Lessons Not Learned

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

June 24, 2024

Back in the early days of COVID, there was one key indicator that signaled or predicted the high inflation ahead: the M2 measure of the money supply. Unlike in the aftermath of the Financial Panic and Great Recession of 2008-09, M2 surged at an unprecedented pace in 2020-21.

So, while others looked back and said “QE doesn’t cause inflation” we didn’t. While many said that inflation was “transitory,” we warned about inflation going higher and being more persistent. And here we are more than four years past the onset of COVID and inflation is still lingering above the preCOVID trend. The Consumer Price index is up 3.3% from a year ago while core consumer prices are up 3.4%.

What we take from all of this is that many economists, investors and policymakers ignored M2 to their detriment. As a result, they have been surprised by the surge and persistence of inflation. You think they might have learned.

But now a new conventional wisdom has taken hold, which says the US is out of the woods on a potential recession. This, in their view, supports a trailing price-to-earnings ratio of 24 on the S&P 500, a level that in the past has been associated with low future returns on equities.

We hope a recession doesn’t happen, but think their dismissive attitudes towards warning signs like M2 (which has declined in the past 18 months) increases the chances they get caught flat-footed by a downturn. We know it’s not visible yet, but every once-in-a-while there’s an economic report that should make people re-think their pre-conceived notions.

That applies to home building in May. Out of the blue, housing starts dropped 5.5%, completions fell 8.4%, and permits for future construction declined 3.8%.

Housing starts and permits are now sitting at the lowest levels since the early days of COVID, even as the flow of immigration remains elevated. Whether you support or oppose high levels of immigration, where are all the newcomers going to live if we aren’t building more housing? And isn’t one of the arguments in support of high immigration that industries like home construction need cheap labor to build more homes?

In the meantime, retail sales surprised to the downside in May, eking out only a 0.1% gain for the month, but including revisions to prior months were actually 0.3% lower. Retail activity is roughly unchanged since the end of last year, which means after adjusting for inflation, consumers are buying fewer goods. Car sales rose slightly in May, but are down from last December and even down from June 2023.

In addition there’s an early sign that the labor market may have some trouble ahead: initial claims for unemployment insurance averaged 211,000 per week in the fourth quarter of 2023, as well as the first quarter of 2024. But initial claims have averaged about 240,000 in the past two weeks. Hopefully this is just some seasonal variation and claims will go back down soon, but it is worth watching closely in the weeks ahead. (One caveat is Thursday’s initial claims report will include Juneteenth, a relatively new holiday which may confuse seasonal adjustments.)

None of this means a recession has already started. Industrial production surged 0.9% in May, which is not a recessionary number at all. The Atlanta Fed GDP Model is back up to tracking 3.0% annualized growth in Q2, while we are tracking 2.0%. And private payrolls continue to average over 200,000 jobs added per month, even if gains appear to have been led by part-time positions.

It's also important to recognize that fiscal policy has never been this “loose” (the deficit so high) when the unemployment rate has been so low. But with the interest burden on the federal debt as a share of GDP suddenly shooting up to the highest since the 1980-90s, the days of using the budget to try to artificially boost growth should soon come to an end.

There’s no guarantee of a recession in the year ahead, but the risk shouldn’t be casually dismissed. Not paying attention to M2 has cost investors more than once already.

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.

Replacing Taxes With Tariffs

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

June 17, 2024

Last week, Donald Trump proposed replacing the income tax with a tariff on imports. Washington DC let out a loud, and collective, scoff. The average American was intrigued. More on this in a few…but to be clear, the idea as it stands won’t work in our current system. The US cannot replace income tax revenues without sky-high tariffs, and sky-high tariffs would shut down world trade. Remember…much lower Smoot-Hawley tariffs in 1930 helped kick off the Great Depression.

But that doesn’t mean we shouldn’t use this as a starting point for discussion. Have you followed Elon Musk and SpaceX? Specifically, the Starship, which just had its fourth launch? Well, what we are witnessing is the process of iterative development. Each launch has gone further and had more success. Henry Ford did the same thing with the automobile and assembly lines.

This process of iterative learning, which is prevalent in the private sector, seems non-existent in government. To use an example that writer Glenn Harlan Reynolds shared in a recent Substack post: Ad Astra, Per Ardua, the Space Shuttle was supposed to be reusable, but it never truly was – it cost over $1 billion per flight. Musk, on the other hand, by figuring out how to re-use boosters has driven the cost per flight down to the range of $3-5 million.

The cost to put a kilogram of payload in space was $55,000 in the Shuttle but is only $2,700 in a SpaceX Falcon 9, a 20-fold reduction. And this cost will keep coming down. It’s an amazing thing to watch, how the private sector can simply crush government in efficiency and progress.

Which takes us back to Donald Trump’s proposal to scrap the income tax and replace it with tariffs on imports. If you look at this proposal like the permanent fixtures of the Beltway do, it’s absolutely ludicrous. Paul Krugman (on X) couldn’t resist running all the numbers, showing how the tariff would have to rise to 133%, or higher, to raise the same revenue.

At least he admitted that in the 1800s the US funded itself with tariffs and excise taxes, but that was when the federal government was significantly smaller. Instead of wondering if we could run the government like SpaceX, and not NASA, he just said anyone who thinks we can shrink government that much is just plain “ignorant.” For the record, calling people ignorant is not proving them wrong.

It is rude, though. Krugman comes from the left, but even those on the right said Trump’s idea was crazy. Most used the same logic as Krugman. Inside the Beltway, the only way to look at anything is to use static scoring models, and very little imagination. Social Security can’t be imagined anew, bureaucracies are entrenched and have decades of momentum. They have no incentive to become more productive or to learn iteratively. Doing so means fewer jobs and smaller budgets. There is no profit incentive at all…government cannot possibly think like the private sector, even though it should.

At least Donald Trump is thinking outside the Beltway Box. The pundits are right, taxing just imports would increase the deficit “hugely” to use his word. We have no idea if that’s what he was thinking. We doubt it, but it takes an idea to lead to iterative thinking. Science fiction writer, Steve Stirling, wrote about Starship: “That's what iterative development does; you don't try to make it perfect the first time. You make it 'good enough for a first try', push it until it breaks, fix what broke, try again, and again and again... until it works all the way.”

One could argue that government keeps trying to iteratively learn. But Great Society programs have led to several generations of welfare and apparently permanent poverty. Programs to fix inequality led to more of it, public schools (especially in inner cities) have failed, Social Security will run out of money in 2033, the Federal Reserve has a $1 trillion loss on its books and has to borrow money to make payroll. The government is so big that even Sports Illustrated, ESPN, and the Weather Channel can’t help but talk about politics.

The problems the US has today are no different than the problems the US had in the 1960s or the 1930s. One could actually argue that they are worse even though government has grown and grown. So, this proposal by Donald Trump is a breath of fresh air. Instead of immediately declaring it dead-on-arrival, why don’t we take this opportunity to discuss the size of government, and how we pay for it.

We know it’s more comfortable for the Beltway crowd to just move on…don’t rock the boat…analyze the same things the same way as always. We, on the other hand, are going to take this opportunity to grab this idea by the horns and discuss it in the context of history, and the current state of affairs in the US.

The Founders did not have an income tax to fund government, that wasn’t instituted until 1913. What they could do was use excise (sales) taxes and tariffs. In the 19th century, actually up through 1930, the peacetime government spent less than 3% of GDP. Today, federal spending is roughly 23% of GDP, while state and local governments spend about 14% of GDP on goods and services. Add in the cost of complying with government rules and regulations and we estimate the government either spends, or directs to be spent, roughly 50% of our annual output.

The private sector can’t afford it…that’s why federal deficits alone are running nearly $1.7 trillion per year, with no end in sight. State debt and unfunded pension liabilities have also grown exponentially. Clearly something is broken, but bureaucrats, lobbyists, politicians, and think tank employees go to work every day and color inside the lines. Every once in a while someone comes up with a new idea, which immediately gets crushed by vested interests.

A couple of things. It is clear China has used existing tariffs and global trade to dominate markets in all kinds of areas. The US would have a tough time, today, producing all the pharmaceuticals, ammunition, batteries, and many other items it needs without trade. We believe trade is a positive for economic growth; we are free traders. However, we are also realists that understand not all our trading partners have our best interests at heart. Counting on imports for our national security is a risk that few talk about.

Second, roughly 40% of Americans don’t pay income taxes. The income tax system has become so progressive that 97.7% of the taxes are paid by the top 50% of income earners. In other words, half of America has no, or little, skin in the game when it comes to income taxes. As a result, top tax rates (along with deductions, etc.) are likely higher than they would be if everyone paid the tax. When there is no pain to you why care what others have to pay? And to all those who say tax rates don’t matter, just look at all the people and businesses leaving California, Illinois, and New York.

A tariff is a tax on consumers because it will be passed on. In other words, it’s a form of a consumption, or sales, tax. Just about every state has one. So, this idea to replace income taxes with tariffs is a step toward a consumption tax. Some say this tax is regressive because low-income earners spend more of their income than high income earners. But this can be dealt with and, don’t forget, high-income earners (or their heirs) eventually spend their savings and therefore pay consumption taxes in the future. If everyone has to pay, then maybe voters will look differently at how government spends.

It seems clear that if we step back, look at the size of federal, state, and local government debts – the fact that after trillions in spending we have not really improved poverty, nor have we addressed the inefficiencies in government – the system is broken. Maybe some kind of iterative process of change is the only way to break the cycle. As a result, we think immediately scoffing at a new proposal is wrong.

We rarely write more than one page but found this idea to be so amazingly new that we couldn’t help it. It is time for America to have a discussion about how much it spends and how it pays for it. Maybe, just maybe, Donald Trump has started that discussion. If so, we will be better for it.

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.

Spotlighting Inequality

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

June 10, 2024

With a Presidential election less than five months away, expect to hear a great deal of discussion about inequality: the gap between the rich, the poor, and the middle class.

It’s been a recurring theme of pretty much every presidential election starting in 1932, if not before. What should the federal government itself do to address poverty, expand opportunities for the poor, and close the gap between the rich and poor? It’s a potent political talking point, large parts of government spending, along with many agencies and programs, are designed to address it. Inflation, immigration, record-high corporate profits, and soaring stock markets are in the spotlight.

Joe Biden proposes student loan debt forgiveness and caps on drug prices, while Donald Trump has said he will end the taxation of tip income for service workers. These policies are focused on relieving financial burdens on specific groups.

More importantly, if we look at the results of policies during COVID (massive monetary and fiscal stimulus), it is clear that those who own assets benefited, while those who do not, were harmed. Those who had accumulated assets of various kinds – stocks, bonds, real estate, crypto,…etc. – have benefited from asset price inflation, particularly those whose jobs allowed them to work remotely.

This same inflation caused by the Federal Reserve hit lower income groups harder than everyone else. It’s a given that those with fewer financial assets benefited less from price appreciation. And while average hourly earnings did accelerate because of inflation…up 22.3% since February 2020, the consumer price index is up 20.8% during that same time frame. But, food prices are up 25.3% and energy prices are up 35.6%, both of which make up a larger share of spending for lower income groups. Airfare, by contrast, is down 1.2% over the same timeframe. No matter how we look at it, living standards have at best stagnated for those with few assets and wage income.

Politicians have pushed for an increase in the minimum wage to try to help lower-income workers keep pace with inflation, but we doubt that’s helping. For example, in California a recent law raised the minimum wage for restaurant workers to $20/hour versus $16/hour for other workers.

Overall unemployment remains low at 4.0%, up only 0.3 percentage points from a year ago. But that overall modest increase masks some large increases among younger workers. Unemployment among 16-17 year-olds has soared to 13.6% from 9.7% a year ago. Unemployment among 20-24 year-olds has risen to 7.9% versus 6.3% a year ago. The kids are increasingly not alright in the current labor market.

And no matter how much time politicians spend talking about inequality, too small a share of it will be spent discussing the horrible long-term effects of COVID Lockdowns on learning, which caused a loss of accumulated skills during COVID itself but also the lingering effects of higher school absenteeism.

One way to address educational inequality is for states to continue to move in the direction of funding students rather than funding government-run schools. After all, even in states with locked-down public schools, many private schools found a way to educate students in person. Because most state governments fund schools and not students, those who could afford private schools avoided a good deal of the learning loss.

Meanwhile, lurking in the background, is the issue of the huge number of low-skilled workers coming across the border in the past few years. Obviously, the people coming to the US will be able to earn more here than in their home countries.

But whether or not this immigration is overall “good” or “bad” for the US economy, low-skilled immigration almost certainly benefits higher-income natives, who, don’t have to compete in the labor market against newcomers, much more so than the low-income Americans, who often do have to compete.

The fact that all these problems became worse during COVID is ironic. Many politicians believe the real source of inequality is capitalism itself, with America as the poster-child. But in the US, during COVID, government (including the Fed) became bigger and more powerful than ever, while living standards stagnated for those who had not accumulated assets.

The real, and only proven, way to create less inequality is to allow free market capitalism to work. Interfering in that process creates more problems than it solves.

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.

Keep Politics Out of Investing

Three on Thursday First Trust Economics

Brian S. Wesbury - Chief Economist

June 6, 2024

The election year is in full swing, bringing with it the usual drama. We all have that one family member who insists they’ll sell everything and go to cash if a certain candidate wins the election. The truth is, letting politics drive our investment decisions can be detrimental. That’s why we believe having a financial professional is crucial—they can help remove emotion from investment decisions. In today’s Three on Thursday, we examine past presidential cycles and their implications for investing. Every four years, the convergence of politics and finance seems more pronounced, leading many to make decisions they later regret. Amid all the drama and political uncertainty with an election right around the corner, what does this mean for the markets moving forward? We’ve provided the three charts below to offer more perspective.

Using the S&P 500 Index as a market gauge, consider this: if you only invested when a Republican was president and went to cash when a Democrat was in office, your $10,000 would have grown to just $83,360.22 by the end of Q1 2024. Conversely, if you only invested during Democratic presidencies, your $10,000 would have grown to $414,703.12. However, if you ignored political factors entirely and stayed invested throughout, your $10,000 would be worth an astonishing $3.46 million by the end of Q1 2024! This illustrates the importance of maintaining a long-term, non-partisan investment strategy.

An analysis of the makeup of the presidency and Congress since World War II reveals that the stock market has performed positively on average, regardless of the political mix. Surprisingly, the best average performance has occurred with a Democratic president and a Republican Congress, although that result might be due to the relatively small sample of years when that’s happened. Contrary to what many Democrats and Republicans might believe, full control by one party has not yielded the best returns. In fact, some of the lowest average returns come from scenarios where one party has a complete sweep: 13.9% for a Democratic sweep and 10.7% for a Republican sweep. This suggests that a balanced political landscape may be more conducive to market growth.

The reality is that the market grows over time because companies consistently innovate, create, and drive increasing profits. It’s easy to let politics cloud our judgment, but history has shown that regardless of who is President or what policies are enacted, entrepreneurs and companies find ways to adapt and thrive within or around the rules. Innovation and creativity are the true engines of market growth over time.

The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. Indices do not change management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Investors cannot invest directly in an index. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

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.

Waiting on the Fed

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

June 3, 2024

One of our main contentions in recent months is that the Federal Reserve, by switching from a scarce reserve model to an abundant reserve model, has completely taken over the short-term interest rates marketplace.

The Fed’s balance sheet has expanded from $870 billion in August 2008 to $7.2 trillion today, a staggering 733% increase, and has averaged 33% of GDP over the past four years, bigger than at any time in history. It’s the 1000 lb. gorilla in the room.

What this means is that the markets are not necessarily focused on economic data itself but are trying to figure out what Jerome Powell and the Fed think about the data. Not long ago, the market was pretty convinced the Fed would cut rates five or six times this year. Now, at the Fed’s meeting next week, there’s basically zero chance that it’ll cut rates at that meeting, or at their late July meeting either.

The lack of rate cuts by the Fed makes sense given the recent lack of progress on inflation. During the year ending in April, the consumer price index rose 3.4%, which is an acceleration from the 3.0% increase during the year ending in June 2023. It looks like consumer prices rose only 0.1% in May, but even with that small monthly increase, the year-to-year gain would come in at about 3.3%, still higher than in mid-2023.

The Fed focuses on other measures of inflation. One, the PCE deflator, is now up 2.7% from a year ago. But it wasn’t that long ago that the Fed told markets and investors that they need to focus on something called “Supercore” inflation, which is PCE prices excluding food, energy, other goods, and housing. That measure is up 3.4% from a year ago and has accelerated lately, including up at a 4.1% annual rate in the past six months. No wonder the Fed stopped talking about Supercore inflation; it doesn’t fit the narrative. And by downplaying this measure, the Fed is signaling that it wants to find a reason to cut.

Meanwhile, the Cleveland Fed’s measure of median PCE inflation is at 3.3% and the Dallas Fed’s measure of “trimmed mean” PCE inflation is 2.9%. None of these are very close to the Fed’s supposed 2.0% target. Maybe this is why the “inside baseball” discussions deep in the Fed, and elsewhere, are saying maybe we should raise the target inflation rate to 3.0%. Once again, signaling a desire to cut rates in this election year.

At the Fed’s meeting in March, members published their anonymous forecasts in a “dot plot” that suggested two or three rate cuts this year. The market is less sure, and when the Fed publishes the next set of dot plots, we expect one or two rate cuts, instead. This makes sense. The economy is growing, inflation is stubborn, jobs are being added and stock markets are strong. Why would the Fed cut rates at all?

The answer is we don’t know what the Fed is thinking, and rather than base forecasts on economic fundamentals, and bank demand for capital, forecasting the Fed has become a guess about motivations. In other words, at the center of financial capitalism these days is what we believe is an unhealthy obsession with the decisions of a government agency.

Long-term, what will drive markets is the process of innovation, entrepreneurship, and, ultimately, profits. AI certainly doesn’t seem worried about rates. Keep that in mind when you hear about next week’s Fed meeting, whether it brings surprises or not. What’s worrying: centrally planned economies always look like they are working, until they don’t.

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.

Housing Update

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

May 28, 2024

Two reports on home prices arrived this morning, one for the Case-Shiller index and another from the FHFA (a government agency that regulates Fannie Mae and Freddie Mac). Both rose in March, and housing prices are up 6.5% and 6.8%, respectively, in the past year.

We think price gains will continue in the year ahead, although not every month, and probably at a slower pace than seen over the past year. Just like very loose monetary policy back in 2020-21 permanently lifted the general price level for goods and services – most of the home price gains during that period will likewise end up being permanent. Some regions around the country (for example Naples, FL) exceeded those gains because of the peculiar dynamics of COVID. They are therefore vulnerable to some pullback, but we are not in a bubble like we saw prior to the financial crisis of 2008-09.

Through March, the Case-Shiller index is up 47.4% and the FHFA index is up 50.2% compared to February 2020 (pre-COVID). Meanwhile, the Consumer Price Index through March was up 20.4% vs February 2020 levels. But other factors are at work in the housing market. For example, over the same period the price index specific to constructing new single-family homes was up 37.9% as commodity and labor costs rose, outstripping general inflation.

Just as important is the lack of supply in the housing market. Homebuilders haven’t been making enough homes since the bursting of the housing bubble. Back in 2009-2015, this made sense: the best way to clear out the excess inventory of homes was to build fewer homes than would normally be needed to meet population growth and scrappage (fires, floods, knockdowns…etc.). But that excess supply was absorbed almost a decade before COVID, and yet builders kept underbuilding.

Don’t get us wrong, we’re not blaming the builders themselves or capitalism. Governments – federal, state, and local – have created extensive regulations on home construction, making it harder and more expensive to build. Environmental rules, zoning limits, historical preservation, the promotion of “smart growth” or “affordable housing” all impede a free market. On top of this, small businesses (which include many home builders) face incredibly complex and burdensome hurdles in managing payrolls, including taxes, rules, and regulations. COVID era policies widened the performance gap between small and big business.

Meanwhile the construction process itself is taking longer. Prior to COVID, the average time from permit to start for single-family homes was 1.1 months; in 2023 (the latest available) it was 1.5 months. This increase was led by the Northeast, where the average time went from 0.9 months prior to COVID to 2.1 months in 2023. For multi-family homes, it used to take 1.9 months from permit to breaking ground, now it's 2.8 months.

Finishing a home that’s been started is also taking longer, now 8.6 months for single-family homes versus 7.0 months pre-COVID. Multi-family construction was taking 15.4 months pre-COVID, now it’s 17.1 months.

No wonder new home sales continue to languish below where they were in 2019. Existing home sales are far below the 2019 pace, too, although much of that is due to “mortgage lock-in,” where homeowners borrowed at very low rates during COVID and now don’t want to move come hell or high water.

Making the housing situation even worse is that government policies that limit home construction are happening at the same time as a massive surge in immigration in the past few years. Whatever you think about our current border situation, the greater the flow of immigration, the more you should support looser restrictions on building homes. If we’re going to have an open border, a free market in housing is more essential than ever.

To summarize, housing prices may rise a little slower, and if we do see a recession, sales will slow as well, but because of underbuilding the housing market overall will likely remain more resilient in any downturn than 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.

Would Trump Reignite Inflation?

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

May 13, 2024

One theory making the rounds is that if President Trump gets back into office, inflation is going to surge. The idea is that if he returns, Trump will raise tariffs, reduce immigration, and jawbone the Federal Reserve to cut interest rates too much, all of which could push inflation higher, maybe even to where it was a couple of years ago when it peaked at 9.1%.

We are certainly not optimistic about the path of inflation in the decade ahead. The Consumer Price Index (CPI) went up at only a 1.8% annual rate in the ten years prior to COVID and we think it’ll be closer to 3.0% per year in the decade ahead. However, we think that’ll likely be the case regardless of the election results later this year. At the same time, we don’t expect anything like the COVID surge in inflation in the next few years.

Take the tariff argument, for example. Yes, tariffs would raise prices for the items being tariffed. But unless the Fed loosens monetary policy in response, the extra money consumers would have to spend on imported items would have to come from money they’d otherwise use to buy other items, putting downward pressure on prices for those other items and not changing overall inflation. Remember, Trump raised tariffs during his first term in office and yet inflation was subdued until the Fed ignited it during COVID.

The same goes for immigration, which was slower in the Trump Administration than it had been under President Obama, without causing a spike in inflation. By contrast, immigration has soared under President Biden while the CPI has averaged 5.6% per year. If immigration was some sort of magic that kept inflation low, why wasn’t inflation much higher during Trump and why hasn’t it been lower under President Biden?

We think this is ultimately because it’s monetary policy that determines inflation, not tariffs or immigration. Which brings us to the last argument suggesting Trump will bring back high inflation, that he will put political loyalists in charge of the Fed who will loosen policy much more than economic conditions suggest, leading to a spurt in inflation.

It is true that Trump would have the chance to put loyalists at the Fed, but the terms of Fed policymakers turn over gradually. Also, every nominee would need confirmation by the Senate. None of these people, not the nominee or nominators, would want to be blamed for causing a surge in inflation.

We are guessing Trump would appoint either Kevin Warsh or Kevin Hassett as Fed chairman to succeed Jerome Powell, neither of whom would want to go down in history as the second coming of the failed Arthur Burns of the 1970s. Moreover, many of the votes on monetary policy come from regional bank presidents not appointed directly by the president. The Fed is full of checks and balances, and part of a new Fed regime’s task will be to fix the inflationary tilt of policy since 2008.

Again, we are not saying inflation won’t be a problem in the years ahead; it likely will be. But it’s likely to be a problem no matter who wins this November.

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 Fed Faithful

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

May 6, 2024

If the financial markets have a religion, we think we know what it is: a deep and abiding faith in the ability of an omniscient Federal Reserve to ride to the rescue if and when the economic weather turns bad.

It’s hard to tell exactly where the economy is right now, but it’s very unlikely to be in a recession or need a rescue yet. The Atlanta Fed’s GDP Now model is tracking 3.3% annualized growth in the second quarter, while our models suggest a growth rate of 2.5%. Both of these are above the 20-year average growth rate of 2.0%.

However, not all the economic signs are as positive. The ISM Services index came in at 49.4 in April, the first reading below 50.0 since December 2022. The business activity component, at 50.9, was the lowest since the onset of COVID in 2020. This is important to us because readings below 50 signal contraction. The ISM Manufacturing index came in at 49.2, the seventeenth month below 50.0 in the past eighteen months.

During COVID, services were locked down in many states for a long time, with many of those workers receiving checks from the government, which they in turn spent on goods. Since opening up, goods have been weak, while services have recovered. That process appears complete now, and the dip in services could signal problems.

It could also be why the labor market lost at least a little bit of luster in April, with slower job growth, slower wage growth, and fewer hours worked. Nonfarm payrolls grew 175,000 for the month, less than the 225,000 the consensus expected.

We like to follow payrolls excluding government (because it's not the private sector), education & health services (because it rises for structural and demographic reasons, and usually doesn’t decline even in recession years), and leisure & hospitality (which is still recovering from COVID Lockdowns). That “core” measure of payrolls rose a modest 67,000 in April, the slowest pace so far this year.

There are two measures of total jobs. One survey (which gave us the data we just mentioned for nonfarm payrolls) looks at existing establishments. The other measures civilian employment by talking directly to workers. It will catch self-employment and small-business start-ups. Last month this measure increased a weak 25,000 (and unemployment rose to 3.9%). Over the past year civilian employment is up 500,000 versus 2.8 million new jobs counted by the payroll survey. This divergence has happened before, but it is still slightly worrisome.

Nothing in the April jobs report suggest a recession, but it’s certainly a move in a more tepid direction versus the prior path of the labor market.

In the meantime, the Fed, as well as market expectations of what the Fed will do, keep bouncing around. On Wednesday the Fed made it clear that, in response to a string of relatively high inflation readings, the bar to cutting rates anytime soon (at least until July) is very high. Why? Consumer prices are up 3.5% in the year ending March, an acceleration from the 3.0% in the year ending in June 2023. Lack of progress on inflation makes it difficult for the Fed to justify rate cuts.

The Fed thinks the stance of monetary policy is already tight enough to eventually bring PCE inflation (its preferred measure) down to its 2.0% target, it’s just taking longer than previously expected.

In fact, the Fed must believe it is making progress on inflation because it announced that it would soon slow the pace of Quantitative Tightening. It will now reduce its portfolio of Treasury securities by $25 billion per month starting in June, less than half the previous rate of $60 billion per month since mid2022. The Fed didn’t change the rate of reduction in mortgage-related securities, holding that target to “up to $35 billion per month,” which makes sense because paydowns have slowed with higher mortgage rates.

In effect, the Fed is moving toward a loosening of monetary policy, even as the Fed claims to be determined to fight inflation. No wonder the expectations surrounding shifts in short-term interest rates this year have bounced around so much, with the Fed thinking of its balance sheet, the money supply, and short-term rates as separate and distinct tools.

Ultimately, if the Fed is going to be successful on inflation, it’s going to need a monetary policy that’s tight enough to hurt real economic growth, as well. That should scare the stock market, and yet the stock market as a whole remains lofty relative to interest rates and profits. This only makes sense if investors believe the Fed will be able to react quickly to economic weakness once it kicks in, without reigniting inflation. Count us skeptical.

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 Worst Malinvestment

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

April 29, 2024

Austrian Economics argues that growth comes from innovation and entrepreneurship, with “the market” directing resources to areas of the economy that provide the greatest returns. It also observes that when government uses interest rates, subsidies, taxes, or other types of market interference, it can cause “malinvestment” – or investment in areas that wouldn’t receive market support. This leads to losses and wasted resources.

While there are many examples of this as government has become bigger and more unaccountable, recent events on many college campuses around the US show some of the worst malinvestment our country experiences year in and year out.

Public universities certainly don’t run like capitalist institutions, but neither do private colleges (like the Ivy League). While people complain about all kinds of corporate welfare, what about university welfare? The eight Ivy League Schools, plus Northwestern and Stanford (all private) received $33.1 billion in grants and contracts from the federal government between 2018 and 2022 in data calculated by Open the Books.

Meanwhile, the government has given $1.6 trillion in “loans” to young people to buy the “services” of schools and their academics. Although these loans are sold as a good thing for young people, we think the main effect is to create jobs for and support the wages of academics who get to pocket the money whether their work leads to new inventions and innovation or a disdain for freedom, capitalism, and America itself.

Yes, it’s certainly true that most people with high-paying jobs have gone to college. But, as George Mason economist Bryan Caplan found, a college degree isn’t actually the cause. They earn more because they’re often highly intelligent, very conscientious, or willing to conform to a corporate culture. Sometimes all three! So unless you’re pursuing a degree in something where you need a specific body of knowledge, like medicine or engineering, going to college likely just signals natural intelligence, conscientiousness, and corporate conformity, not important knowledge.

In turn, Preston Cooper at FREOPP.org has researched about 30,000 bachelor’s programs around the country and found that more than 25% of programs experience a negative return on investment (ROI), which certainly helps explain why so many people feel burdened by student loans. And, going to a very selective school is no guarantee of a positive ROI.

We can’t help but wonder if these economic realities, and evidence of malinvestment, aren’t at least partly responsible for turmoil on college campuses. After all, malinvestment leads to slower long-term economic growth, which undermines growth in living standards. More debt and less growth are a recipe for bad outcomes.

We aren’t positive everyone will see it this way, but the data and reality on the ground seem to be saying the US ought to find a way to separate academia and government. One key item, which we have mentioned before, is that universities and colleges should be on the hook for all, or at least a portion, of unpaid student loans. And why does the federal government give billions to schools who have massive and un-taxed endowments? Any action, which reduces malinvestment, will lead to better outcomes for 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.

April Market Review

April 30, 2024

Dear Friends and Clients,

In April, the S&P 500 experienced its first 5% pullback since October 2023. This wasn’t surprising since the market had advanced over 25% from then and investors were brimming with optimism about future stock market gains. With bullish sentiment tempered, attention should focus on earnings results to re-assert the market’s upward momentum. 

Raymond James Chief Investment Officer Larry Adam is constructive on the market, saying: “While the scope of scenarios for Federal Reserve (Fed) rate cuts has contracted, accelerating earnings and a still healthy economy should support the market going forward.” 

Most sectors were down for the month with energy outperforming because of increases in oil prices related to unrest in the Middle East and with utilities outperforming due to their defensive characteristics. Technology underperformed the S&P 500. However, the earnings outlook for technology companies remains positive. The worst performer was real estate, no surprise since it’s the most interest rate-sensitive sector.

Bond yields rose to year-to-date highs as expectations for Fed rate cuts have been delayed due to persistent inflation and stronger-than-expected growth. And on the international front, central banks in Europe and the U.K. are looking more likely to cut interest rates if their rising unemployment remains under control, thanks in part to their lower Consumer Price Index (CPI), which doesn’t factor in housing costs as heavily as the U.S.

Before we move ahead, let’s take a look at the year-to-date results:

Steady growth expected to continue

U.S. real Gross Domestic Product (GDP) came in lower than expected at 1.6% quarter over quarter, annualized, but has the potential to climb higher throughout the year in the subsequent revisions as the Bureau of Economic Analysis collects more robust data on the performance of the economy. The CPI spooked markets for a third consecutive time to cap a stronger than expected first quarter for U.S. inflation, sending markets down and analysts back to the drawing table to try to figure out how many, or if any, rate cuts are now expected during the year. U.S. retail and food services sales were stronger than expected in March as employment and income growth continue to drive demand. Housing was a mixed bag, with existing home sales down while new home sales regained lost momentum from February.

Equities facing a short-term bounce

Ongoing inflation pressure led to a reset in Fed expectations and higher bond yields, causing the S&P 500 to pull back -4.1%, the Nasdaq -4.4% and the Russell 2000 -7.1% for the month. But this is expected with the market having gotten ahead of itself by rising 28% in just five months. Inflation should still be on its way down, albeit on a bumpier path than perhaps expected. Short-term indicators suggest that we are due for a brief slowdown, but with conditions allowing for recovery to a stronger market overall throughout the next 12 months. Upcoming Q1 earnings reports and bond yields will serve as indicators of what’s to come.

Large caps outperform amid higher yields

Fear of inflation, as well as unrest in the Middle East, increased equity volatility in April with the S&P 500 falling below the 50-day moving average. Energy, utilities and consumer staples outperformed while real estate, consumer discretionary and technology sectors fell short. Small cap companies underperformed their large cap counterparts largely driven by the move to higher yields.

Expected rate cuts less likely

Fears of reaccelerating inflation have called into question whether the Fed will make good on its promise to cut interest rates throughout the year, with some worried that it may even go in the opposite direction and raise interest rates should inflation rise. The expectation of five cuts in 2024 back in January had dwindled to three by March and is now at two or fewer based on Fed funds futures trading. These trends have consequently increased Treasury yields, with interest rates increasing roughly 50 basis points on durations of five years and beyond.

Amid two wars, oil prices are near six-month highs

In addition to the Russia-Ukraine war, which involved drone strikes on Russian refineries in March, Israel’s war in Gaza has also increased the risk premium in oil prices. In April, Israel’s airstrike on the Iranian consulate in Syria was met with Iran’s first-ever direct missile attack against Israeli territory, though both sides are refraining from all-out war. Such geopolitical unrest has contributed to the near six-month highs in oil prices observed at the end of April, unwelcome news ahead of the summer driving season that is unlikely to subside in the absence of a durable ceasefire.

TikTok faces ban as U.S. strengthens trade stance against China

As part of a $95 billion aid package signed by President Biden in April to assist Ukraine, Israel and Taiwan, a provision was enacted that will require popular social media platform TikTok to divest from ByteDance, its Chinese parent company, within the next 12 months or face a permanent ban on U.S. operations. It is expected that China will not allow divestment and therefore it is increasingly possible that TikTok will no longer operate in the U.S. by mid-2025. This move comes during a period when the U.S. is taking a more assertive stance against China on tech and trade policy, which could soon involve tariffs on items sensitive to national security issues like semiconductors, solar technology and electric vehicles.

Europe predicting rate cuts with U.K. likely to follow

Considering economic data and events in the Middle East, many investors have been skeptical that the central banks in Europe will cut interest rates as previously indicated. However, bank leaders have remained optimistic and, partly resulting from their confidence, European sovereign bonds have not seen the same rise in yield as their U.S. counterparts. Senior officials at the European Central Bank have signaled strongly that subdued inflationary pressures, if sustained, will allow for a rate cut as soon as June.

In the U.K., the equity index hit a new all-time high after Bank of England Governor Andrew Bailey implied the likelihood of following in their European counterpart’s decision to cut interest rates in the coming months. However, there is still ambiguity regarding that decision, which could prove sensitive to factors such as private sector wage growth, which remains higher than the central bank would like.

When comparing CPI in Europe to that of the U.S., it’s important to consider that the stickiness of domestic inflation and higher CPI in the U.S. is largely the result of the much higher weighting of housing costs, which have risen faster than other prices that contribute to the overall calculation. It should be noted that in Europe, owner-occupier housing costs are not included at all.

The bottom line

With uncertainty regarding inflation, the Fed and international conflicts, there are significant risk factors at play. However, statistics seem to point toward a positive upswing in the markets over the course of the next 12 months. And despite the first 5% pullback in the S&P 500 in six months, our outlook continues to be positive in the long term.

We’re glad to be able to bring you these updates and hope you find them helpful. Your financial goals are always top of mind, so please don’t hesitate to reach out regarding any questions or concerns you may have.

Sincerely,

Investing involves risk, and investors may incur a profit or a loss. All expressions of opinion reflect the judgment of the Raymond James Chief Investment Officer and are subject to change. There is no assurance the trends mentioned will continue or that the forecasts discussed will be realized. Past performance may not be indicative of future results. Economic and market conditions are subject to change. The Dow Jones Industrial Average is an unmanaged index of 30 widely held stocks. The NASDAQ Composite Index is an unmanaged index of all common stocks listed on the NASDAQ National Stock Market. The S&P 500 is an unmanaged index of 500 widely held stocks. The MSCI EAFE (Europe, Australasia and Far East) index is an unmanaged index that is generally considered representative of the international stock market. The Russell 2000 is an unmanaged index of small-cap securities. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. An investment cannot be made in these indexes. The performance mentioned does not include fees and charges, which would reduce an investor’s returns. Investing in the energy sector involves special risks, including the potential adverse effects of state and federal regulation, and may not be suitable for all investors. A credit rating of a security is not a recommendation to buy, sell or hold the security and may be subject to review, revision, suspension, reduction or withdrawal at any time by the assigning Rating Agency.  Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. Income from municipal bonds is not subject to federal income taxation; however, it may be subject to state and local taxes and, for certain investors, to the alternative minimum tax. Income from taxable municipal bonds is subject to federal income taxation, and it may be subject to state and local taxes. Investing in commodities is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. The companies engaged in the communications and technology industries are subject to fierce competition and their products and services may be subject to rapid obsolescence. The Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Studies. The Leading Economic Index (LEI) provides an early indication of significant turning points in the business cycle and where the economy is heading in the near term.

Material created by Raymond James for use by its advisors.

Fed’s Inflation Calculations Explained

Three on Thursday First Trust Economics

Brian S. Wesbury - Chief Economist

April 18, 2024

In this week’s “Three on Thursday,” we explore the Personal Consumption Expenditures (PCE) Price Index, which became the Federal Reserve’s preferred inflation gauge starting in 2000. This shift occurred after Federal Reserve Chairman Alan Greenspan highlighted its advantages in The Monetary Policy Report to Congress. The Fed favors the PCE Price Index over the Consumer Price Index (CPI) for several reasons. Firstly, the PCE Price Index uses a formula that adapts to changes in spending habits, reducing the upward bias inherent in the CPI’s fixed-weight approach. It also employs weights based on a broader expenditure measure. Additionally, the PCE Price Index’s historical data can be revised to incorporate new information and improvements in measurement techniques, which include refinements to the source data used in the CPI, leading to a more consistent time series. While the Federal Open Market Committee (FOMC) has adopted the PCE as its preferred measure, it continues to use a range of price metrics and other cost information to assess inflation trends. For further clarity, we’ve included a table and two detailed charts in this edition.

The PCE Price Index can be divided into two main categories: Goods and Services. Goods represent 33.1% of the index, with Durable Goods (items intended to last three years or more such as appliances and furniture), and Nondurable Goods (items with a shorter lifespan, like food and clothing) contributing 11.6% and 21.4% to the overall index, respectively (off 0.1% due to rounding). Services account for 66.9% of the index, dominated by Household Consumption Expenditures, which hold a substantial 64.0% weighting. Nonprofits contribute a smaller portion at 2.9%. Within Household Consumption Expenditures, Housing and Utilities form the largest group, influencing the overall index with a 17.7% weighting, followed closely by Health Care at 16.3%.

Since 2000, the annualized gain in the PCE Price Index has typically been about 0.4 percentage points lower than the CPI due to several key differences. First, the CPI uses a fixed basket of goods and services with quantities based on past consumption, rarely updating. In contrast, the PCE Price Index adapts more dynamically, reflecting changes in consumer behavior and substitutions in response to price changes by frequently adjusting item weights based on current spending data. Second, consumption categories in the CPI and PCE are weighted differently; for instance, housing accounts for about 45% of the CPI but only 15.4% of the PCE. Third, the CPI measures direct out-of-pocket expenses by consumers, while the PCE includes all goods and services consumed by households, even those paid by employers and the government, like medical premium payments made by employers, providing a broader view of consumption. Lastly, variations in seasonal adjustments and price calculations for identical products also contribute to discrepancies. For example, the PCE’s airline fare index is based on passenger revenue and miles traveled, whereas the CPI measures ticket prices for specific routes, leading to different pricing insights.

For decades, economists have excluded food and energy prices from inflation measures – commonly referred to as “core prices” – because they can be both seasonal and volatile. Starting in November 2022, the Federal Reserve said it will focus on a narrower measure known as “Supercore” inflation, which refines this perspective even further. Fed economists categorize core inflation into three segments: core goods, housing services, and core services minus housing. The latter category, often referred to as Supercore, gained traction after the COVID lockdowns. This focus stems from the Fed’s belief that service sector prices, unlike goods prices, are predominantly influenced by labor costs—a factor the Fed thinks it can influence. Raising interest rates typically cools economic activity, and jobs growth, which should limit wage hikes. In contrast, they believe goods prices are more susceptible to global dynamics like supply chain variations. Interestingly, in spite of major interest rates hikes, Supercore has remained stubbornly elevated, up 3.3% from a year ago. This is likely a significant argument for fewer rate cuts this year than the market has been expecting.

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.

Continued Growth in Q1

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

April 22, 2024

The economy continued to grow in the first quarter at what we estimate is a 2.6% annual rate. That’s a slowdown from the 3.1% rate in 2023, but still good compared to the past couple of decades when the average growth rate has been 2.0%.

However, we think a chunk of recent growth is artificial, and temporary, the by-product of too much government. Directly, this includes “real” (inflation-adjusted) government purchases that grew 4.6% in 2023 and we estimate grew at a 2.3% annual rate in the first quarter.

It also includes the indirect effects of the expansion in the budget deficit in FY 2023. The official deficit didn’t expand much, but that’s because President Biden announced a plan to forgive student loans in 2022 and then the Supreme Court struck it down in 2023. Neither of these affected the government’s cash flow but they did change official government accounting. Taking them out means the deficit expanded to 7.5% of GDP in FY 2023 from 3.9% in FY 2022.

In addition, and as we explained recently (MMO, April 8), if monetary policy were really tight, inflation would be persistently declining. But CPI prices were up 3.0% in the year ending in June 2023 and are now up 3.5% in the past year. This suggests residual effects of past monetary looseness are still boosting the economy.

We estimate that Real GDP expanded at a 2.6% annual rate in the first quarter, mostly accounted for by an increase in consumer spending.

Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector declined at a 3.0% annual rate in Q1 while auto sales declined at an 8.7% rate. However, it looks like real services, which makes up most of consumer spending, soared at a 4.7% pace. That’s the fastest pace for service growth since the re-opening from COVID in 2020-21. Excluding that re-opening, when all the data were whacky, it's the fastest pace for service growth since the peak of the Internet Bubble in 2000. Putting it all together, we estimate that real consumer spending on goods and services, combined, increased at a 3.1% rate, adding 2.1 points to the real GDP growth rate (3.1 times the consumption share of GDP, which is 68%, equals 2.1).

Business Investment: We estimate a 2.4% growth rate for business investment, with gains in intellectual property leading the way, while commercial construction declined. A 2.4% growth rate would add 0.3 points to real GDP growth. (2.4 times the 14% business investment share of GDP equals 0.3).

Home Building: Residential construction is showing some resilience in spite of some lingering pain from higher mortgage rates. Home building looks like it grew at a 5.0% rate, which would add 0.2 points to real GDP growth. (5.0 times the 4% residential construction share of GDP equals 0.2).

Government: Only direct government purchases of goods and services (not transfer payments) count when calculating GDP. We estimate these purchases were up at a 2.3% rate in Q1, which would add 0.4 points to the GDP growth rate (2.3 times the 17% government purchase share of GDP equals 0.4).

Trade: Looks like the trade deficit expanded in Q1, as exports grew but imports grew even faster. In government accounting, a larger trade deficit means slower growth, even if exports and imports both grew. We’re projecting net exports will subtract 0.5 points from real GDP growth.

Inventories: Inventory accumulation looks like it picked up in Q1, but only slightly versus Q4, translating into what we estimate will be a 0.1 point addition to the growth rate of real GDP.

Add it all up, and we get a 2.6% annual real GDP growth rate for the first quarter. Solid for now, but we expect slower growth later this year as the temporary effects of government deficit spending wear off.

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.

Elections Matter

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

April 15, 2024

Many, us included, see parallels between today’s big issues and those of the 1960s and 1970s. Mistakes in both geopolitical and fiscal policies compound overtime, often leading to more mistakes. After Vietnam ended badly, US weakness likely encouraged terrorism. The 1972 Munich Massacre of Israel Olympic Athletes, Entebbe in 1976, and finally US hostages held in Iran from 1979 to 1981.

At the same time both fiscal and monetary policy became unhinged. The result was stagflation, with inflation hitting and unemployment approaching double digits. We don’t have room for a complete historical explanation, but Presidents Johnson, Nixon, Ford, and Carter each made mistakes in either foreign or fiscal policy that led to these problems.

Then, Ronald Reagan was elected, and while his opponents claimed he would cause nuclear war, the exact opposite happened. Stagflation was ended, the Berlin wall fell, and the world entered a mostly peaceful era. Elections matter.

With Iran attacking Israel over the weekend, and unsustainable budget deficits eroding the US fiscal situation, we are reminded of the 1970s. In fact, there were two decisions made under President Carter almost fifty years ago that have helped create both of these issues.

We focus on policy, not personality. We are not attacking President Carter himself. He appears to be a very good and decent man. His great charitable work after leaving the presidency speaks for itself and sets a great standard for other former officeholders. In addition, President Carter bucked his party and deregulated both the trucking and airline industries.

However, Carter also made some serious blunders. On the geopolitical front, it was Carter who decided (1) not to back the Shah of Iran in 1978 and after that (2) not to pursue regime change in Iran after the seizure of American hostages and a coup d’état against the duly-elected Iranian President Banisadr (who had to flee for his life back to France).

Now the Islamic Republic of Iran effectively controls Syria, much of Iraq, Lebanon, Gaza, some of Yemen, and in the meantime is aligning with rivals of the US, such as China and Russia. With every passing decade it has become more difficult to dislodge the regime in Iran and now, in the absence of a change in the near future, it may only be a matter of time before Iran is able to acquire a nuclear weapon.

On the fiscal side, President Carter also championed an arcane but incredibly important change to Social Security enacted in 1977. This change virtually guaranteed the long-term insolvency of the old-age pension portion of the Social Security system unless future policymakers agree to some combination of tax hikes or benefit cuts.

Before these changes were made, Social Security payments were adjusted by inflation, what we call the cost-of-living adjustment (COLA). Until the mid-1970s, Congress had to vote to make this adjustment and politicians took credit every time they did. But, as inflation became more of a problem, the annual COLA was tied directly to the Consumer Price Index.

The COLA adjustment automatically increased both current and future benefits. But Carter added a wrinkle. Current recipients would receive the COLA adjustment, but future benefits would rise by both the COLA plus an estimate of real wage gains. At first this made little difference, but through the magic of compounding, this adjustment for real wages adds up and the current trajectory of payments is unsustainable.

Carter and other policymakers were warned about this problem at the time, but didn’t pay it heed. No wonder people see similarities between today and the 1970s. Current policies and past policies are colliding to create the very same problems. As November approaches, voters would do well to remember this history. Their decisions are not just about the next few years, but will resonate for decades to come. Solid US leadership can change the entire world.

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 Fed Tight, or Not?

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

April 8, 2024

In the waning seconds of one of the most watched women’s college basketball games ever, a foul was called. The University of Connecticut was playing the University of Iowa in the semifinals of the women’s NCAA championship tournament. Officials called a UConn player for an “illegal screen” on an Iowa defender, which helped Iowa win the game. This happened Friday night, and on X (formerly Twitter) the debate about this call still rages.

In spite of the debate, that game is over. On Sunday, Iowa lost to South Carolina in the finals and the world moves on. Meanwhile, in the realm of economics, a different debate rages. Is Federal Reserve policy tight, or not?

Ultimately, there is an ironclad two-part test to determine if monetary policy is tight. First, has the economy weakened to below trend growth? More clearly, is GDP falling, or unemployment rising? And second, has inflation persistently declined. If those things haven’t happened, it's hard to argue monetary policy has been tight.

At present, we are tracking Real GDP growth at about a 2.0% annual rate in the first quarter, which is close to the long-term average. This follows all of 2023, and the last two quarters of 2022, where quarterly real economic growth was faster than 2.0% each and every quarter. At the same time, unemployment remains below 4.0%. In other words, we haven’t yet had an economic slump consistent with tight money.

For inflation – after dropping from what appears to be a supply-chain induced spike of about 9.0% in mid-2022 – CPI inflation fell to 3.1% in mid-2023. But lately, CPI inflation has stopped its decline. We estimate that consumer prices rose 0.3% in March and the Cleveland Fed’s CPI Nowcast currently projects 0.3% for April, as well. If so, the overall CPI will be up 3.3% in April versus the year prior.

So, both real growth and inflation show little impact from Fed tightening, in spite of many of the traditional measures of monetary policy signaling tightness. For example, the M2 measure of the money supply peaked in April 2022 and is down 4.3% since. We haven’t had a drop like that since the early 1930s during the Great Depression. Yes, the monetary base is up 10.7% in the past year, but unless that base money is converted into M2, it likely has little impact. Following the 2008-09 financial crisis, quantitative easing didn’t turn into M2 and inflation remained tame…but during COVID, QE did cause M2 to spike, and inflation jumped.

Meanwhile the slope of the yield curve between the target federal funds rate and the 10-year Treasury yield has been inverted since late 2022, a typical sign of tight money. And while not as clear cut, the federal funds rate has been 2.0 percentage points, or more, above inflation in the past six months. While we would say these rates are roughly neutral, not really helping or hurting growth, this is a huge change from the 2009-2021 period, when rates were held well below inflation.

Think of it this way: imagine you’re trying to freeze water, at sea level. A thermometer shows the temperature is 25⁰F and the water isn’t freezing. Does this mean the laws of chemistry and physics have been repealed? Of course not! Any sensible person would think that the thermometer must be broken, or maybe the liquid you’re trying to freeze isn’t water after all.

Which brings us to one signal of monetary tightness that hasn’t been triggered yet. History suggests that interest rates should be roughly equal to “nominal” GDP growth (real GDP growth plus inflation) – a cousin to what is called the “Taylor Rule.” Nominal GDP is up 5.9% in the past year and a 6.5% annual rate in the past two years. Yet, the federal funds rate is just 5.4%. That’s not tight money! Maybe that’s the measure of tightness we should have been following all along.

In other words, maybe one of the reasons we haven’t yet experienced economic turbulence is that monetary policy hasn’t been as tight as most investors thought. If so, it could take much longer to bring inflation down to 2.0% than the Fed expects, which means short-term rates could stay much higher for much longer.

In turn, that would mean more economic pain ahead than most investors currently expect. Some calls are hard to make no matter how much time is left in the game.

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