and re-opening played out pretty much like we thought. GDP collapsed in the first half of 2020, then exploded in the third quarter, followed by strong, but erratic, quarterly growth ever since. The fourth quarter data, when it’s released in January, will show 2021 had the fastest GDP growth, and highest inflation, since the 1980s.

As a reminder, this is not a normal business cycle and shouldn’t be treated like one. We have never locked down businesses, we have never seen such a rapid peacetime expansion of federal spending, and we have rarely seen such a huge increase in the M2 measure of money.

Shutting down the economy destroys supply chains because they work best with a free flow of information. And paying people not to work after the economy is open makes it worse. Small businesses have suffered much more than large companies, so while profits and stock prices are at, or near, all-time highs, real GDP will still end 2021 lower than it would have if COVID had never happened. Meanwhile, inflation under COVID has been much higher than the pre-COVID trend.

Normally, government involvement in an economy does not alter its path so much from quarter to quarter, or year to year. Sure, Fed rate hikes, or tax rate changes must be accounted for, but the massive nature of government interference in the economy since March 2020 has made us all Keynesians now. Factoring in how much spending is borrowed from the future, how much new money the Fed is printing, and whether tax rates will become more punitive is all part of any forecast.

For example, some of our economic peers are now saying 2022 growth will be slower than it otherwise would have been because Joe Manchin has said “no” on the Build Back Better plan. Their forecast argues that fewer government handouts will reduce spending and therefore GDP growth.

We think that is simplistic analysis. Yes, fewer handouts will lead to a reduction in deficit spending. However, with 11 million job openings, it will likely lead to more actual employment. So, any slower growth from less government spending will be offset by more growth from the private sector, which will help supply chains. At the same time, without BBB, tax rates will not rise, which is a positive for longer-term growth.

Putting it all together, we expect real GDP to rise at about a 3.0% rate in 2022. Why slower than 2021? Because 2021 was artificially boosted by big deficit spending. Why not slower than 3.0%? Because small businesses will bounce back and the BBB tax hikes and distortionary spending are now less likely.

For inflation, it looks like the Consumer Price Index will be up in the 6.5 - 7.0% range this year. The consensus among economists is that will slow to 2.7% next year, but we think inflation will run 4.0% or more. On a granular level, look for the rental price of housing, which makes up more than 30% of the CPI, to be a key driver of inflation for the next few years. In addition, we expect oil prices will move higher again as regulatory ambiguity related to environmental rules curbs exploration.

For the job market, look for solid job growth to continue. Job openings remain plentiful and, slowly but surely, some of the people who have left the labor market should get pulled back in by rising wages. Look for about 325,000 – 350,000 jobs per month next year. Don’t get too excited, though; at that pace, at the end of 2022, we’ll be barely 700,000 jobs above the pre-COVID level. Not impressive for a time period of almost three years. Yes, the unemployment rate should get down to the 3.5% the Federal Reserve expects by the end of 2022, equaling the pre-COVID rate, but it’ll be with much lower labor force participation, so 3.5% is not as impressive as it sounds.

Put it all together and we have an inflation problem that is obviously not “transitory” and economic growth that’s a glass half full: good growth versus historical measures but not yet enough to get us back to where we would have been if COVID had never happened.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

12-22 / 7:30 am Q3 GDP Final 2.1% 2.1% 2.1%

7:30 am Q3 GDP Chain Price Index +5.9% +5.9% +5.9%

9:00 am Existing Home Sales – Nov 6.530 Mil 6.490 Mil 6.550 Mil

12-23 / 7:30 am Initial Claims – Dec 18 205K 197K 206K

7:30 am Personal Income – Nov +0.4% +0.5% +0.5%

7:30 am Personal Spending – Nov +0.6% +0.6% +1.3%

7:30 am Durable Goods – Nov +1.8% +1.9% -0.4%

7:30 am Durable Goods (Ex-Trans) – Nov +0.6% +0.6% +0.5%

9:00 am New Home Sales – Nov 770K 769K 745K

9:00 am U. Mich Consumer Sentiment- Dec 70.4 70.4 70.4

Faster Taper, Setting Up for Rate Hikes

December 20, 2021 Tyler Goodrich

First Trust Economic Research Report

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Deputy Chief Economist

December 15, 2021

A renominated Powell is a different Powell. The Federal Reserve didn't raise interest rates today, a policy move we think is overdue, but it made major changes that set the stage for multiple rate hikes in 2022 and beyond.

First, the Fed doubled the pace of tapering to a speed where it could completely end quantitative easing by March, rather than in June. That's important because the Fed has said it wants to finish tapering before it considers raising rates. An earlier end to QE means a potential earlier start for rate hikes.

Second, the Fed's "dot plots," which show the pace of rate hikes expected by policymakers, now suggest three rate hikes in 2022 (assuming they're 25 basis points each), another three hikes in 2023, and two more in 2024. That contrasts sharply with the dot plot from September, when policymakers were evenly split on whether there'd be any rate hikes at all in 2022 and suggested a total of four rate hikes in 2022 and 2023, combined.

Third, the Fed officially removed from its statement the reference to inflation being "transitory," but maintained a reference to "supply and demand imbalances" as the key factor behind elevated inflation. Demand-driven inflation is exactly the kind of inflation for which policymakers think rate hikes are appropriate.

Fourth, the Fed statement added that "[W]ith inflation having exceeded 2 percent for some time, the Committee expects it will be appropriate to maintain [short-term rates near zero] until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment." In turn, the Fed maintained its view that the long-run average unemployment rate is 4.0% while changing its economic forecast to show the job market hitting 4.0% in the Spring. It's almost as if the Fed wants to limit its own discretion about raising rates. Putting this altogether, it sure looks like the Fed will be ready to start raising rates by June, if not earlier.

Fifth, the Fed went out of its way to make changes to the statement that "talked up" the economy, referring to solid job gains and a substantial decline in unemployment. At the press conference, Powell noted "high inflation," "strong growth," and "rapid progress toward maximum employment."

Before today, we had thought that Fed policymakers would chicken out of raising rates more than once next year. But, given the tenor of today's Fed statement – including the use of the labor market as a guide for when they think rate hikes could start, the sharp change in the dot plots, as well as Powell's willingness to sound hawkish in the press conference – we think two or three rate hikes is a reasonable projection for 2022.

Yes, economic circumstances may change. The Fed anticipates 4.0% real GDP growth next year and we think the economy will probably come in slower. But the Fed also expects 2.6% PCE inflation next year and we think actual inflation will come in higher. Net-net, we think there's ample room for rate hikes, although we still doubt the Fed would raise rates during a stock market correction.

Ultimately, we view today as good news for the long-term health of the US economy. The Fed is behind the curve on fighting inflation, tapering should already be over, and rate hikes should already have begun. Today's changes and positioning by the Fed are long overdue, but a big step in the right direction.

The Fed needed to end its pandemic monetary response at some point and today's news is welcome in that regard. However, we are puzzled slightly by the market response. Stocks rose sharply and bond yields barely budged. It's almost as if now that the Fed has stopped saying transitory, the market has decided that inflation really is transitory.

We aren't so sanguine. Yes, we still think stocks will end 2022 higher (5,250 for the S&P 500), but inflation is not going to go away easily. And it is hard to imagine a world where bond yields stay significantly below inflation forever. So, we will take the near-term victory of a more sane Federal Reserve policy, but still question the ability of policymakers to bring the US economy in for a perfectly soft landing.

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.

S&P 5,250 - Dow 40,000

December 13, 2021 Tyler Goodrich

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

December 13, 2021

We were bullish in 2021 and bullishness obviously paid off. As of the Friday close, the S&P 500 is up more than 25% so far this year. Meanwhile, a 10-year Treasury Note purchased at the end of 2020 has generated a negative total return, as interest earnings have been more than offset by capital losses.

The reason we were bullish a year ago even amid widespread fears about COVID-19, is because we stick to fundamentals, assessing fair value by using economy-wide profits and interest rates, what we call our Capitalized Profits Model. And, one year, later, we are still sticking with fundamentals. Our year-end 2022 call for the S&P 500 is 5,250 (up 11.4% from last Friday), and we expect the Dow Jones Industrial Average to rise to 40,000.

The Capitalized Profits Model takes the government’s measure of profits from the GDP reports, discounted by the 10- year US Treasury note yield, to calculate fair value. Corporate profits for the third quarter were up 20.7% versus a year ago, up 22.3% versus the pre-COVID peak at the end of 2019, and at a record high.

The key question then becomes what discount rate should we use? If we use 1.50%, roughly the current 10-year Treasury yield, our model suggests the S&P 500 is grossly undervalued. But, with the Federal Reserve still holding short-term interest rates at artificially low levels, the 10-year yield might be artificially low, as well.

So, to be cautious, we plug in some alternative higher long term interest rates. Using third quarter profits, it would take a 10-year yield of about 2.75% for our model to show that the stock market is currently trading at fair value. And that assumes no further growth in profits.

We expect the 10-year Note yield to finish 2022 in the vicinity of 2.00%. Nonetheless, we have chosen to use a more conservative discount rate of roughly 2.50%. Using third quarter 2021 profits, that creates a fair value estimate for the S&P 500 of 5,250. And this does not take into account higher profits in the year ahead.

The bottom line is that although we remain bullish, we are not quite as bullish as in recent years, projecting an increase in stocks of 11.4% from Friday’s level. We haven’t had a 10% correction in 2021, and, although we never try to time the market, we wouldn’t at all be surprised by one happening at some point in 2022. Moreover, the stock market is likely to grapple with either higher short-term rates in 2022 or, in the alternative, a Federal Reserve that is even further behind the inflation curve, risking a higher peak for short-term rates sometime in the future.

Another issue is the battle between fading fiscal stimulus and a gradual return to normalcy. The budget deficit will still be very large this year even if the Democrats-only “Build Back Better” proposal doesn’t pass. But the deficit will be much smaller than the past two years. That will generate a short-term headwind for growth. Meanwhile, more businesses should be getting back to normal and small business start-ups gradually replacing businesses that were killed off by overly strict COVID rules.

On net, this adds up to a scenario that is likely to be constructive for equities. We’ve been bullish since 2009 but we are not perma-bulls. There are clouds on the horizon, and at some point in the next few years, we may be (temporarily) bullish no more. In the meantime, though, the clouds are on the horizon, not overhead. Equities have further to run.

Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous

12-14 / 7:30 am PPI – Nov +0.5% +0.6% +0.6%

7:30 am “Core” PPI – Nov +0.4% +0.3% +0.4%

12-15 / 7:30 am Retail Sales – Nov +0.8% +0.8% +1.7%

7:30 am Retail Sales Ex-Auto – Nov +0.9% +1.1% +1.7%

7:30 am Import Prices – Nov +0.7% +0.3% +1.2%

7:30 am Export Prices – Nov +0.5% +0.8% +1.5%

7:30 am Empire State Mfg Index – Dec 25.0 27.3 30.9

9:00 am Business Inventories – Oct +1.1% +1.2% +0.8%

12-16 / 7:30 am Initial Claims – Dec 12 198K 194K 184K

7:30 am Housing Starts - Nov 1.565 Mil 1.570 Mil 1.520 Mil

7:30 am Philly Fed Survey – Dec 30.0 27.6 39.0

8:15 am Industrial Production – Nov +0.7% +0.7% +1.6%

8:15 am Capacity Utilization – Nov 76.8% 76.9% 76.4%

The attached information was developed by First Trust, an independent third party. The opinions are of the listed authors at First Trust Advisors L.P, and are independent from and not necessarily those of RJFS or Raymond James. All investments are subject to risk. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Individual investor's results will vary. Past performance does not guarantee future results. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. Any information provided is for informational purposes only and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary.