Debit Limit Drama

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

January 30, 2023

The US federal budget is on an unsustainable path…but not for the reasons that most people think.

Yes, the national debt is $31 trillion, well higher than annual GDP, and only going higher. Yes, the budget deficit last year was more than a $1 trillion for the third year in a row. None of this is good.

But the real root of the fiscal problem, and our biggest concern, isn’t the debt or the deficits, it’s government overspending. If the government had an enormous debt, but spent little, the private sector could produce the country’s way out of the debt problem. And if the US had little debt, we could still have economic problems from too much government spending. Ultimately, the government funds itself by borrowing or taxing the wealth produced by private industry. If spending were high and borrowing low, taxes would have to be prohibitively high. The bottom line is that excessive spending leads to economic ills.

According to the CBO, spending on entitlements like Social Security, Medicare, Medicaid, and other health care programs will rise from 10.7% of GDP to 15.1% in the next thirty years. Meanwhile, the net interest on the national debt will almost certainly be higher than it was last year, unless and until we bring the deficit down and slow the growth in debt.

This is why the debt limit debate now going on in Washington, DC is so important. Don’t fall for the false narrative that one group of politicians wants to push the country into default. Nor, should anyone want to abolish the debt ceiling altogether. If there is a way to shine some light on overspending, why shouldn’t it be used? If debt ceiling politics can focus attention on fiscal issues, it’s done its job.

What we expect is a last-minute budget deal that includes either caps on discretionary spending for future years, some sort of commission or committee that can make proposals to reform entitlements (with expedited procedural rules so the proposals get a congressional vote), or both, as part of a bipartisan deal to raise the debt ceiling.

But let’s go down the highly unlikely path that the debt limit isn’t raised. The Treasury Department would still have enough cash flow to pay all securitized debt as it came due, as well as entitlements such as Social Security, Medicare, and Medicaid. It’s true that other programs and agencies would have to take substantial cuts to make sure those higher priority payments get made; and yes, the Biden Administration will not enjoy making that choice. But it’s still a choice that they alone get to make.

Ultimately, investors and voters need to realize that not every national debt is the same, even if they’re the same amount. The US had a debt problem after the Revolutionary War, which was a small price to pay for starting an independent country. We had a debt problem after World War II, but that was a price we paid to win a crucial war. Our current debt problem is not like those. In too many cases, politicians spend to win favor with constituents. It’s not wrong to use the debt ceiling as a way to focus attention on this problem and the endemic overspending that it creates. That’s a habit this debt limit debate needs to break.

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.

Rearview Mirror OK, Collision Ahead

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

January 23, 2023

First, the good news: we estimate that real GDP grew at a solid 2.8% annual rate in the fourth quarter. But you shouldn’t dwell on the solid GDP report that comes out Thursday. Why? Because the report shows what’s going on in the rearview mirror. Meanwhile, there’s an economic collision ahead.

Just think about the news so far for December. The ISM Manufacturing and ISM Service indexes are both below 50. Excluding the early days of COVID, both indexes haven’t been below 50, signaling at least a contraction in sentiment, since the aftermath of the 2008-09 Financial Panic.

Retail sales fell 1.1% in December after a 1.0% decline in November. Industrial production fell 0.7% in December after a 0.6% decline in November. Medium & heavy truck sales are still at a respectable level, but dropped sharply in December, down 13.5%, the second fastest drop for any month in the past twenty years. Housing starts declined, as well.

The good news is that the labor market still seems strong. Initial claims for unemployment insurance claims are still very low. But the job market is often a lagging indicator of economic health and jobless claims should be expected to be at or near a bottom very close to the peak in the business cycle.

A recession will arrive sometime in 2023. Given recent data, it would come as no surprise if we’re already in a recession and the economy shrinks in the first quarter and beyond. A surge in the M2 measure of the money supply led a rebound in economic growth from the COVID Lockdown and then a surge in inflation in 2021-22. But growth in M2 came to a halt in early 2022. Now, with a time lag, the economy is getting weaker and inflation is coming down. Buckle up, it’s going to be rough ride.

In the meantime, our calculations show economic growth at a 2.8% annual rate for the fourth quarter.

Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector declined at a 2.4% annual rate in Q4. However, sales of autos and light trucks grew at a 28% rate and it looks like real services, which makes up most of consumer spending, should be up at a solid pace. Putting it all together, we estimate that real consumer spending on goods and services, combined, increased at a moderate 2.3% rate, adding 1.6 points to the real GDP growth rate (2.3 times the consumption share of GDP, which is 68%, equals 1.6).

Business Investment: We estimate a 4.1% growth rate for business investment, with gains in equipment and intellectual property more than offsetting a decline in commercial construction. A 4.1% growth rate would add 0.5 points to real GDP growth. (4.1 times the 13% business investment share of GDP equals 0.5).

Home Building: Residential construction is still absorbing the pain of much higher mortgage rates and looks like it fell at a 24.0% rate, which would subtract 1.0 points from real GDP growth. (-24.0 times the 4% residential construction share of GDP equals -1.0).

Government: Only direct government purchases of goods and services (not transfer payments) count when calculating GDP. We estimate these purchases – which represent a 17% share of GDP – were unchanged in Q4, meaning zero net impact on GDP (0.0 times the 17% government purchase share of GDP equals 0.0).

Trade: Looks like the trade deficit shrank a little in Q4, as exports declined at a slower pace than imports. We’re projecting net exports will add 0.3 points to real GDP growth.

Inventories: Inventories look like they grew faster in Q4 than in Q3, suggesting an add of about 1.4 points to the growth rate of real GDP. Look for slower inventories in 2023, which should be a significant drag on economic growth this year.

Add it all up, and we get a 2.8% annual real GDP growth for the fourth quarter. That headline sounds good. But when much of the growth is from inventories and the economy is about to get hit from slower M2, investors need to focus on the collision ahead, not the pretty scenery in the rearview mirror.

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.

Soft Landing?

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

January 17, 2023

We wrote last week about the soft landing that markets now seem to expect. If the US does have a soft landing it would be because the Federal Reserve tightened enough to slow inflation, but not enough to throw the economy into recession.

In our opinion, Fed policy should not be measured using interest rates alone. The Fed held the federal funds rate at 0% from 2008 to 2015 without inflation. During COVID, the Fed held the funds rate at zero for just two years. If seven years didn’t cause inflation, how did two years?

The answer to that question is that following the financial crisis, the Fed shifted to an “abundant reserve” monetary policy and held rates at zero, but increased capital requirements and liquidity rules by enough to keep the M2 money supply in check.

During COVID, the Fed expanded reserves through Quantitative Easing again but relaxed liquidity rules; using banks to distribute pandemic loans and hand out unemployment checks. As a result, M2 peaked at 27% year-over-year growth in February 2021. This is why inflation accelerated, right on time to prove Milton Friedman correct again.

Looking at the two things the Fed can control – interest rates and the growth rate of the money supply – there is a massive divergence. The funds rate is still below inflation. Looking at just rates, monetary policy is not yet tight.

But, looking at M2, money is tight. The growth rate of M2 has slowed from 27% year-to-year in early 2021, to 12% in January 2022, to 0% in November 2022. Given that Milton Friedman told us a slowdown in M2 growth would impact economic growth with a lag of roughly six to nine months, the economy should be showing the impact. There are a few signs of slow growth (like the ISM surveys showing contraction), but gold prices are surging (up $260 per ounce in the past three months) and the jobs market hasn’t weakened materially.

Hold on, though, before thinking that M2 doesn’t matter, it is important to remember that pandemic policies were unprecedented. Shutting down most services, and only really opening them up freely in 2022, has distorted economic data. Services were held below trend for two years and are now artificially boosted – no matter what money growth does.

In addition, when the Fed started its Abundant Reserve monetary policy, the Treasury started using its Fed checking account, called the Treasury General Account (TGA) to hoard money. For decades, the TGA had an average balance of roughly $5 billion. But, lately, the TGA has held hundreds of billions and this money does not count as M2 even if it is cash held at the Fed.

Taxpayers write checks from their bank accounts. If the Treasury puts those taxes in the TGA rather than spending them, they do not return to the banking system. From the end of 2021 to November 2022, the TGA grew from $134 billion to $524 billion. In other words, M2 was reduced by $390 billion because the Treasury held cash out of the system. This has slowed reported M2 growth and just maybe money isn’t as tight as it appears.

Another sign that money may not be as tight as it appears is that loans and leases at banks are up 12% in the year ending December even though M2 has not grown.

Nonetheless, money growth has slowed rapidly. When the money supply brakes are slammed, economic growth should suffer before inflation comes down. When this happens at the same time that distortions caused by pandemic policies come to an end, a recession seems inevitable.

Our forecast for real GDP growth this year is -0.5%, with inflation remaining above 4%. In other words, a recession with higher inflation – stagflation. That’s what we expect…and it’s not a soft landing.

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.

Not Goldilocks

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

January 9, 2023

Not long after Friday’s Employment Report multiple analysts and commentators were calling it a “goldilocks” report, by which they meant it showed that the economy was neither “too hot” nor “too cold,” but instead, “just right.”

In turn, the theory goes, the Federal Reserve could stop raising short-term rates earlier and at a lower peak than previously expected, inflation would continue to cool, and the economy could pull-off an elusive “soft landing.”

The biggest headlines from the Employment Report were definitely good news. Nonfarm payrolls rose 223,000 in December, beating the consensus expected 203,000. Meanwhile, civilian employment, an alternative (although volatile) measure of jobs that includes small-business start-ups, surged 717,000. Rapid job creation helped push the unemployment rate down to 3.5%, tying the lowest level since Joe Namath was a reigning Super Bowl champion. (If you’re a Millennial or Gen Z, yes, that’s the same guy in the Medicare commercials.)

But, behind the headlines, the data were not as good. Temporary help service jobs (temps) fell 35,000 in December, the fifth straight monthly decline, to a level of temp jobs below a year ago. Why are these jobs important to watch? Because, when businesses face increased demand, the quickest way to respond is hiring temporary help. And the same thing happens in the opposite direction.

Meanwhile, the total number of hours worked in the private-sector ticked down 0.1% in December, the second consecutive monthly decline. Even though payrolls were up, total hours worked data show less work was done. Putting it all together, this is the equivalent of losing 125,000 jobs in December, not gaining jobs. Fewer temporary workers and fewer hours worked suggest some weakness in the job market. What this means is that businesses are still hiring, but their workers have less to do.

Why would businesses do that? Because finding qualified workers has been unusually difficult during the re-opening from the COVID shutdowns. In turn, many firms might be willing to keep hiring workers until it’s clear the economy is in a recession.

But this also means that if a recession happens – and we continue to think it will – more workers have to be let go.

The figure that the optimists focused on the most was the wage report, which showed a relatively moderate gain of 0.3% in average hourly earnings in December and a gain of 4.6% versus a year ago. Moderate wage growth, the conventional thinking goes, diffuses the potential for a “wage-price spiral” that keeps inflation high or even pushes it higher. But this is a basic misunderstanding of inflation dynamics. As Milton Friedman taught us, it’s loose money that causes inflation to go up. The fact that wages sometimes go up faster at the same time is also a sign of loose money, but it’s not a sign that wage growth causes inflation.

What analysts, commentators, and the markets should have spent more time chewing over was the ISM Services report, which screamed stagflation. The overall index came in at 49.6, well below consensus expectations and the first reading in contraction territory since the onset of COVID. In fact, excluding very early COVID, it was the first sub-50 reading since 2009. Meanwhile, although the prices paid index declined to 67.6 (versus 70.0 in November), that’s still higher than it ever was between mid-2011 and early-2021.

This week’s CPI report should show tame overall inflation for December itself, but that’ll largely be due to falling energy prices. The ISM report suggests inflation isn’t going back to the Fed’s 2.0% target anytime soon.

Put it all together and it looks like both the surge in M2 growth in 2020-21 (which created the inflation) and the abrupt slowdown in 2022 (which would cause slower growth) are still wending their way through the economy. If so, we should see weak economic data, soon. Further forward, if the Federal Reserve maintains slow M2 growth – an open question given the Fed’s reluctance to focus publicly on the monetary aggregates when setting policy – we could see a major slowdown in inflation in 2024. Time, and the direction of monetary policy, will tell.

Right now, it looks like Real GDP expanded at a 2.5 – 3.0% rate in the last quarter of 2022. But how fast it’s growing in the first quarter of 2023 – if at all – is anyone’s guess.

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 Housing Outlook for 2023

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

January 3, 2023

The housing sector was a huge and early beneficiary of the super-loose monetary policy of 2020-21. But, once the Fed started tightening, housing took the lead downward, as well. This isn’t a repeat of the 2006-11 housing bust, but it will drag on. Don’t expect any real recovery in housing until at least late 2023 or early 2024. Home sales and prices will continue to drag in 2023, particularly in the existing home market.

From May 2020 until June 2022, both the national Case-Shiller price index and the FHFA price index rose more than 40%. But, since June 2022, Case-Shiller is down 2.4% and the FHFA is down 1.1%. The biggest declines so far have been out West, in San Francisco, Seattle, Phoenix, San Diego, and Las Vegas. But every major metropolitan area is down in the past three months, no exceptions.

The drop in home prices should continue. Prices got too high relative to rents and need to fall more to better reflect rental values. We expect a total decline, peak-to-bottom in the 5-10% range, nothing like the 25% drop in 2006-11. Why a smaller drop this time around? First, compared to the average of the past forty years, home prices are already close to fair value when measured against construction costs. Second, there is no massive excess inventory of homes, unlike during the prior housing bust. And, unlike during the subprime-era, the vast majority of homeowners with mortgages are locked-in at extremely low fixed rates, which means they will be very reluctant to sell.

The real effect of the change in interest rates is evident in the existing home market. Sales hit a 6.65 million annual rate in January 2021, the fastest pace since 2006. But, by November 2022, sales were down to a 4.09 million annual rate, a drop of 38.5% so far. Meanwhile a decline in pending home sales in November (contracts on existing homes) signals another drop in existing home sales in December.

Existing home buyers have two major problems: first, much higher mortgage rates, which means substantially higher monthly payments. Assuming a 20% down payment, the rise in mortgage rates and home prices since December 2021 amounts to a 52% increase in monthly payments on a new 30-year mortgage for the median existing home.

Meanwhile, it’s hard to convince a current homeowner with a low fixed-rate mortgage to sell. If anything, it makes sense for them to ask for even more money if they’d have to take out a new mortgage elsewhere at a much higher rate. In other words, sellers should now want more for their homes, while buyers want to pay significantly less. This won’t change soon and so expect existing sales to be even weaker in 2023 than last year.

New home sales are also down substantially since the COVID peak, but should find a bottom sooner. The key is that with a new home, the seller is a contractor. Also, housing has been underbuilt in the previous decade. The average price of a new home will likely fall, but we need more of them. And more houses will be likely be put in rental pools.

What’s important to remember is that this business cycle isn’t normal. COVID led to a massive surge in government stimulus, both monetary and fiscal, to fight widespread and overly draconian shutdowns. Housing is rarely a bright spot in recession years and this year should be no different. But don’t expect a catastrophe like the prior bust and, once a recession is over, housing will rebound much more swiftly than after the Great Recession in 2008-09.

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.

High Frequency Data Tracker 12/23/2022

First Trust Economics

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 12/23/2022

We live in unprecedented times. The recession in 2020 was not so much a recession as it was a lockdown. Using “normal words” to describe the economy in the last 2 years, we believe, does not make sense. Now with two consecutive quarters of declining real GDP, many are saying we are back in a recession. The charts in the High Frequency Data Tracker follow data that are published either weekly or daily, providing a good real-time look at where the economy stands. As of now we believe these measures, along with other monthly economic data coming in, show we are not in a recession.

To view more important information click on the link below!

https://www.ftportfolios.com/Commentary/EconomicResearch/2022/12/23/high-frequency-data-tracker-12232022

Still Unprecedented

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

December 19, 2022

What a difference a year makes!

One year ago the Federal Reserve was forecasting that real GDP would grow a strong 4.0% in 2022, that PCE prices would be up a relatively moderate 2.6%, and we should expect a grand total of three 25 basis point (bp) rate hikes by the end of the year.

Instead, it looks like real GDP will be up about 0.5%, PCE prices will be up 5.6%, and we had the equivalent of seventeen 25 bp Fed rate hikes, finishing the year at 4.375%. So, if you feel a little dizzy about all of this, imagine how the Fed feels.

For 2023, the Fed is forecasting another year of 0.5% real GDP growth, inflation of 3.1%, and the unemployment rate rising to 4.6%. As for Fed policy, the dot plot shows another 75 bps of rate hikes in 2023, and no planned cuts.

We think growth will undershoot the Fed’s forecast in 2023. Instead of growing 0.5% in 2023, we expect real GDP will shrink about 0.5%. Meanwhile, we think inflation will overshoot: ending next year above 4.0%. Sure, inflation moderates in 2023, but not as much or as fast as many expect.

What does that mean for the Fed? While others obsess about short-term interest rates, we still think investors (and the Fed) should pay more attention to the money supply, M2 in particular. M2 surged in 2020-21, hitting a peak of 27% yearover-year growth and rising a cumulative 40%. But in the past year, M2 growth hit a wall, and is up just 1% from a year ago. If accurate, this means economic activity is likely to slow very sharply – and soon.

However, we think some of this decline in M2 growth is because the Treasury General Account at the Fed (the Treasury’s checking account) grew from $100 billion at the end of 2021, to a current level of $600 billion. In other words, the Treasury has extracted roughly $500 billion of M2 from taxpayers and bond buyers and put it aside in an account that does not count as M2. If we adjust M2 for this sleight-of-hand, M2 is up roughly 4% in the past year, not 1%.

We also can’t rule out the possibility that measurement error has led to the Fed miscalculating M2. If M2 has really slowed to 1% in the past year, it’s hard to figure out how total bank credit is still up more than 7% from a year ago.

If their calculations are true, the dramatic slowdown in M2 growth in 2022 would be entirely consistent with a recession starting sometime in 2023. But, so far, we don’t see evidence of any large squeeze in overall economic liquidity.

Lurking in the background of all these forecasts, including our own, is the fact that we are in unprecedented times. Forget COVID lockdowns; every prior episode of inflation in the post-World War II era was accompanied by the Fed operating in a “scarce reserve” system, whereby it would tighten monetary policy by draining reserves from the banking system to make short-term interest rates move higher. Meanwhile, those reserves would generate zero income for the banks unless they lent them to other banks.

Now, for the very first time with high inflation, the Fed is operating in an “abundant reserve” system, trying to tighten monetary policy by directly paying banks higher interest rates to hold the copious reserves that well exceed banks’ needs. The continued growth in bank credit suggests that, so far, this experiment in monetary policy is not quite going according to plan.

Interest rates all along the yield curve remain below every economic model of neutral rates (i.e. The Taylor Rule). The Fed has held the federal funds rate below inflation for 90% of the past thirteen years. This is all part of the unprecedented policies that investors must analyze and deal with.

Put it all together and the only thing we’re confident about is that whatever happens in 2023, it will likely look very different from what the Fed is forecasting.

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.

S&P 3,900 – Dow 33,000

Predicting stock values in 2023 is tough. Unprecedented actions during COVID leaves a wide range of possible outcomes. Let us explain.

As always, we start out with our Capitalized Profits Model. That model takes a government measure of nationwide profits from the GDP report, discounted by the 10-year US Treasury yield, to calculate fair value for stocks. These data go back to the early 1950s, so almost seventy years. Our measure of profits, which excludes the profits earned by the Federal Reserve system, were up 2.0% in the third quarter, are up 7.8% from a year ago, and are up 23.4% versus the pre-COVID peak. One interesting thing to think about is that while profits rose 7.8% during the year ending in Q3, the GDP Price Index was up 7.1%. Very slow growth in inflation-adjusted profits and higher interest rates combined to push stock values down in 2022.

Using a 10-year Treasury yield of 3.6% (near the Friday close) to discount profits suggests the S&P 500 index is fairly valued at about 3,700. At a 10-year Treasury yield of 4.0%, fair value would be down to 3,350. Fair value for the S&P 500 index would also be about 3,350 if the 10-year yield stays at 3.6% and profits go down 10%, which is what we’d expect to happen in a recession.

What happens if the 10-year yield goes up to 4.0% AND we get a recession? Then fair value would be 3,000. The problem with this scenario is that if we do get a recession, the 10-year yield is unlikely to stay as high as 4.0%. So, it appears that there will be no double-whammy for stocks. However, if even one of these downside risks occurs – higher rates or a profits recession – and fair value drops, even temporarily to 3,350, then stocks will likely spend some time below 3,350, just because stocks always vary above and below actual fair value. That suggests a low for the S&P 500 of about 3,200.

Our forecast is that the US economy enters a recession around mid-2023, for two reasons. First, we never fully felt the impact of lockdowns because we flooded the system with liquidity and borrowed money. Second, monetary policy is now in reverse. And a monetary policy tight enough to slow inflation is likely to generate a recession, as well. It’s hard to see the Fed going from very rapid M2 growth in 2020-21 to essentially zero M2 growth in 2022 without the economy, at least temporarily, hitting a brick wall.

However, stocks are likely to bottom within the first few months of the recession as investors realize this is not another Financial Panic like in 2008-09. That would give stocks room for a rally late in the year even if a recession continues, as equities see the light at the end of the tunnel.

As a result, we are comfortable with a forecast of the S&P 500 finishing next year around 3,900 with the Dow Jones Industrials Average at about 33,000. Not much change from where we are today.

Obviously, if it turns out that the Chairman Powell and the Federal Reserve have engineered a soft landing – no recession in 2023 and with the market ending 2023 confident of not having a recession in 2024 – then stocks should rally substantially in 2023 and easily beat our S&P 500 target of 3,900. By contrast, if it turns out a recession starts later in 2023, providing less time for a rally from the bottom, or if a recession turns deeper than we expect, then stocks could finish 2023 substantially below 3,900.

The bottom line is that while stocks suffered this year from higher interest rates, the greatest headwind in 2023 should be lower profits. We expect the next bull market will be prolonged and strong. But, for the time being, the economy still needs to pay a price for the massive artificial stimulus of 2020-21. Part of that bill came due this year and we think the rest comes due in 2023.

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.

A Plow Horse With Shin Splints

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

December 5, 2022

Our position on the economy has been that the US is headed for a recession, but we’re not quite there yet. Nothing in all the recent data reports changes our minds. Look for a recession to start in the second half of 2023, with some possibility of it starting earlier in 2023 and some possibility of a delay until early 2024. Until then, expect mediocre economic growth.

We called the recovery after the Financial Panic and Great Recession of 2008-09 the “Plow Horse Economy.” Real GDP growth averaged 2.2% annualized in the eight years after that recession ended. That was very slow by historical standards and we think it was due to a large expansion in the size and scope of government. The bigger the government, the smaller the private sector, creating slower real growth.

It’s hard to tease out the underlying pace of growth so far in the current recovery because of the nature of COVID-related shutdowns. However, it looks like real GDP growth will be roughly +0.5% in 2022 (Q4/Q4), which would be slower than any calendar year without a recession since the end of World War II. Call it a “Plow Horse with Shin Splints.”

This description of the economy might surprise some investors, particularly given Friday’s robust increase in payrolls. But we think many journalists, analysts, and investors misinterpreted the employment report, which wasn’t as strong as the headline. Yes, payrolls rose a very solid 263,000 in November. But the most important data point each month is the change in the total number of private-sector hours worked, which declined 0.2% for the month. That’s the equivalent of losing about 250,000 jobs. Total hours worked are up at a modest 1.1% annual rate in the past three months, signaling slower job growth ahead.

The Atlanta Fed’s “GDP Now” model suggests real GDP growth at a 2.8% annual rate in the fourth quarter, but we think growth is very likely going to fall short of that pace; we’re penciling in growth at only a 1.5% annual rate, instead. In particular, look for the trade sector, which was the key behind more rapid growth in the third quarter, to be a major drag on growth in the final quarter of the year.

Another report we’re concerned about is the upward creep in continuing jobless claims. Continuing claims averaged 1.363 million in the four weeks ending October 1. In the four weeks ending November 19, they averaged 1.539 million. A jump like that is not the end of the world, nor does it show we’re in a recession already. But it probably signals that the low point in the unemployment rate is behind us (at 3.5%) and is another reason to think job growth will be slower in the months ahead.

The factory sector, in particular, is showing early signs of softness, with the ISM Manufacturing index coming in at 49.0 for November, the first sub-50 reading since the early days of COVID. Yet, the ISM Services index came in at 56.5, reflecting a catch-up from all the service closures during COVID.

If you want to weave a very negative story, you have the data to do it with. But it’s important to look at a full range of reports and not get captured by your own narrative. Some key parts of the economy remain solid. For example, sales of medium and heavy trucks were up 11.4% in November versus a year ago. Usually, this measure goes negative at least several months before a recession starts.

Put it all together and you have a weak economy that’s still growing but showing some signs of wear and tear. A Plow Horse, with shin splints. Stay tuned: rougher times are ahead, a recession is still in the future, but not happening today.

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.

This Rally Shouldn't Last

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

November 28, 2022

It’s that special time of the year, and we will all hear and read a great deal about Black Friday, Thanksgiving Weekend, and Cyber Monday during the next few days. Many pundits are going to make sweeping conclusions about the economy based on these very limited reports.

Our recommendation: please feel free to ignore this news. Christmas-time spending is a marathon, not a sprint. Slow sales early could be bad news, or it could just mean shoppers are waiting to pounce later; fast sales early could be good news, or it could mean consumers get tapped out sooner. Past patterns are no indication of this year’s results. Even more important: it’s not how much consumers are spending that matters, but how much the economy is producing, which is the ultimate source of future purchasing power.

Instead, focus on fundamentals, like monetary policy and corporate profits. It’s these fundamentals that determine the path of markets in the next year or so. And in that regard, the near future is flashing many warning signs.

With results in from 97% of S&P companies for the third quarter, according to FactSet, it looks like corporate profits are up only 2% from a year ago. We would not be surprised at all if the GDP report (due Wednesday morning) shows economy-wide corporate profits fell in Q3 and, given bottom-up earnings estimates so far, continue to decline in Q4.

The stock market depends on two important factors. Profits and interest rates. As the Federal Reserve has lifted short rates, the entire yield curve has risen, and higher interest rates have been a big drag on stocks. Now stocks look like they’ll also have to grapple with stagnant to declining earnings. This is why we think the recent rally does not signal the end of a bear market, just like the rally from mid-June through mid-August, which ended with the S&P 500 peaking just north of 4300.

The lowest close so far this year is 3577. We think the market will test that low and likely go lower before the next recession is through. (We will provide more clarity on what to expect in 2023 before year end.)

The only way the recent rally turns out to signal that the worst is behind us is if the US somehow avoids a recession. But with monetary tightening (highlighted by a significant slowdown in M2), avoiding a recession is unlikely. This is especially true when we add in the fact that much of the economy, especially in the goods sector, has to get back toward normal after being artificially supported by trillions in temporary stimulus in 2020-21.

Yes, some recent economic reports have been solid, including retail sales, manufacturing output, and new home sales. Meanwhile jobs have kept growing. But the link between tighter money and less economic growth is long and variable.

Back in 2020-21 we consistently said that the bill for massive over-stimulus would eventually come due. We are now much closer to getting that bill. Don’t let the time lag, or the belief that the Fed can reverse course just in the nick of time, convince you it’s not coming at all.

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. 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.

The Aftermath Economy

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

November 21, 2022

We will forever believe that locking down the economy for COVID-19 was a massive mistake. There is virtually no evidence that death rates were lowered by government mandates and lockdowns.

Business activity in certain sectors would surely have slowed as individuals protected themselves from COVID: think hotels, cruises, restaurants & bars, amongst other services. But the government didn’t have to aggravate the problem by applying a version of medical central planning. Doctors, epidemiologists, and scientists can be very good at coming up with treatments, cures, and vaccines, but they’re not equipped to weigh trade-offs that involve costs outside the medical arena, like loss of income or basic freedoms.

There is clear evidence that closing schools caused a harmful loss of learning, which could affect the incomes of future workers for decades, while paying people not to work has warped the labor force.

Economically, the United States ran up about $5 trillion in additional debt and boosted the M2 measure of the money supply by more than 40% during the pandemic, which caused a 40-year high in inflation. In turn, this inflation led politicians to release hundreds of millions of barrels of oil from the strategic petroleum reserve in an attempt to temporarily reduce energy prices.

In other words, the US enters the decades ahead with more debt, less spending power, an undereducated population, and less petroleum put aside for national defense. The US has made the future riskier.

At the same time, no one can know exactly what the near-term future looks like. Right now, the conventional wisdom is that the US faces a recession. Normally, we would disagree with the conventional wisdom, but this time we agree. Unwinding COVID policies will be painful.

Most people think that a recession is coming because the Federal Reserve is lifting interest rates. Last week, the US yield curve was inverted with 2-month Treasury bills yielding more than 30-year notes, suggesting that long-term investors think the Fed has gone too far.

Obviously, raising interest rates has hurt the housing market and imagining more economic damage to other sectors as these rate hikes bite seems straightforward. However, this is the first rate-hiking cycle in an inflationary environment under an “abundant reserve” model of managing monetary policy. The Fed has held interest rates artificially low for a very long time, and at least for now, the entire yield curve is still below current inflation rates.

But the real reason we expect a recession is that COVID policies severely distorted the economy. For example, from February 2020 through September 2022, real personal income increased just 2.6%, while real personal consumption climbed by 6.6%. And this happened with fewer people working because of lockdowns and overly generous unemployment benefits. We estimate that Americans have worked about 30 billion fewer hours during the past 2½ years than would have happened if COVID had never hit.

Yet, federal tax receipts hit 19.6% of GDP in 2022, a near record high, in spite of the lockdowns, while corporate profits jumped 23% between the end of 2019 and the second quarter of this year.

The US borrowed from future generations and handed out pandemic benefits that more than replaced lost earnings. Then it taxed the economic activity that this borrowing created, and kept small businesses closed in many states, while large public companies remained open. The result is that spending, profits, and tax receipts were all artificially lifted above normal. The whole economy got distorted and is still untwisting from those distortions.

It’s as if the US economy had a car accident and the emergency responders injected it with morphine. As this morphine continues to wear off – via rate hikes and smaller deficits – it is hard for us to imagine that these above normal trends will continue. In other words, a recession is in the cards.

And with that recession, profits are likely to fall. The combination of lower profits and higher interest rates create a headwind to markets and turbulence for investors.

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.

Democrats Overperform

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

November 14, 2022

The Democratic Party substantially beat expectations on Tuesday, already having clinched control of the US Senate for the next two years and, for now, hanging on to a (very slim) possibility of keeping control of the House of Representatives. If they win the Georgia run-off in early December, their Senate majority will be one seat larger than it was for the past two years.

In the five states we thought would have the closest Senate races – Nevada, Pennsylvania, Georgia, Arizona, and New Hampshire – the GOP ended up competitive in four of them but coming up empty, unless they win the Georgia runoff. Oddly, Republicans appear to have fared well in the national vote total for the House, even while falling well short of expectations in terms of seats. That suggests they ran up the score in uncompetitive districts while losing narrowly in many competitive districts around the country.

It’s important for investors to recognize that even if the Democrats end up with narrow control of the House, they are unlikely to raise taxes in the next couple of years. Federal tax revenue was 19.6% of GDP in the fiscal year that ended September 30. That’s the highest on record with the exceptions of the peak of the first internet boom in 2000 and World War II.

At the same time, the Federal Reserve needs to impose a tight monetary policy to get inflation under control. As a result, the risk of a recession is unusually high. Moderate Democrats in “purple” states and swing congressional districts will be very reluctant to raise taxes. The Democrats will have to defend 23 of the 33 Senate seats that will be up for grabs in 2024, with about half of those 23 in “purple” or “red” states. None of them wants to be accused of raising taxes into a recession.

If the Republicans are able to hang onto some voting leads and narrowly take control of the House, that means every piece of legislation going to the president’s desk will have to be bipartisan. In that scenario, debt-ceiling cliffhangers are possible, but we don’t expect any Treasury debt defaults.

Another piece of major news last week was that a federal judge ruled the president’s actions on student loans – providing large-scale debt relief and limiting future payments relative to income – are unconstitutional.

Yes, the student loan law gives the president the authority to provide some relief. But, the court ruled, Congress can’t pass a law that circumvents the Constitution’s requirement that Congress itself must authorize federal spending. The Congressional Budget Office estimates that debt forgiveness alone (so, not including the cost of future limits on repayments) costs the federal government $379 billion, which is a huge amount of money for the president to spend without a direct appropriation from Congress.

Look for this issue to be a major bone of contention for the next year or so, but for the federal courts to ultimately strike down the Biden Administration proposal.

As we wrote last week, ultimately, the stock market will be dominated not by election results but by fundamentals, including higher interest rates this year and weaker profits next year. The election results are unlikely to have an effect on interest rates or corporate profits. Remember: whether you’ve been cheering or jeering the election results, don’t let that cloud your investing judgement. The bear market has further to go and a recession is highly likely in the next 18 months.

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. 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.

How will midterm elections impact the market?

MARKETS & INVESTING

October 28, 2022

CIO Larry Adam provides context ahead of the November 8 elections. Click the link below to watch full video.

https://www.raymondjames.com/commentary-and-insights/markets-investing/2022/10/28/how-will-midterm-elections-impact-the-market?utm_source=ccemail

All expressions of opinion reflect the judgment of the author, the Investment Strategy Committee, or the Chief Investment Office and are subject to change. Past performance may not be indicative of future results. There is no assurance any of the trends mentioned will continue or forecasts will occur.

Beware a "Gridlock Rally"

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

November 7, 2022

Election day is tomorrow and will bring results for key Senate, House, and Governors races from all around the country, plus local legislative races and more. For the federal races, our projection is that the Republicans are essentially a slam-dunk to take back the House of Representatives (98% likely) and very likely to take back the Senate (about 80%).

To be exact, our best guesses are that the GOP will end up with around 53 seats in the Senate (which, if exactly right, would be a gain of 3) and 240 in the House (which would be a gain of 28 seats compared to where the GOP finished in 2020). We’re confident we won’t get this exactly right, but, as of today, that’s how we see the races breaking.

If you want a scorecard for the Senate races, we suggest focusing on five elections, in particular: New Hampshire, Pennsylvania, Georgia, Arizona, and Nevada. To keep the Senate, the Democrats need to win at least four of those five races. Not impossible, but very unlikely; we’re projecting they win only one of these, not four. In particular, if the Republicans win New Hampshire, they are also likely to win at least one of those other four states (and, therefore, Senate control), you might be able to go to bed early tomorrow night.

If we’re right about the election outcomes, or even close, many stock market investors might take it as a reason to be bullish. The result would be “gridlock,” which means no major federal legislation could be enacted unless it got significant bipartisan support.

Gridlock has been good for stock market investors in the past few decades, particularly when there’s been a Democratic president and the Republicans in control of at least one house of Congress. For example, under President Clinton, from the market close on election night 1994 – when the Republicans took control of both houses of Congress for the first time in forty years – to the end of the Clinton presidency, the S&P 500 generated a total return of 20.7% per year. Under President Obama, from the close on Mid-Term Election Night 2010 – when the GOP took the House and made gains in the Senate – through the end of his presidency, the S&P 500 generated a total return of 13.3% per year.

But there are some big differences between the current economic situation and those other two episodes. In November 1994, consumer price inflation (on a year-ago comparison basis) was running at 2.7%; in November 2010, the CPI was running at 1.1%. Right now, inflation is running north of 8.0%, and the Fed is ratcheting up rates no matter who wins.

Back in the 1990s, theoretical “gridlock” ended up being a mirage, as President Clinton and congressional Republicans ended up agreeing on welfare reform, trimming Medicare, cutting the capital gains tax, and expanding free trade. If scandal hadn’t interceded late in the Clinton presidency, even Social Security reform would have been possible. President Obama and congressional Republicans agreed on much less, but “gridlock” meant no more expansion of entitlements, like health care, and did result in a compromise that extended much of the Bush tax cuts originally enacted in 2001-03.

If the stock market soon rallies broadly because investors think a current episode of gridlock under a Democratic president will end up looking like the last two, we think they end up disappointed; the rally will fade, just like the bear-market rally we had this past summer (mid-June to mid-August).

This doesn’t mean investors should ignore the election results. Who wins and loses should have an influence on which sectors might do better for at least the next couple of years. But expecting a quick and broad end to the bear market is expecting too much.

The same goes for a rally that might materialize if and when the Federal Reserve stops raising short-term interest rates next year. Yes, investors might bid up stock prices initially in relief. But that rally should fade, as well.

Ultimately, the stock market will be dominated not by election results but by fundamentals. Higher interest rates have been the key headwind for stocks this year; next year it’s likely to be weaker profits as the “sugar high” of stimulus fades.

The election results tomorrow are unlikely to have an effect on interest rates or corporate profits in 2023. Meanwhile, President Biden is very unlikely to start cutting tax rates, government spending, or regulations that impede energy production. Vetoes and Executive Orders are more likely.

If you like one political side or another, we’re sure tomorrow will give you reasons to cheer or jeer. But don’t let your personal political preferences cloud your judgement. The bear market has further to go and a recession is highly likely in the next 18 months, no matter what the outcome.

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. 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.