Still Growing

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

July 24, 2023

No one should be popping champagne when they see Thursday’s GDP report. The good news is that it won’t be negative. The bad news is that even if it hits our estimate of 2.1% this is a far cry from the robust growth of the economic expansions in the 1980s and 1990s.

The US is in desperate need of policies that raise the long-term growth of the US economy, policies that encourage more capital formation, better education, and making it easier to raise the next generation.

In the meantime, we still think the US is headed toward a recession, but it wasn’t in one in the second quarter. Be careful, though. While some others say we can’t fall into a recession because the job market is so strong, it’s important to realize that the job market is almost always at or near a peak when the economy enters a recession. This doesn’t mean the recession has to be anywhere near as severe as the COVID Lockdown or even the Great Recession/Financial Panic of 2008-09. But even a mild recession will bring some pain.

In the meantime, however, the economy grew at a moderate rate in Q2, which we estimate at 2.1% annualized.

Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector declined at a 3.3% annual rate in Q2. However, sales of autos and light trucks increased at a 9.5% rate and it looks like real services, which makes up most of consumer spending, should be up at about a 2.5% pace. Putting it all together, we estimate that real consumer spending on goods and services, combined, increased at a tepid 1.2% rate, adding 0.8 points to the real GDP growth rate (1.2 times the consumption share of GDP, which is 68%, equals 0.8).

Business Investment: We estimate a 7.5% growth rate for business investment, with gains in intellectual property and commercial construction once again leading the way. A 7.5% growth rate would add 1.0 points to real GDP growth. (7.5 times the 13% business investment share of GDP equals 1.0).

Home Building: Residential construction is showing some resilience in spite of some lingering pain from higher mortgage rates. Home building looks like it declined at a 2.6% rate, which would subtract 0.1 points from real GDP growth. (-2.6 times the 4% residential construction share of GDP equals -0.1).

Government: Only direct government purchases of goods and services (not transfer payments) count when calculating GDP. We estimate these purchases – which represent a 18% share of GDP – were up at a 2.3% rate in Q2, which would add 0.4 points to the GDP growth rate (2.3 times the 18% government purchase share of GDP equals 0.4).

Trade: Looks like the trade deficit expanded in Q2, as both exports and imports declined but exports declined faster. We’re projecting net exports will subtract 0.9 points from real GDP growth.

Inventories: Inventories look like they grew faster in Q2 than in Q1, suggesting they’ll add about 0.9 points to the growth rate of real GDP. When a recession hits, we expect inventory declines to play a significant role in the drop in GDP.

Add it all up, and we get a 2.1% annual real GDP growth rate for the second quarter.

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.

Has the Inflation Threat Passed?

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

July 17, 2023

The best news last week was that inflation came in below expectations for June. Consumer prices rose a moderate 0.2% for the month, while producer prices increased only 0.1%.

That was good news for both stocks and bonds, because it made it less likely the Federal Reserve would raise rates multiple more times this year, in turn reducing market perceptions about the risk of an eventual recession. Meanwhile, the news boosted the markets’ odds the Fed would be in a more aggressive rate cutting mode in 2024, not necessarily because the economy would be weak but because inflation would be low.

We think the optimism is overdone. The M2 measure of the money supply has dropped in the past year and we think that drop is starting to gain traction, including in the form of lower headline inflation.

Historically as Milton Friedman taught the world many decades ago, fluctuations in the money supply – up or down – tend to affect the real economy first and inflation rates about a year later. But, fortunately for him, Uncle Milty never had to live through a COVID Lockdown and subsequent Reopening. The sample size on how monetary policy interacts with a COVID Lockdown/Reopening is (barely) one, and we wouldn’t be surprised at all if the unique nature of this business cycle has distorted the normal pattern of money affecting the real economy first and inflation a year later.

The CPI is up 3.0% from a year ago, a remarkable improvement from the peak 9.1% gain in the year ending in June 2022. But don’t expect another tepid headline inflation number for July itself. Oil prices have been persistently higher so far this month.

Core inflation hasn’t improved nearly as much as headline inflation. Core prices, which exclude food and energy, are up 4.8% from a year ago versus a 5.9% gain in the year ending in June 2022.

If the M2 measure of money (next reported Tuesday July 25) declines further, then, yes, perhaps better inflation news is ahead, including a continued decline in core inflation, as well. But it’s hard to see a drop in core inflation down to the range of 2.5% or below unaccompanied by some significant economic pain. In the past several decades a drop in core inflation of 1.5 percentage points or more over the course of two years has always been associated with a recession. Now the Fed is projecting that size drop in core inflation in about one year, not two.

If core inflation drops substantially, that also means many businesses will find their pricing power is less than they expected. That should undercut corporate profits and restrain business investment.

Yes, there has been a boom in the construction of manufacturing facilities in the past year or so, largely due to government policies focused on building out tech-related manufacturing capacity domestically. But those resources are being pulled from other sectors and eventually the artificial government-induced spike in that sector will peter out. Remember, the government can be good at temporarily picking winners: the economic planners in Japan picked consumer goods and had a good run; even the planners in the Soviet Union were pretty good at building nuclear weapons. But, ultimately, artificial booms in certain sectors due to government policies don’t end well. We don’t expect this one to be different.

The bottom line is that if the Fed keeps the money supply trending down it will succeed in bringing inflation down. But we remain skeptical it can pull that off while leaving the economic expansion intact.

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.

Still Overvalued

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

July 10, 2023

Prior to 2008, when the Federal Reserve ran a “scarce reserve” monetary policy, just about every bank in the US had a federal funds trading desk. These trading desks lent and borrowed federal funds (reserves) amongst each other.

In other words, there was an active marketplace that set the federal funds rate. Yes, the Fed could guide the overnight rate by adding or subtracting reserves. But this system meant there was a direct link between the money supply and interest rates.

Since the financial panic of 2008, and the introduction of Quantitative Easing, the Fed has flooded the system with reserves. Reserves are so abundant that banks no longer borrow or lend them. The Fed pays banks to hold them. As you can imagine, the Fed would like to pay almost nothing to banks, as it did for nine out of the last fifteen years. Under the new system there is no direct link between interest rates and the money supply.

Instead, the Fed just decides what rates should be. And this explains why market expectations about interest rates jump around with every piece of economic data. It’s all about what the Fed “might” or “might not” do. Earlier this year, the market was pricing in multiple rate cuts in the second half of 2023.

But after last week’s employment report, which showed continued solid job growth, the futures market finished the week with the odds of a July rate hike at almost 90%. We think the market is underestimating the odds that the Federal Reserve will raise short-term rates again this year, after July. Recent economic reports have been stronger than expected, and inflation remains stubbornly high around the world.

The Fed pays close attention to the labor market and average hourly earnings rose 0.4% in June and are up 4.4% from a year ago. We think the Fed needs to focus on actual inflation and the money supply, but its models tell Fed policymakers to focus on the labor market. Given a 2.0% inflation target and slow productivity growth, we think the Fed would like to see average hourly earnings grow at more like a 3% annual rate, not 4.4%.

Meanwhile, the unemployment rate is now 3.6% versus the 4.1% the Fed projected for the fourth quarter (back in June). Low unemployment is another reason the Fed is likely to be aggressive. Remember, back at the June meeting, two-thirds of Fed policymakers (twelve of eighteen) thought the Fed would raise rates at least two more times this year, so the flow of data on the economy and inflation would have to be generally weaker than expected to suggest only one rate hike is on the table for the remainder of 2023.

In turn, this bolsters the case that equities are overvalued. If the Fed ends up raising rates more than currently expected, long-term interest rates have some more risk to the upside in the months to come. Our Capitalized Profits model, which uses a measure of nationwide profits from the GDP report, discounted by the 10-year US Treasury yield, suggests that with the 10-year Treasury yield at 4.00%, the S&P 500 index is fairly valued at about 3,350. All else equal, a higher 10-year yield would drive this measure of fair value even lower.

We have been focused on the M2 measure of the money supply, which has dropped the most since the Great Depression. The US economy is still absorbing the massive money printing during COVID, but this is almost over. A decline in M2 should pull the economy into recession soon.

Apparently, investors aren’t worried about that because they think the Fed will cut rates. And we would not be surprised if 2024 brought more aggressive rate cuts than the market is currently pricing in. However, our model says that if the 10-year yield fell to 3.00% but profits fell 15%, the S&P 500 would have a fair value of just 3,800.

In other words, the Goldilocks future, where the Fed manages everything perfectly, is likely too optimistic. Some stock valuations have become too high in our opinion. More defensive strategies are appropriate at this juncture.

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 Red, White, and Blue Swan

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

July 3, 2023

In 1852, Karl Marx said "Men make their own history, but they do not make it as they please; they do not make it under circumstances chosen by themselves, but under circumstances directly encountered and transmitted from the past."

He, obviously knew about the Magna Carta (1215) and the English Parliament’s Bill of Rights (1689), which created a separation of powers between the King and elected representatives. What he didn’t pay much attention to was how the United States had improved upon these documents or he would have seen a country of entrepreneurs that had freedom and property rights along with a constitution so well thought out that it has only been amended 27 times in 234 years. No one puts it better than Ronald Reagan; the excerpt below comes directly from his Commencement Address at the University of Notre Dame back on May 17, 1981.

"This Nation was born when a band of men, the Founding Fathers, a group so unique we've never seen their like since, rose to such selfless heights. Lawyers, tradesmen, merchants, farmers – 56 men achieved security and standing in life but valued freedom more. They pledged their lives, their fortunes, and their sacred honor. Sixteen of them gave their lives. Most gave their fortunes. All preserved their sacred honor.”

“They gave us more than a nation. They brought to all mankind for the first time the concept that man was born free, that each of us has inalienable rights, ours by the grace of God, and that government was created by us for our convenience, having only the powers that we choose to give it. This is the heritage that you're about to claim as you come out to join the society made up of those who have preceded you by a few years, or some of us by a great many.”

“This experiment in man's relation to man is a few years into its third century. Saying that may make it sound quite old. But let's look at it from another viewpoint or perspective. A few years ago, someone figured out that if you could condense the entire history of life on Earth into a motion picture that would run for 24 hours a day, 365 days – maybe on leap years we could have an intermission – this idea that is the United States wouldn't appear on the screen until 3.5 seconds before midnight on December 31st. And in those 3.5 seconds not only would a new concept of society come into being, a golden hope for all mankind, but more than half the activity, economic activity in world history, would take place on this continent. Free to express their genius, individual Americans, men and women, in 3.5 seconds, would perform such miracles of invention, construction, and production as the world had never seen."

America has proved that men and women not only can make their own history, but they can make it as they please, with circumstances chosen by themselves. As we approach July 4th it's important to take a step back and realize that a Red, White and Blue Swan really did allow people to make their own history and truly change the world! Happy 4th of July to you 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.

Burns or Volcker?

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

June 26, 2023

We get a big bunch of data reports this week: GDP revisions and economy-wide corporate profits for the first quarter; durable goods, new home sales, personal income, and consumer spending for May; home prices for April. Throw in some regional manufacturing reports for June by various Federal Reserve Banks. In other words, by the end of the week, we should know more about the recent underlying trends in the economy.

But the one report we will be following the most is the one that might get the least media and investor attention: the Fed’s report on Tuesday about the money supply. No matter how you slice – M1, M2, or M3 – the key measures of the money supply have all been falling lately.

In turn, this means the Fed has been tight. It remains to be seen how quickly this tightness can get inflation back down to the Fed’s 2.0% target, but that’s where it would ultimately head if these measures of money remain in decline. Hence our focus on Tuesday’s report, where we will see whether monetary policy has stayed as tight as it’s been the past few months.

Meanwhile, for those still focused on short-term interest rates, back on June 14 the Fed tried to have its cake and eat it, too, when policymakers decided to refrain from raising rates but, at the same time, signaled two more quarter-point rate hikes later this year.

The most absurd part of all this is that the decision was unanimous; literally not one policymaker dissented from this “split the baby” tactic. We say it’s absurd because have you ever known even just two economists or policymakers to agree on everything? And yet the Fed is trying to represent itself as an organization with no alternative thoughts or narratives, as if it were part of the government of North Korea or the old Soviet Union.

Either way, while we recognize the absurdity of the Fed unanimously supporting skipping a rate hike while signaling two more later on this year, we think the Fed is likely to follow through on its projections of two more rate hikes. We are forecasting that when all is said and done that the economy ends up a little weaker than the Fed expects this year, but inflation stays higher than the Fed thinks. Combined, if we are right, that should keep the Fed on track to raise rates as it recently projected.

Another factor that might get the Fed back to raising rates in July is that the UK inflation problem remains acute. The UK version of the consumer price index was still up 8.7% in the year ending in May, which has and will continue to keep the Bank of England in hiking mode, even if it leads to a major recession.

Ultimately Fed Chairman Powell has a decision to make: would he prefer to be remembered like Arthur Burns or Paul Volcker? Burns kept monetary policy too loose and let inflation reignite; he was respected at the time but now his name is Monetary Mudd. Paul Volcker tightened monetary policy to what was then considered excruciating levels in the early 1980s. Despised by many at the time, he’s now considered a great leader at the Fed, the slayer of the inflation dragon that Burns let loose.

Making the decision even harder for Powell is that we are on the cusp of a presidential election year, which means all the moves the Fed makes (or refrains from making) will be seen through the prism of him trying to help one political side or the other. A recession in 2024 could tempt Powell to turn into Burns, but maybe, just maybe, he will be Volcker, instead.

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.

Is the Recession Threat Dead?

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

June 20, 2023

Lately, it’s been easy to see the optimism. As of the Friday close, the S&P 500 is up 15% so far this year (not including dividends) and up 23% (again, without dividends) versus the lowest bear-market close back in October.

Some investors attribute this to the Federal Reserve being very close to finished with the series of rate hikes that started back in March 2022. But that doesn’t really make sense. If investors thought the Fed were finished (or nearly finished) because it had tightened monetary policy enough to induce a recession sometime soon then we don’t think stocks would be going up like they have of late.

Instead, what makes more sense is that stock market investors think the Fed is nearly done and will not induce a recession, that it has somehow positioned monetary policy to be tight enough to bring inflation back down to its 2.0% target but not so tight that we have a recession.

We hope they’re right about this; wouldn’t it be great! Unfortunately, we still have strong doubts and think the US is headed for a recession. If monetary policy is tight enough to fix inflation, it’s going to hurt economic output, as well.

Yes, CPI inflation has slowed down substantially in the past year. The consumer price index is up 4.0% versus May 2022 while it was up 8.6% in the previous year. But this slowdown is largely due to volatile categories like food and energy. “Core” CPI inflation, which excludes food and energy, has barely slowed, to 5.3% from 6.0% a year ago. Socalled “Super Core” CPI inflation – which excludes food, energy, other goods, and rents – has slowed to 4.6% from 5.2%.

Other measures of CPI inflation calculated by the Cleveland and Atlanta Federal Reserve Banks, which are designed to measure the underlying pace of inflation, also suggest no major decline. In other words, we think recent optimism about inflation is overdone.

Which is not to say that the Fed itself hasn’t sent mixed signals. The Fed decided to skip raising rates last week for the first time since early 2022, even though most Fed policymakers thought the Fed would raise rates by a (cumulative) half a percentage point later this year.

The general policy by the Fed of signaling multiple future rate increases while skipping a rate hike last week makes no sense to us. Instead, the Fed would be better off if, at each meeting, it moved the short-term interest rate target to a level where Fed policymakers were evenly split about the next move being a rate hike or a rate cut. Coaches tell young hockey players to skate to where the puck is going, not where it is right now. The Fed is doing the opposite.

Regardless, the Fed remains far from declaring victory over inflation. PCE prices – the Fed’s favorite measure of inflation – rose 4.4% in the year ending in April; core PCE prices rose 4.7%. These figures are roughly 2.5 percentage points above the Fed’s official target of 2.0%.

To put this in perspective, let’s guess that the Fed would like to see PCE inflation at or near 2.0% within eighteen months (which would be late 2024). Looking back at the past sixty years, the only time the PCE inflation rate has dropped that much has been during or right after recessions. Maybe this time is different, but we remain skeptical.

This is true whether you think the Fed has already done enough to eventually wrestle inflation back down to 2.0%. We have consistently followed the M2 measure of money the last few years, which did the best job of warning us about inflation. That measure surged in 2020-21 but has dropped in the past year. If that drop continues, then it will eventually absorb enough of the prior excess surge in M2 to bring inflation down to the Fed’s target (and maybe lower!). But that drop in M2 should also eventually throw us into recession, as well.

If you prefer to measure monetary policy by using shortterm rates, and do not think they’re high enough yet to bring inflation down to 2.0%, then you should also believe rates may go significantly higher from here. And yet markets are currently pricing-in a much more benign story for the months ahead.

The effects of monetary policy are long and variable, as Milton Friedman said many years ago. Right now, some investors may be drawing conclusions about its future path and effects way too early.

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.

It's Still About the Money

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

June 12, 2023

The Federal Reserve will meet this week and announce its decisions on Wednesday. As of the close on Friday, the futures market indicated about a 30% chance of the Fed raising shortterm rates by a quarter point, with about an 85% chance the Fed raises rates by a quarter point by the end of the next meeting in late July.

We believe another rate hike is likely coming in late July, but also think investors should be more focused on what has been happening lately to the money supply. No matter how you cut it the Fed has finally gotten tight. Through April, the relatively narrow M1 measure of the money supply has dropped thirteen months in a row. The broader M2 measure, which we have followed the most, has dropped nine months in a row and is down 4.6% from a year ago.

Some careful observers have noted that the M2 measure of money does not include large time deposits (such as CDs above $100,000). But larger time deposits are included in the M3 measure of money, which the Fed stopped producing in 2005, but is still tracked by an international group (the OECD) and can be found online in the St Louis Fed’s FRED database. That measure is down 4.1% from the peak last July.

Meanwhile, bank credit at commercial banks is down 1.4% in the past three months and commercial and industrial loans are down 1.8% versus the peak in January. Deposits are down, as well. These are signs that the Fed is finally tight. The only question is how long this policy stance will take to bring inflation back down and whether the Fed will have the fortitude to maintain a tight enough policy to keep inflation down once it gets back to its 2.0% target, even if it causes recession.

The odd part of all this is that the Fed insists the money supply is irrelevant as a forecasting or policy tool. If we look back at 2020 and 2021, the Fed engineered a tsunami of easy money, allowing M2 to increase by a total of 41%.

The Fed could have easily taken measures to make sure the money supply did not surge in response to all that COVID borrowing and spending. Or, it could have at least decided not to do more Quantitative Easing, which would have led to a smaller gain in money. Instead, the Fed happily allowed the money supply to surge. We assume it did so because it thought this would alleviate financial stress from lockdowns.

So, while the Fed insists money doesn’t matter, it forced massive amounts into the system. That’s where inflation came from. And, now that the Fed is concerned with inflation, it certainly looks like it has reversed course and engineered the mother of all riptides in the money supply. That riptide has already helped pull some banks under and put others in distress. All this volatility in money growth suggests that maybe the Fed isn’t so sanguine about money after all.

Where does that leave the economy? At present, unfortunately, caught between the economic growth and inflation left over from the 2020-21 tsunami, but also feeling the negative effects of the 2022-23 riptide.

In the year ahead, we expect a recession to start as the pull from the riptide increases. Why so many, including the Fed, are ignoring what has been an integral part of economic theory for hundreds – if not thousands of years – is beyond us. What we do know is that these kinds of policies have a price. Rates may rise in June or July, but that’s the least of our worries.

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.

Jobs With Little Growth Means Less Productivity

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

June 5, 2023

We have used the word “unprecedented” to talk about the economy during and after COVID. We have never before locked down economic activity, while printing trillions of new dollars to help finance trillions of extra government borrowing to pay people not to work. But now, it’s all over…the Federal Reserve has lifted rates, M2 is falling, and we’ve stopped paying people not to work.

We can’t look at history for help, we’ve never done this before. At the same time, we cannot see a way to avoid paying a price for these policies…a recession seems almost inevitable. But after Friday’s employment report, and the new fascination with Artificial Intelligence (AI), the markets are acting like everything is perfectly fine.

The S&P 500 jumped 1.5% on Friday and is now up 11.5% this year after a strong headline jobs report with signs of moderating wages. Nonfarm payrolls increased 339,000 in May and the US has added 1.57 million jobs this year, a 2.5% annualized growth rate. In the past year, total jobs have increased 2.7%.

One would think that with 2.7% more people working the economy would grow by at least that much, yet, real GDP is only up only 1.6% over the past year and rose just 1.3% at an annualized rate in the first quarter. In other words, productivity is falling. At the same time that AI is making so many people think technology will lift profits and economic activity, the actual data on the economy say the US economy is pumping the brakes.

For seven months in a row the ISM manufacturing index has been below 50, meaning contraction. Gross Domestic Income (GDI) has declined for two quarters in a row and is down 0.9% in the past year. GDI is often overlooked, but it shouldn’t be.

What is GDI? It’s the other side of the GDP accounting sheet. GDP measures what is spent, on construction, imports, consumption, and investment,…etc. But every dollar that is spent can also be thought of as income/revenue to someone else. Technically, GDI and GDP should equal, but income is measured with a different set of statistics, and the US economy is huge and diverse, so the numbers don’t always add up.

While real GDP rose 1.3% at an annualized rate in the first quarter of 2023, real GDI fell at a 2.3% annualized rate, the second consecutive quarterly decline. We don’t think this is impossible to understand. During COVID, Amazon doubled its workforce (from roughly 800,000 employees to 1.6 million). Its business model was made for COVID, delivering things directly to people’s homes. Jobs in transportation and warehousing jumped 9.0% in 2021 and 8.4% in 2022 and are today well above pre-COVID levels.

The real pain of lockdowns fell on the services sector, specifically hotels, restaurants, and bars. Jobs in the leisure & hospitality industries today are still lower than pre-lockdown levels by roughly 350,000. More importantly, if COVID had never happened, we would have seen more growth in the number of restaurants and bars, etc. In the three years prior to lockdown, leisure & hospitality jobs rose by about one million. But, now that pandemic unemployment benefits have ended, these jobs are picking up. In the first five months of 2023, leisure & hospitality jobs have risen at a 4.2% annualized rate, while transportation & warehousing jobs have grown at half that rate, 2.1% annualized.

So, while it may appear that wages are slowing, it is really the mix of jobs, back toward lower hourly pay positions (but with more earnings from tips) that is changing. In other words, the economic data are not as clear as many seem to think.

Now that we are getting back to pre-COVID levels it is hard to imagine where more growth will come from. If people normally go to three baseball games or two movies a year, they aren’t likely to double down to make up for what they missed during COVID.

In other words, the economy may be finally seeing the end of COVID distortions, but the data suggest that growth is getting a lot harder to come by. Many companies have likely been hoarding workers and if GDI is sending the correct signals this can’t last.

We still expect a recession starting sometime in the next twelve months, but with productivity falling that recession may not be the long-term fix for inflation that many seem to believe. This is hard for us to say, but the market seems to be ignoring a whole lot of economic problems and pain that aren’t really that hard to see.

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.

Discount the Happy Talk

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

May 30, 2023

The stock market finished Friday on a high note, with the S&P 500 index just north of 4,200 for the first time since August 2022 and up 17.6% versus the market bottom in October.

Part of recent gains are related to optimism about the effect of Artificial Intelligence on some high-tech stocks. Another part might be due to signs that Congress and the White House are closing in on a budget agreement that might limit spending growth for the next couple of years while averting a debt default.

But the recent rally also seems related to a general sense of increasing optimism about the broader economy, with investors getting more confident the economy will avoid a recession this year and next.

For the long-term, we remain optimistic about the US economy and the stock market. But we don’t share the stock market’s optimism about the next year or so and think recent data support the case that the US is still headed for a recession.

Economy-wide corporate profits declined 5.1% in the first quarter of 2023, the fastest drop for any quarter since 2020 during the early days of COVID. As some analysts have pointed out, the drop appears to be driven by large and unprecedented losses at the Federal Reserve, a result of the Fed paying banks higher interest rates for them to hold reserves, combined with the Fed’s massive balance sheet.

But appearances can be deceiving. Yes, the Fed is losing more money than ever before, but those losses are due to payments to banks that should lift those banks’ profits. And despite that boost to banks’ profits, economy-wide profits excluding the Fed’s losses were still down 2.7% in Q1.

These profits are important because that’s what we use in our Capitalized Profits Model to assess the stock market. That model takes these profits and discounts them by the 10-year US Treasury yield. These data go back seventy years to the early 1950s. Using a 10-year Treasury yield of 3.8% (the Friday close) to discount profits suggests the S&P 500 index is fairly valued at about 3,500, well below the Friday close of 4,205.

Meanwhile, there was trouble lurking beneath the surface of Thursday’s GDP report, which included our initial look at first quarter Gross Domestic Income, an alternative way to count economy-wide production (as opposed to GDP) that is just as accurate. Real GDI declined at a 2.3% annual rate in first quarter, not the 1.3% annualized gain counted for Real GDP. In addition, Real GDI is now down 0.9% versus a year ago, compared to a 1.6% gain for Real GDP during the same timeframe.

One last problem: The Fed delivered its monthly report on the money supply last Tuesday and it showed that M2 declined another 0.8% in April, the ninth consecutive monthly drop. We have gone from the Mount Everest of M2 increases in 2020-21 to the Death Valley of declines in 2022-23, with the largest drop since the Great Depression. It’s hard to see the economy not eventually feeling the pain caused by that drop.

We’re not trying to say the economy is already in a recession. Recent figures show the job market is still holding up and consumer spending is still expanding. What we are trying to do is show that we are not out of the woods regarding recession risk, not by a long shot.

We are not often pessimistic about equities and think the long-term is still bright. However, we think there are still problems ahead in the near term and investors need to be prepared.

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.

Agents of Change?

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

May 22, 2023

If you’ve been to a high school or college commencement lately, then you know the drill: at some point at least one speaker will urge the graduates to be “agents of change,” suggesting they’d like to see these students make the world a better place through some sort of social activism.

The problem with goading students to think this way is that it assumes they should be dissatisfied with the status quo. It asks students to dwell on the negative, to focus on what is wrong, to obsess on injustices, whether perceived or real. Which makes us imagine an alternative message that we rarely, if ever, hear: for graduates to go forth thinking about what is already good, to dwell on what is worthy of conserving, and why sometimes it can be important to be barriers to change.

In the context of protecting the environment, this message makes sense to pretty much everyone: let’s be careful stewards of nature. People may disagree with what this means in certain contexts and may disagree about how to weigh trade-offs, but everyone agrees that environmental concerns shouldn’t be casually dismissed.

At the same time; what does changing or reimagining the US mean? No country close to the population size of the US has wealth or income per person even close. People from around the world are eager to move here. Think about our blessings: property rights, freedom of contract and the ability to enforce those contracts, a democratic republic with a Constitution that separates executive and legislative functions, a bicameral legislature that makes it tough for temporary voting majorities to impose their will, and social institutions that foster individual rights. The list goes on and on.

And yet the academic class would like those graduating its intellectually narrow, and often overly shallow, confines to dwell on how to make our society different from what it is today.

Maybe that’s a natural consequence of living in a highincome and wealthy society. Academics, who in times past had higher status than those who run businesses, must think to themselves that something must be seriously wrong or rotten with a society in which so many others have more prestige than they have. If so, what’s being taught in schools and conveyed in commencement speeches simply reflects the status anxiety of the intellectual class and we should accept it as a symptom of longterm economic improvement (higher income and wealth) for people outside academia.

But, even if so, that doesn’t mean we should completely ignore or reject their message to be agents of change. After all, our country’s Founders were, in a sense, agents of change themselves, while also doing so in a way that conserved and expanded freedoms that had developed in certain parts of Western Civilization.

We can think of two areas in particular that are ripe for change, just in the education system itself. One would be breaking up government-run primary and secondary school systems by making school vouchers as widespread as possible. Another would be requiring colleges to have skin in the game when they get student loan money. If a student can’t repay a student loan, maybe colleges should eat half the cost. Or, instead of getting all the loan funds up-front, colleges should only get half up front, while also getting a 50% stake in all future loan payments (interest and principal) made by their students. How about that for change?

In the end, it’s also important to remember that preserving our dynamic free-market economic system is also a way to foster the kind of change that America needs, the kind that leads to less poverty and higher incomes. More entrepreneurship means more change, not less. Every single day, the US is built back better by entrepreneurs, while government flounders around making mistakes.

Look, it may be that the US is headed for a recession in the near term. But we also think that once graduating students embrace real change that also conserves what is best, while addressing the government failures that make things worse, they will help lead to the next bull market, which will be a long and strong one.

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.

Battle of the Budget

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

May 15, 2023

It’s hard to open up a newspaper these days and not see a scary story about the debt ceiling debate. The Biden Administration is saying that a “default” is approaching if an agreement isn’t reached soon.

The US has enough revenue to pay all bondholders, but a roughly $1.5 trillion deficit this year means that if the debt ceiling isn’t lifted, it won’t be able to pay all its obligations, maybe even entitlement payments under Medicare, Medicaid, or Social Security.

We’ve been here before, and as we have seen in the past, we think an agreement will be reached and that all bond payments will be made on time. We also think it’s very unlikely that any payments on entitlements will get delayed. Much more likely is that the Congress and White House will agree on some sort of framework to hold the line on increases in discretionary (non-entitlement) spending. Maybe they’ll also agree to form some sort of bipartisan commission to review proposals to reform entitlements.

In other words, lots of smoke and very little fire. If an agreement is reached to limit discretionary spending, those limits are not likely to last. History is clear. In the past 90 years, non-defense government spending has grown ten times faster than GDP, and that trend is unlikely to change anytime soon. We’re also guessing that if an entitlement commission is formed, that the recommendations would not come up for a vote until after the next presidential election and would likely fall short of the necessary votes.

All of this is important because the path of federal spending, largely dominated by entitlements, is unsustainable. According to the Congressional Budget Office, this year Social Security, Medicare, Medicaid, and other health-related entitlement programs will cost the federal government 10.8% of GDP. Thirty years from now these same programs will cost 14.9% of GDP.

Tax revenue is scheduled to be higher, too, due to the expiration of some of the tax cuts enacted in 2017 as well as “bracket creep” (incomes tend to rise faster than inflation, resulting in a larger share of income getting taxed at higher marginal tax rates). But the gain in revenue relative to GDP is less than one percentage point, which is well below the expected increase in spending.

You don’t have to be a rocket scientist to figure out where this is heading. Simple budget accounting trends forecast a huge increase in federal debt, which means a huge increase in net interest payments by the government. In other words, the real problem isn’t whether the US raises the debt ceiling right now, it is how the US will pay for all this spending over time.

At some point the US will either reform entitlement programs or raise future taxes to pay for them. Reducing entitlements would help keep more workers in the labor force and more dollars in the private-sector, which would help boost future GDP growth.

By contrast, higher future taxes would put us on the same path as many countries in Europe, with a huge size of government. This creeping Europeanization of the US would suppress future work, saving, and investment. Worse, the process would be gradual, and much harder to notice than a tidal wave of interest payments. The frog gets boiled, slowly.

While most investors are focusing on the straightforward issue of whether debt payments due this summer get fully paid, wise investors need to keep their eye on the key longterm issue. That’s what we are watching. Will politicians make progress on limiting future spending? If not, the longterm growth path of the US will continue to slow.

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.

Bank Problems Aren’t Over, But It’s Not 2008

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

May 8, 2023

Yes, we have banking problems. No, this is not 2008. It’s much more like the 1970s Savings & Loan problems. In other words, we do not have credit problems today, we have duration (asset-liability) problems. These are exacerbated by the fact that Quantitative Easing inflated total deposits in the banking system.

In the 1970s, the Federal Reserve held interest rates too low for too long. From 1974 through 1978, the federal funds rate was below inflation most of the time, and the “real” federal funds rate averaged -1%. At the same time, because of strict regulations on lending, branch banking, and other issues, S&Ls only made, and held, long-term fixed rate mortgages.

So, S&Ls were paying relatively low short-term rates to depositors (even though they slowly rose as inflation picked up), while earning higher returns on long-term mortgages. As the 1970s progressed, and with Paul Volcker taking over the Fed, short-term rates rose above rates on loans. By the end of the 1970s, the entire S&L industry had negative net capital.

Today, in some ways, we are facing the same problems. Between 2008 and 2021, the Fed held the federal funds rate at close to 0% for nine years, and below inflation 84% of the time. At the same time, because of QE, the M2 measure of money has increased 188%. And because of COVID and financial panic (2008/09) borrowing; total government debt has grown massively as well.

In other words, banks got stuffed with deposits at the same time government debt (of all kinds) exploded. And banks, because of the Fed, could pay depositors very little, while favorable capital rules on Treasury, FNMA, GNMA, and SLMA debt encouraged them to hold long-term bonds.

Now that the Fed is lifting interest rates, two things are happening: 1) bank assets bought at lower rates are worth less and 2) rates paid on deposits are now much higher than rates earned on many of these assets. For example, in 2020, the 10- year Treasury yield was 0.6%. If a bank thought the Fed would not raise rates above 0%, then they could anticipate positive cash flow, even from that low rate. But now, short-term rates are 5%. The result: huge losses.

Before going into what this means for the economy, it is important to say that this didn’t need to happen. Today’s problems are because of a combination of QE, abundant-reserve monetary policy, and ultra-low interest rates. The Fed told market participants that inflation was “transitory” and therefore many banks expected any increases in short-term interest rates to be short-lived as well. If you believed the Fed, you now have an un-balanced balance sheet.

So, what can the Fed do? If it lowers short-term rates, inflation may be more of a problem, and it doesn’t want to do that. So, instead, it is backstopping the problem by going in and taking back, at par, government debt, which in essence is restarting QE. We think this policy helps the government at the expense of private sector loans, but this has been going on for many years now.

The other thing the Fed and FDIC can do is insure “all” deposits, not just up to a $250,000 limit. If they don’t do this, money will continue to move to the very large banks, and it is highly likely that more small, medium and regional banks will get in trouble. In other words, the Fed (like in the 1970s) is finding its way through the problems it created by making new policies up as it goes along. It’s not 2008. We are not seeing widespread credit problems and markets are not freezing up.

Finally, in the past year, M2 has contracted by 4.1%, the fastest drop the US has experienced since the Great Depression. However, in spite of this decline, M2 is still up $5.4 trillion from where it was pre-pandemic. The decline in M2 will show up as a decline in deposits at some banks, but the bulge in money has still not worked its way entirely through the economy. Hence, for the time being, some modest continued economic growth.

In other words, inflation is likely to remain elevated this year and the Fed is unlikely to cut rates anytime soon. The end of the story is not written. We fully expect more banking problems, but also anticipate these problems to be dealt with by policies that kick the can down the road. The stock market appears to be saying “no problem” – we think it may be overly optimistic about that.

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.

All Eyes on the Fed

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

May 1, 2023

For nine of the last fifteen years, few people thought about the Fed. Sure, we discussed QT and QE, but the Federal Reserve held interest rates at zero year after year. In 2017 and 2018, they lifted rates and it was all anyone talked about. Then they cut them to zero and the noise went away. Now, with rates headed up, all eyes are again on the Fed, and investors are parsing every word of its statements and the Powell press conferences.

As of Friday, the futures market expects a quarter-point rate hike on Wednesday, but then a series of rate cuts that start in the third quarter.

Why the market expects rate cuts is unclear. The next key inflation print – the consumer price index for April, which arrives, May 10 – is coming in hot. At the same time, longer term bond yields are drifting down, and stock prices have been rising. That’s not a tightening of “financial conditions” that some models of monetary policy watch. And we have yet to see the kind of weakness in the labor market that would get the Fed to stop hiking rates.

At the same time…yes, banks are in some trouble because of mismatched liabilities and assets…but the Fed has used the FDIC and a bond buyback program to wall off these problems.

Meanwhile, too few policymakers or investors are following what’s happened to the M2 measure of the money supply. After surging about 40% in the first two years of COVID, M2 hit a plateau in early 2022 and then started dropping last summer. M2 is down 4.1% in the past eight months, the steepest decline since the early 1930s.

If this decline is real (there are some reasons for skepticism given that the Fed releases these data less frequently than in the past and with less detail) and if it continues through 2023, then by 2024 the economy could be in for not only a recession but also a sudden and sharp decline in inflation. Why the press never asks about a decline in M2 that we haven’t seen since the Great Depression is a mystery.

Also a mystery, is whether anyone in the press corp – even just one journalist – has the bravery to ask Powell in public how the Fed is financing its day-to-day expenses now that it’s paying banks more to hold reserves than it earns on its portfolio of Treasury and mortgage-backed bonds. The Fed has negative cash flow and has lost more than its actual capital. Is the Fed letting some of these bonds mature and using that cash for expenses? Is it printing money?

So far this year, we think most investors have convinced themselves of overly pleasant narratives about the economy and the path for monetary policy. One of them is that the Fed will cut rates this year. We don’t think this happens and maybe a re-thinking of those pleasant narratives starts soon.

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.

Closer to a Turning Point

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

April 24, 2023

In spite of weakness in some economic data, problems in the banking sector, and much higher interest rates, real GDP in the first quarter will almost certainly show moderate growth. Meanwhile, the S&P 500 is 15% higher than its low point in October 2022. And, now, many are starting to believe that a recession isn’t going to happen.

But we still think a recession is coming. Ultimately, recessions are about mistakes. In particular, there’s too much investment broadly throughout the economy or in some important segment of the economy, like technology back in 2001 or housing several years later. Once businesses realize they made a mistake – that the return on their investment will be too low – they ratchet back economic activity to bring the capital stock back into line with economic fundamentals.

Almost always, it is government policy mistakes that cause this over-investment (or “malinvestment”). Then, when imbalances become too great, and policymakers change course after realizing their prior mistakes, the economy contracts and a recession becomes nearly inevitable.

Sound familiar? We think so. The Fed opened the monetary spigot in 2020-21 while Congress and two different presidents passed out enormous checks to try to smooth over the damage done to the economy by COVID Lockdowns. Inflation has been the result. Now both fiscal and monetary policy have turned tighter. The unprecedented nature of policies during the COVID Era makes the timing of a contraction in activity difficult to predict, but, in our opinion, this contraction is almost certain.

If anything, the notion among some businesses and investors that recession risk is declining may, by itself, contribute to greater risk, as it’s also consistent with less of a pullback in investment. It means businesses are not as widely coming to terms with past mistakes, which, in turn, means more problems ahead.

This is why we think no one should get excited about a positive first quarter GDP report. As always, it tells us where the economy has been recently, not where it is going. The economy grew 2.9% in 2000; we had a recession in 2001. And, real GDP grew 2.4% in the year ending in mid-1990, right before a recession.

Most importantly, recent data show some early signs of weakness. Jobless claims have risen. Manufacturing production in March was lower than a year ago. Real (inflation-adjusted) retail sales are down from a year ago.

In addition, keep in mind that the Fed used policy measures (like insuring more deposits) in the wake of the banking problems in March in order to prevent any widespread crisis in the financial system. In turn, that makes the likely path for short-term interest rates, for at least the next several months, higher than most investors anticipate.

We think the futures market is correct in anticipating another 25 basis point hike in May, just like we had in February and March. But the markets are not as prepared for another rate hike in June, which we think is more likely than not. Inflation remains a problem and the April inflation print, arriving May 10, should confirm that problem. The federal funds futures market expects the Fed to end the year with short-term rates lower than they are today; we think they end up higher than today at year-end, instead. Where does that leave equity investors? We understand the desire for optimism, but our model still says equities are overvalued. There will come a time to get bullish, but that’ll be after the recession starts, not before.

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.

January Surge Kept Q1 Positive

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

April 17, 2023

The US economy is being tugged in two different directions right now. On the positive side we have the lingering effects of the massive stimulus of 2020-21, the renormalization of the service sector after COVID Lockdowns, and, as always, the entrepreneurial and innovative spirit of the American people. On the downside we have the early stages of a drop in the money supply that started last year and too much government spending.

The problem with forecasting the economy right now is we have never been in this position before, where an unprecedented two-year surge in the money supply (plus massive temporary transfer payments) were closely followed by a dive in the money supply unlike anything we’ve seen in decades.

Eventually, we believe the balance of these forces will tilt the US economy into a recession. However, largely due to a temporary surge in consumer spending in January, Real GDP growth remained positive in the first quarter. As we set out in a Monday Morning Outlook two months ago, January came in strong due to odd factors like unusually warm weather, a big Social Security cost-of-living adjustment, and seasonal-adjustment issues due to the timing of COVID stimulus payments in 2020-21.

As we set out below, we think the economy grew at a 2.3% annual rate in Q1, although we may tweak this forecast slightly in the next ten days based on reports on housing, inventories, and international trade.

In addition, we think the second quarter will likely be weaker than Q1, and very possibly negative. The ISM Manufacturing index has been below 50 for five straight months and, at 46.3, is at a level often (although not always) associated with a recession. Manufacturing production is down 1.1% from a year ago. The ISM Services index is barely north of 50. Continuing unemployment claims are up 37% from six months ago. Retail sales are down in four of the past five months, the lone exception being the January surge.

Don’t look for Real GDP growth to remain positive much longer. But, in the meantime, our calculations show economic growth at a 2.3% annual rate for the first quarter.

Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector grew at a 1.7% annual rate in Q1 while sales of autos and light trucks surged at a 29% rate and it looks like real services, which makes up most of consumer spending, should be up at a moderate pace. Putting it all together, we estimate that real consumer spending on goods and services, combined, increased at a robust 4.3% rate, adding 2.9 points to the real GDP growth rate (4.3 times the consumption share of GDP, which is 68%, equals 2.9).

Business Investment: We estimate a 5.1% growth rate for business investment, with gains in intellectual property and commercial construction leading the way. A 5.1% growth rate would add 0.7 points to real GDP growth. (5.1 times the 13% business investment share of GDP equals 0.7).

Home Building: Residential construction is still absorbing the pain of higher mortgage rates and looks like it fell at a 13.0% rate, which would subtract 0.5 points from real GDP growth. (-13.0 times the 4% residential construction share of GDP equals -0.5). Government: Only direct government purchases of goods and services (not transfer payments) count when calculating GDP. We estimate these purchases – which represent a 18% share of GDP – were up at a 1.7% rate in Q1, which would add 0.3 points to the GDP growth rate (1.7 times the 18% government purchase share of GDP equals 0.3).

Trade: Looks like the trade deficit expanded in Q1, as imports rose faster than exports, thanks to re-opening in China and better growth in Europe than many expected. We’re projecting net exports will subtract 0.4 points from real GDP growth.

Inventories: Inventories look like they grew slower in Q1 than in Q4, suggesting a subtraction of about 0.7 points to the growth rate of real GDP. Look for continued slower inventories in 2023, which could be a significant drag on economic growth later this year.

Add it all up, and we get a 2.3% annual real GDP growth rate for the first quarter, juiced by a temporary spike in consumer spending in January that is unlikely to be repeated.

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.