Don't Fall for the Q3 Head-Fake

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

September 25, 2023

We have plenty of data reports to go, but, so far, the third quarter is shaping up to be a strong one for the US economy. The Atlanta Fed’s GDP Now model is tracking a Real GDP growth rate of 4.9% for Q3, which would be the fastest quarterly growth rate since the earlier part of the COVID recovery.

Our models aren’t tracking quite so high but are projecting growth at about a 4.0% rate, still strong by the standards of the past couple of decades.

However, we would not get too excited about what’s happening in the third quarter and don’t think one quarter of strong economic growth means a recession is off the table.

With all the oddities of the COVID era – first overly strict lockdowns and then overly gradual re-openings – it’s entirely possible the GDP reports are exhibiting some “seasonality,” where certain quarters look better than the underlying economy really is. The third quarter is when children typically go back to school, for example, but, unfortunately, they did that less so during COVID. As a result, normal back-to-school behaviors might make the economy look extra strong for now.

To put some numbers on this, statistical adjustments to retail sales (called seasonal adjustments) subtracted 1.8% from reported sales in July 2019, prior to pandemic shutdowns. Back to school spending in July (much like Christmas) makes for some big spending months, and the statisticians adjust the numbers down. But in 2020, 2021 and 2022 July sales fell because so many schools were closed. This reversed the seasonals and this July (2023) seasonal adjustments added 1.4% to reported sales. We think this is distorting our view of the economy.

Meanwhile, the economy is likely feeling the last positive remnants of the surge in the money supply in 2020-21. The lags between monetary policy and the economy have always been long and variable, as Milton Friedman taught us. Beyond the third quarter, the economy is likely to show more of the effects of the drop in the M2 measure of the money supply from mid2022 through early 2023.

Another reason we think the third quarter is a head-fake is that deficit spending by the federal government is very unlikely to expand in 2024 like it has in 2023. Were it not for President Biden announcing his student loan debt forgiveness plan last year the budget deficit would have been 4.0% of GDP in Fiscal Year 2022, high but not extraordinary.

And if it hadn’t been for the Supreme Court striking down that plan this year, the deficit would have been about 7.8% of GDP for Fiscal Year 2023, well beyond even the highest deficit under President Reagan in the 1980s and all while the unemployment rate is averaging about 3.6%.

The rise in the deficit of almost four percentage points of GDP with the unemployment rate so low is unprecedented. Other prior leaps in the deficit of this magnitude have been during major wars or recessions, not when the US is at peace and the unemployment rate is unusually low.

In particular, the way some of the extra deficit spending is structured looks designed to temporarily and artificially boost economic growth. The CHIPS Act, for example, is encouraging private investment in chip manufacturing facilities in the US. So far this year (through July), private spending to construct manufacturing facilities in the computer, electronic, and electrical sector are up 228% versus the same period in 2022.

But these buildings don’t have to be rebuilt every year. Sometime soon the gains in this sector will dwindle and reverse, with collateral damage to other sectors, like trucking.

To be clear, we do not believe government spending is a positive for long-term growth. In fact, it often distorts and diminishes overall activity. However, in the short-term, as we saw during COVID (and apparently this year as well) it can make the economy look stronger than it really is. A price will be paid, and as all this extra stimulus wears off a recession is highly likely. We don’t see how it is avoided.

The next recession is unlikely to be as devasting as the ones in 2008-09 or 2020. But our view remains that a recession is on the way.

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.

Higher Rates & A Shutdown On The Menu

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

September 18, 2023

The University of Colorado Buffaloes are undefeated and suck up a lot of oxygen in the college football world. After just three games as the new head coach, Deion Sanders was interviewed by 60 Minutes. For now, the Buffs have gone from irrelevant to essential in the college football world. In the competitive arena of sports or business you need to stand out to be noticed. But, when you’re the government, standing out isn’t hard to do.

This week, the Federal Reserve is set to release a new statement on monetary policy. And, by the end of this month, Congress is supposed to either pass a new budget or possibly shutdown non-essential government services. Investors will be watching intently.

We don’t think the Fed will provide many surprises. As of the Friday close, the futures market was putting the odds of a rate hike at this week’s meeting at less than 1%. That may be too low, but the Fed won’t surprise on this front. It will release a new batch of economic forecasts as well as “dot plots” that show where policymakers see short-term interest rates heading.

This could be the surprise: The futures market’s odds of a rate hike by the December meeting are roughly 45% and we think that’s too low. Oil prices are lifting inflation once again, and rising health insurance rates will keep inflation elevated later this year. Meanwhile, real GDP growth looks solid in Q3. Mixing stubbornly high inflation with solid economic growth is not a recipe for a prolonged pause by the Fed, at least not yet.

We think the Powell presser and the dot plots will make it clear the Fed is leaning toward one more rate hike before the year is through. Our greatest hope is that someone asks Powell about the money supply and he acknowledges its importance for conducting monetary policy, but if that happens we’d be (happily) surprised.

Instead, we expect to hear at least one question for Powell about the looming possibility of a government shutdown at the end of September. The media and investors are starting to focus on this issue. We don’t think this is time well spent. History shows no relationship between federal shutdowns and the performance of the economy.

We had two shutdowns in late 1995 and early 1996, and saw no recession either time. There was a shutdown in 2013, no recession. There was a brief shutdown early in 2018, no recession. The most recent shutdown was the longest, thirty-five days from December 2018 through January 2019. You guessed it, no recession. The last time a shutdown coincided with a recession was in October 1990. That was only a four-day shutdown, but money was already tight and a recession was inevitable either way.

Here's another way to think about it: In the last forty years, the government has been shut for 91 days. Among those days, the US was in recession for four days and not in recession for eighty-seven. By contrast in the past forty years the US has been in recession about 8% of the time. That means the economy was more likely to be growing when the federal government was shut than when it was open!

This doesn’t mean a recession can’t start in the fourth quarter. But if we do get a recession it’ll be a coincidence, due to the lagged effects of the tighter monetary policy of the last year, not a shutdown itself.

Note that unlike some other budget confrontations in the past, this one does not involve paying the federal debt. For better or worse the debt limit has been suspended until January 2025. This means that even if the government is shut all the debt will get paid on time; there will be no default.

Social Security checks and other benefit payments will still go out. The mail still gets delivered. Essential government workers keep working, including those needed for national defense. The government is not the economy, even though many in DC (and many voters) think it is. But, those that produce wealth are the ones who have to pay for it. And that cost keeps going up. In 1930, the federal government (without defense) was about 2% of GDP. Today that percentage is 22%. The government has grown about 10 times more than the economy as a whole. Debt is at a record high and, with higher interest rates and rapidly rising entitlement costs, we are on an unsustainable path.

As we said two weeks ago, the federal government is running the most reckless and irresponsible budget in US history. Even John Maynard Keynes’ would not support such massive deficits with the unemployment rate so low. This can’t go on now that interest rates have returned to more normal levels. If a shutdown is the price we pay to start moving in the direction of less government spending, investors should be eager to see that happen. The shutdowns in the mid-1990s caused the government to become more fiscally responsible and led to Clinton era surpluses. And that was good for everyone.

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.

Our Stagflationary Future

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

September 11, 2023

A month ago, many people were pretty sure serious inflation concerns had passed. After the equivalent of 22 quarter-point rate hikes and the biggest drop in the M2 money supply since the Great Depression, consumer prices rose only 0.2% in July, with the year-over-year rate of increase down to 3.2%, well below its 8.3% increase in the twelve months ending in August 2022, after Russia invaded Ukraine.

But oil prices have reversed course, and in a few days, the monthly increase in the August CPI will likely show inflation came in hot. If we are right that consumer prices rose 0.6% for the month, then consumer prices are also up about 3.7% versus a year ago, an acceleration.

This is a far cry from the Federal Reserve’s stated inflation goal and more than enough to show that inflation wasn’t just the “transitory” result of COVID-related supply-chain issues or Vladimir Putin.

Other measures also show the job isn’t done. Last November, the Fed invented something called “Super Core” inflation, dropping energy, food, and housing prices, but even this measure is up 4.7% in July versus a year ago, higher than the 4.4% when it was introduced.

Some now dismiss this measure of inflation, but these are often the same people who focused on it (touting it as a better gauge than overall inflation). It’s hard for us to shake the sneaking suspicion that they went from enthusiastic to skeptical about this measure because it wasn’t showing the progress on inflation that they’d like to believe. Meanwhile, the Cleveland Fed’s median PCE inflation rate is up 4.8% in the past year.

We are not back to the 1970s yet, but there are some similarities. Great Society spending pushed government spending on a steep upward trajectory in the 1970s, in spite of the eventual wind-down of the Vietnam War. In turn, policymakers monetized much of this extra spending. The result: a wet blanket of big government which slowed growth, but a boost to inflation from easy money. Reagan and Volcker reversed these two policies and growth accelerated, while inflation fell, after going through a severe recession early in the 1980s.

Does this ring a bell? The government’s response to the Great Recession and Financial Panic of 2008-09 was a big shift upward in spending and the economic recovery that followed was unusually weak. Then policymakers responded to COVID with more of the same, now adding higher inflation to the mix.

It is entirely possible that the drop in the M2 measure of money ends up bringing inflation down to the Fed’s 2.0% target sometime over the next couple of years. But, if so, we don’t expect low inflation to last. There is a growing series of voices calling for the Fed to raise its long-term inflation target from 2.0% to something closer to 3.0%.

In the short run, we expect the Fed to stick to a 2.0% inflation goal. Changing the target at this juncture risks severely undermining the Fed’s credibility. This happened in the 1970s…even if not explicitly stated, the Fed shifted their thinking on inflation and said it was too hard to stop.

Inflation averaged 1.8% in the ten years pre-COVID. Don’t expect inflation to average that low in the decade ahead. Not until the US finds a way to repeat the 1980s policy mix.

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.

Fiscal Madness

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

September 5, 2023

Back in the 1980s, President Reagan took enormous political heat (Sam Donaldson comes to mind) for being fiscally irresponsible. His offense? Presiding over a budget deficit that peaked at 5.9% of GDP in Fiscal Year 1983.

But at least Reagan had an excuse. Actually, multiple excuses. The unemployment rate averaged 10.1% in FY 1983, which pushed up spending, while reducing revenue. The Reagan tax cuts were phased-in, so many people pushed off income (and taxes) into future years. Finally, the US decided to bury the USSR under massive defense spending.

The reason we bring this up is that we estimate the budget deficit for this year (FY 2023, ending September 30) will be $1.74 trillion, or 6.5% of GDP. That’s larger relative to GDP than the largest budget deficit ever under Reagan. Worse, this is happening when the unemployment rate will average about 3.6%, the lowest average for any fiscal year in more than fifty years.

But the current budget situation is even worse than these numbers suggest. Last year (FY 2022), the budget deficit came in at $1.375 trillion. But this deficit was artificially boosted by government accounting. President Biden’s plan to forgive student loans lifted the deficit by $379 billion, the present value of the extra future losses estimated on the forgiven debt. The government’s budget accounting rules included it as extra spending last year, even though it didn’t affect the government’s cash flow.

In other words, without the Biden loan forgiveness plan, the budget deficit would have been about $996 billion last year, or 4.0% of GDP. Not good, but not horrible, either.

But this year the Supreme Court struck down most of the loan forgiveness plan. As a result, extra future loan repayments are now being added back into the budget. The government counts this as a “negative outlay,” and this change results in a one-time artificial reduction in the deficit of $330 billion. Without the Supreme Court ruling we estimate the budget gap this year would be about $2.07 trillion, or about 7.8% of GDP.

These government accounting rules might make sense in normal times, but right now they are leading to a bizarre result that hides a massive increase in the “cash flow” deficit of the US government. The result is a much bigger change than the “official” numbers, which will show the budget deficit going from $1.375 trillion (5.5% of GDP) to $1.740 trillion (6.5% of GDP).

There is no economic justification for expanding the “cash flow” deficit by 3.8 percentage points of GDP (from 4.0% to 7.8%) unless there is a recession or World War III. We never had a budget deficit greater than 6.5% of GDP in any year from 1950 through 2008. Not one. Reasonable people can disagree about the size and scope of the budget deficits we should have run in the aftermath of the Great Recession as well as during COVID Lockdowns. But running a budget deficit this high right now is madness!

We are supply-siders. We think the key to long-term economic growth is removing barriers and disincentives to work, save, and invest. We do that with lower tax rates, smaller government, and less regulation. We think institutions matter, like democracy, property rights and freedom of contract. We are not Keynesians. But even John Maynard Keynes must be rolling over in his grave. No serious or intellectually honest Keynesian can support a deficit at 6.5% of GDP (much less 7.8%) in a year when the US is at peace and unemployment is averaging 3.6%.

And just so everyone knows, we are not attacking one party over the other. TARP, multiple rounds of quantitative easing, COVID lockdowns, unprecedented fiscal stimulus during COVID, and repeated failures by both parties to address entitlements have all paved the way to the current deficit bubble.

We realize the US had bigger deficits right after the Financial Crisis and during COVID, but given low unemployment and peacetime, we don’t think we’re overdoing it when we say that this year’s budget is the most reckless and irresponsible in the history of the Republic.

We think that the unprecedented surge in the deficit this year is a key reason why a recession has yet to materialize. A surge in the deficit this large can sometimes artificially maintain growth in the very short-term. But, given higher interest rates on government debt, this kind of support can’t last. The party continues for now, but a hangover looms in our future.

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.

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,