Stocks Look Pricey

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

August 28, 2023

At the heart of our assessment of the stock market is our Capitalized Profits Model.

That model takes economy-wide profits (excluding profits or losses generated by the Federal Reserve) quarter by quarter going back nearly seventy years and discounts those profits by the 10-year Treasury Note yield in each of those quarters. We then compare discounted profits in those quarters with discounted profits today, putting equal weight on every previous quarter, and using that average to estimate value.

At Friday’s close, the 10-year Treasury was yielding 4.24%. Plugging that yield into the model (and assuming profits remain at the same level as they were in the first quarter) suggests a fair value for the S&P 500 of 3,170, substantially lower than the Friday close of 4,406.

It's important to recognize that the Cap Profits Model isn’t a “trading” model. You shouldn’t use it day-to-day; stocks can remain significantly overvalued or undervalued for prolonged periods of time. However, the model can be used to gauge how attractive stocks are relative to normal.

Today, stocks look expensive. Moreover, when we review what would have to happen for the model’s estimate of fair value to rise to where the stock market is today, it looks even more likely that stocks will face headwinds in the year ahead.

One way to bring fair value up to Friday’s close of 4,406 would be for the 10-year yield to drop to 3.05%. But what do the economy as a whole and profits in particular look like in a scenario with a much lower long-term bond yield? The yield curve would be very deeply inverted and nominal GDP growth would have to be either much slower or expected to slow substantially in the near future. In turn, that would probably mean weaker profits.

Another way for the model to project a fair value for stocks at 4,406 would be for profits to rise 39% while the 10-year holds around 4.24%. What makes this absurd is that a world in which profits surge 39% is one where the 10-year yield is almost certainly higher, because nominal GDP growth is much higher as well. Between the end of 2019 (pre-COVID) and Q1(2023) profits are already up 24%. Another 39% gain would put profits relative to GDP well above where they’ve been during the entire post-World War II era.

So, if a large drop in the Treasury yield would likely come with a recession and lower earnings, and a sharp increase in profits would likely mean higher long-term interest rates, the market is stuck at current levels. And this, in our opinion, leaves only one main mechanism to bring actual stock prices and fair value back toward alignment: a drop in equity values.

Again, don’t use the model as a reason to sell all your stocks today; that would be foolish. Investors should be focused on their long-term goals and their appetite for risk. The model is telling investors they should be at least a little wary and should allocate to sectors that are cheap relative to the market as a whole. Allocation is always important, and doubly so under conditions like these.

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 stock indexes mentioned are unmanaged and cannot be invested into directly.  Past performance is no guarantee of future results. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market

Assembling Your Wealth Planning Team

Raymond James

Retirement & Longevity

Whatever you envision for your wealth, it’s important to have professionals around you who share and support that vision.

With all you’ve put into building your wealth, you deserve to get the most for its future. That starts with a team. Working with experienced financial, tax and legal professionals can help you translate your goals into a living plan that can grow along with your needs and support your vision well into the future.

Here’s a look at the key advisors who deserve a spot on your wealth roster, as well as other experts who can offer specialized guidance tailored to your unique planning needs.

Financial advisor

The keystone of your wealth planning team, your financial advisor will craft and maintain an interconnected financial plan focused on meeting your current needs and long-term goals.

Qualities to look for

Relatability and reliability: Wealth planning is as personal as it is technical – you’re building a future for your life’s work, so it’s important to work with an advisor whose ability and insight you trust.

Sophisticated skill and support: Your advisor should offer the broad knowledge and full-scale resources to identify and implement appropriate investment and wealth management strategies.

Objectivity: Financial plans shouldn’t be one-size-fits-all. Look for an advisor who is free to prioritize your best interests and make recommendations accordingly.

Questions to ask

  • Tell me about your qualifications and professional experience. Have you pursued continuing education or specialized certifications?

  • How are you compensated?

  • What is your process for working with clients?

  • Will I work directly with you or with a team? What will the meeting cadence be?

  • What experience do you have working with financial situations like mine (e.g., significant wealth, complex income sources, business ownership)?

  • What systems do you have in place to support information privacy and business continuity?

Estate planning attorney

With an eye for detail and a future focus, your estate planning attorney will oversee trust and estate planning – including long-term care, end-of-life and wealth transfer considerations.

Qualities to look for

Trusted reputation: Seek recommendations from loved ones, your financial advisor, professional associations, or even the state bar association to help you identify candidates.

Specialization: Because the laws governing trusts and estates differ by location and change over time, it’s important to engage counsel who specializes in this unique area of the law.

Accreditation and experience: Your attorney should be licensed with the state where your trust(s) or estate reside, have applicable training and experience, and maintain their skill through continuing education and membership in professional associations.

Questions to ask

  • Tell me about your qualifications and professional experience. Do you have specialties within estate planning?

  • How are you compensated (e.g., hourly, flat fees based on size of the estate or and nature of the planning involved)? Are there costs in addition to these fees?

  • What is your process for working with clients?

  • Will I work directly with you or a team? What is the anticipated timeframe for completion?

  • What experience do you have working with estate situations like mine (e.g., significant assets, multiple properties, complex family dynamics, elder law, business ownership)?

  • What systems do you have in place to support information privacy and business continuity?

Tax accountant

Your accountant will help find and implement tax-efficient strategies in your wealth planning process in accordance with federal, state and local tax laws.

Qualities to look for

Current knowledge: Because tax laws frequently change, your accountant should be well-versed in the latest policy developments and strategies available to help you maximize tax efficiency.

Strong communication: Look for a professional who responds promptly, keeps you informed in language you understand, and will collaborate closely with your other professional advisors.

Proactivity: The time to take tax-efficient action is often well before the filing deadline. Your accountant should lead the tax strategy conversation and offer actionable ideas early.

Questions to ask

  • Tell me about your qualifications and professional experience. Do you hold any professional licenses, designations or memberships? Do they require continuing education?

  • What is your process for working with clients?

  • Will I work directly with you or with a team? How will we work together throughout the year?

  • What monthly and annual reporting do you provide?

  • What experience do you have with tax situations similar to mine (e.g., investments in private companies, business ownership, multiple income sources, international holdings)?

  • What systems do you have in place to support information privacy and business continuity?

Special teams

Depending on your situation, additional, more specialized professionals can help round out your advisory team.

  • Philanthropic consultants: From developing strategies to maximize your impact to helping you select foundation staff, philanthropic advisors help donors realize large-scale charitable goals.

  • Private collections specialists: If a prized collection – art, autos, artifacts – makes up part of your assets, a collection manager can help support your heirs in preserving, gifting or ensuring full valuation in a sale.

  • Healthcare advocates: These professionals can help navigate public and private medical resources, provide contacts for second opinions and alternative care, and evaluate in-home and long-term care options.

  • Aging-in-place experts: To ensure the home you want to stay in can meet your needs as they evolve, these specialists support the renovation and restructuring of beloved properties.

Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional. Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value.

Where is the Economy?

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

August 21, 2023

What’s going on with the markets and the economy? Long-term Treasury yields are up substantially since last Fall while the stock market, after a big rally, has stumbled so far this month. Meanwhile, the real economy appears to continue to chug along – even accelerating! – while inflation has dropped a great deal versus a year ago but will likely go up again soon due to rising oil prices. What do we make of all this and has this changed our fundamental outlook?

As recently as April this year the 10-year Treasury yield was 3.30%. This morning we awoke to 4.30%, a full percentage point higher. We think multiple factors have played a role. First, the real economy has remained stronger for longer than most expected. The economy grew at a moderate 2.4% annual rate in the second quarter and the early projection from the Atlanta Fed’s GDP Now model is that real GDP will be up at a stunning 5.8% annual rate in the third quarter.

We think real GDP growth is more likely to clock in at a 4.0% annual rate in Q3, but even that would be unusually strong. With the exception of COVID re-opening in 2020-21, we haven’t had a quarter at 4.0%-plus since 2017.

Meanwhile, inflation isn’t going back to the Fed’s 2.0% target anytime soon. Yes, inflation is down substantially from a year ago: the consumer price index was up 8.5% in the year ending in July 2022 but a much smaller 3.2% in the year ending in July 2023. But, given the recent spike in oil prices, look for the year-ago comparison to grow to about 3.6% in August. In turn, we are projecting that GDP prices will be up at a 3.6% annual rate in Q3.

If we are right about both real GDP and GDP prices in Q3, it is very hard to see the Federal Reserve standing pat at the current 5.375% level for short-term rates. The futures market is pricing in only a 11% chance of the Fed raising rates by 25 basis points in September as well as a 40% chance the Fed raising by a cumulative 25 bps through November. We think both these odds should be higher and if the market shifts toward our view, then long-term rates should also go up further in the next month or so.

The bottom line is that faster growth and persistent inflation are a recipe for the Fed to either move higher than the market now expects or stay at a higher level longer than the market expects, or possibly both.

In turn, we remain convinced that our call from the end of last year that the S&P 500 would finish this year at 3,900 remains a solid forecast. When we plug a 10-year Treasury note yield of 4.30% into our capitalized profits model, it spits out a “fair value” estimate for the S&P 500 of 3,126. We are not predicting a drop that low in stocks, but this method makes us comfortable keeping a target of 3,900.

In addition, we are not waving the white flag on our forecast of a recession and think the conventional wisdom has lurched too far and way too fast against the odds of a recession. Many investors think that with an unemployment rate of 3.5%, the economy is somehow invulnerable to a recession. But we think this theory is wrong; recessions almost always start when the jobless rate is at or near a low.

Recessions are ultimately about mistakes, about too much optimism given underlying economic conditions and the need for economic activity to adjust back downward. Consumers are soon going to be without the temporary extra purchasing power generated by COVID spending programs. Meanwhile, businesses are facing labor costs that continue to escalate faster than justified by productivity growth while business investment looks poised for a correction.

In addition, the government policies enacted in the last few years have not boosted long-term growth prospects and, although AI is a long-term positive, it is unlikely to generate enough extra growth in the short run to spare us a downturn.

A monetary policy that is tight enough to eventually wrestle inflation down to 2.0% doesn’t make for a pleasant economic ride in the next year. The road is smooth today, but potholes are ahead.

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.

An Age of Fiscal Limits

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

August 14, 2023

Wars cost money, and throughout history countries have borrowed to fight them. There are plenty of examples of wars bankrupting countries, but the US was so dominant in the 1940s that at the end of World War II, its debt only cost about 1.8% of GDP to service. By 1959, debt service was back down to 1.1% of GDP.

Policymakers then got complacent about the budget in the 1960s and 1970s. Great Society programs included Medicare and Medicaid. Vietnam spending was huge. The Fed attempted to monetize all this spending, and inflation sent interest rates higher. The result: between 1982 and 1998, interest on the national debt averaged about 3.0% of GDP.

But as rates rose, the US worked to get its act together. Reagan spent to win the Cold War, but slowed spending in other areas. The peace dividend that resulted as well as budget deals between Clinton and Gingrich led to balanced budgets. In turn, the interest burden started heading back down. Between 2000 and 2020, interest on the national debt averaged 1.5% of GDP.

And even though spending soared during the 2008 financial panic and COVID, the Fed was holding interest rates artificially low, and monetizing some of that spending.

But just like the 1970s, the US is paying the price. Interest costs last year were 1.9% of GDP, the highest since 2001. We’re projecting this year will be 2.5% of GDP, the highest since 1998.

Unlike the 1980s, however, politicians don’t seem interested in changing course. The US isn’t Argentina, but as the interest burden climbs back to 3.0% of GDP, we believe it will capture the attention of more politicians, who won’t like sending so much money to bondholders. In turn, that should generate some bipartisan interest in finding ways to bring the interest share of GDP back down.

But here’s the problem: back in the 1980s-1990s, as policymakers started focusing on controlling budget deficits (remember Gramm-Rudman-Hollings and the Bush budget caps in 1990) they had some favorable winds at their backs.

The Reagan-led victory in the Cold War led to a “peace dividend.” National defense spending peaked at 6.0% of GDP in 1986 and then dropped to 2.9% by 1999. Meanwhile, the Baby Boom generation wasn’t collecting Social Security or Medicare. In fact, that generation was in its peak earning years, and paying into those programs. That demographic wave plus lower spending and the legacy of the Reagan tax cuts meant robust economic growth.

Bottom line: we controlled discretionary spending (like the military budget), didn’t enact new entitlements, and then essentially grew our way out of the problem. But growing our way out of the current budget situation will be much tougher.

Interest rates declined substantially in the early 1980s, as inflation was tamed, and then fell further when the Fed switched to its abundant reserve policy and manipulated them lower. So even when economic growth was strong, the budget was helped by these lower rates. But faster economic growth usually comes with higher long-term interest rates than we have experienced in recent years. It’s a conundrum that AI can’t solve.

Meanwhile, the Baby Boom generation is now drawing on Social Security and Medicare and leaving the workforce, putting persistent upward pressure on federal spending. In addition, the peace dividend is gone and the US must prepare for a potential military confrontation with China in the decade ahead.

The US is on the cusp of some very big budget challenges. If policymakers don’t address entitlement spending, expect worse budget news in the years ahead. Whether voters actually hold politicians’ feet to the fire will determine whether the US becomes another Argentina, or France, or finds its way back to the fiscal sanity as it has in the past.

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.

Here’s Something to “Fitch” About

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

August 7, 2023

What would you do if you won the Mega Millions? It’s now up to a record $1.55 billion! We would start a not-for-profit to educate people not to play the lottery. Why? Your odds of winning are 1 in 302.6 million…you are 70 times more likely to die in a shark attack than win this lottery.

But it’s even worse than that because only 50% of the proceeds of ticket sales go into the prize pool. Half of your “investment” is gone the second you buy a ticket. The other half is gone when they do the drawing, unless lightning strikes, which is unfair to lightning because you are more likely to get hit by real lightning. In other words, it’s a total waste of money.

But people still play, and dream. We think about this because government sponsors this crazy lottery at the same time it shirks its own fiduciary responsibilities. Things have become so bad that last week, Fitch (a bond rating firm) downgraded US Treasury debt from AAA to AA+.

Fitch said they downgraded the US because of massive deficits, “fiscal deterioration” and “erosion of governance.” Obviously, this downgrade, like the one by Standard & Poor’s in 2011 created political heat. We hope it creates action.

Following the June 2, 2023 vote to suspend the debt ceiling for two years, the Treasury borrowed $1.1 trillion in just two months, pushing total debt from $31.5 trillion to $32.6 trillion.

Why has it borrowed so much? Because tax revenue is falling rapidly at the same time spending is soaring. During the first nine months of Fiscal Year 2023 (through June) revenue is down 11.0% versus the same period in FY2022, while spending is up 10.5%. The deficit through June is $1.39 trillion, already above the 2022 full year deficit of $1.37 trillion. With July, August and September still to come, we expect the deficit in FY2023 will be about $1.8 trillion. It’d be much higher than $2 trillion, but it will be held down artificially because the Supreme Court struck down President Biden’s illegal college loan relief plan.

Apparently, government has no desire to act responsibly. During COVID, lockdowns – which we argued fiercely against – were forced on businesses and workers, and compensating them for the economic damage that ensued was necessary. But what many don’t realize is that the money we borrowed from future generations and then used to pay workers was taxed. The government artificially increased its revenue by taxing the very money it borrowed and handed out. That’s why revenues are collapsing right now, the taxable handouts are over.

On the other side of the ledger, once government starts spending more, it rarely gives up the higher budgets. Emergency spending becomes permanent spending. It did so after the 2008/09 financial panic and it seems to be happening again today. So, while the White House claimed victory in bringing the deficit down last year, this year it is moving in reverse.

The Federal Government is spending 25% of GDP, and never in history (no matter what tax rates existed) has the budget been balanced when spending is above 19.5% of GDP. Why? Because the bigger the government gets, the harder it is to grow, which reduces tax receipts. With spending so high, budget deficits have become permanent. And this will only get worse as entitlements for seniors (Social Security and Medicare) eat more and more of our GDP in the years ahead.

Which brings us to an important point. Like playing the lottery, politicians know our fiscal path is unsustainable, but still spend. And voters support them anyway. Yes, you paid into entitlement programs, but your taxes were used to pay the prior generation of retirees.

Meanwhile, these programs distort our decisions. Why carefully save resources for retirement when the government has promised to take care of us? People spend more and save less; they take flyers on the lottery. Economic growth is reduced from what it could be, and living standards grow more slowly. It’s a vicious circle and the Fitch ratings cut is appropriate.

Both parties are responsible. And to fix it, both parties need to be involved. We can “Fitch” about “governance” all we want, but the politicians who use every tool they can to reduce spending are at least trying to fix things. Someone may get lucky and win the lottery, but fixing our budget fiasco will take more than luck. Nothing should be off the table. It’s time to cut spending, before it’s too late.

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.

Time Will Tell

First Trust Economic Research Report

Brian S. Wesbury - Chief Economist

Robert Stein, Dep. Chief Economist

July 26, 2023

Anyone hoping for excitement from today’s Fed statement was severely disappointed. As expected, the federal funds rate was lifted 25 basis points (bps) to a range of 5.25 to 5.50%. With the exception of the rate hike and slight wording changes – the “modest” pace of economic growth strengthened slightly to “moderate” – today’s statement was a virtual carbon copy of the mid-June release.

It's worth noting that, while the Fed did not release new economic forecasts today, the economy has progressed largely in-line with what the Fed projected back in June. At that meeting, the Fed forecast it would be appropriate to raise rates two more times before year end. The first of those two hikes came today, and there is little reason to believe their view on the path forward has shifted.

During today’s press conference, Chair Powell faced a barrage of questions trying to get a hint on the timing for the next rate move or guidance on when the job will be done, but Powell stuck firm to the Fed’s data dependent mantra. Powell said that between now and the Fed’s next meeting in September there will be two more employment reports, two more CPI reports, and a report on employment costs. Markets will be watching them closely to figure out whether the Fed will raise rates again in September.

If the Federal Reserve were paying close attention to the money supply, it would know that monetary policy is already tight. While M2 rose modestly in May and June following nine consecutive months of decline, the money supply has contracted 3.6% in the past year. Meanwhile, bank credit at commercial banks as well as their commercial and industrial loans are both down. If this isn’t tight, we’re not sure what tight means.

It remains to be seen how quickly the reductions in the money supply will translate into inflation getting back to the Fed’s 2.0% target, but the Fed has gained some traction against the inflation problem. And yet, once again, the Fed uttered not one peep about the money supply in its policy statement, nor did any journalist broach the topic.

It’s like the Fed has been operating in a fog without the appropriate tools to guide their way. Focus on supply chain disruptions, the level of the federal funds rate, consumer and business surveys, and inflation expectations had the Fed late to act and constantly adjusting course since. Having abandoned its long tradition of implementing monetary policy through scarce reserves and imposing a new policy based on abundant reserves following the financial crisis, they made their mistakes harder to correct. Whether they can cross the inflation finish line before the economy goes into recession will depend on how quickly the reductions in the money supply effects the economy later this year. They have their work cut out for them.

Text of the Federal Reserve's Statement:

Recent indicators suggest that economic activity has been expanding at a moderate pace. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated.

The U.S. banking system is sound and resilient. Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 5-1/4 to 5-1/2 percent. The Committee will continue to assess additional information and its implications for monetary policy. In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Lisa D. Cook; Austan D. Goolsbee; Patrick Harker; Philip N. Jefferson; Neel Kashkari; Lorie K. Logan; and Christopher J. Waller.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all variable data necessary for making an investment decision, opinions or forecasts provided herein will prove to be correct. Any opinions are those of Brian S. Wesbury and not necessarily those of Raymond James.

Nine Steps to Raising Money-Smart Kids

Dear Friends and Clients,

In giving children the gift of financial literacy, you’re helping set them up for a brighter future. Through a purposeful approach, we can all do our part to raise the next generation of resourceful citizens. We hope you find the article linked below as interesting as we did. There is lots of helpful information to read and share!

We look forward to hearing your thoughts on this or anything else you’d like to discuss. Please feel free to reach out anytime, we always enjoy hearing from you.

Kind regards,


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.