M2 Slowdown Finally Gaining Traction

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

June, 15, 2024

The lags between a shift in monetary policy and the economic impact are long and variable. While the actions of the Federal Reserve during the pandemic were unprecedented, it finally looks like the excess money pumped into the economy has worked its way through the system. And with the M2 measure of the money supply down from its peak, the economy is reacting.

This measure of the money supply surged in 2020-21 in the first two years of COVID as the government massively increased deficit spending and enacted temporary tax cuts that didn’t improve the long-term incentives to work, save, and invest. The resulting spike in inflation in 2021-22 certainly didn't surprise us, and it should not have surprised anyone else.

Yet it did. Many went out of their way to find other things to blame for inflation. They ignored M2, and blamed “Putin” or “supply chains” and called inflation “transitory.”

Sure, some prices were boosted by the lockdowns and war, but that was only a small fraction of the problem. If it was the whole problem or most of it, we wouldn’t be sitting here more than four years later with the consumer price index up 3.0% from a year ago. If it were all “transitory,” we should have seen a widespread drop in consumer prices, and that didn’t happen.

The Fed itself continues to ignore the money supply. Fed officials never bring up the topic on their own and reporters rarely if ever ask about it. And on the rare occasion when Fed Chairman Jerome Powell is asked about the money supply, he goes out of his way to say it’s not something the Fed pays much attention to.

However, the link between money and inflation is starting to get some more attention. A recent paper by Greg Mankiw, an academic economist who was the chairman of the Council of Economic Advisers under President George W. Bush, noted that forecasts of high inflation that were made back in 2021 that considered the M2 surge turned out to be right. (Note: the First Trust economics team won an award as the most accurate economists for the US economy for 2022, and we recognized the importance of the M2 surge.)

Which brings us to where the economy is right now. Consumer prices declined 0.1% in June, the largest drop for any month since the early days of COVID. Much of this was due to a drop in energy prices, but even “core” consumer prices were soft, up only 0.1% for the month, the smallest increase for any month in more than three years.

Meanwhile, we are seeing some softness in economic growth. Overall retail sales in May were no higher than in December (after adjusting for normal seasonal variation) and it looks like retail sales fell in June (to be reported Tuesday). Manufacturing production is likely lower than a year ago (reported Wednesday).

Considering that the M2 measure of money peaked roughly two years ago, this should not be surprising. The drop in M2 from early 2022 through late 2023 appears to be finally having an effect.

The wild card is that M2 is up at a modest 2.3% annual rate since last October. If this keeps up, a soft landing is possible while inflation continues to move back down to the Fed’s target. It could also leave room for some rate cuts by the Fed. By contrast, if the M2 money supply resumes a decline, that would raise the risk of a recession and if M2 surges again, it could herald a revival of inflation like we had in the 1970s.

Either way, we are glad the M2 money supply is starting to get more attention, we still follow it closely, and think investors should pay attention, as well.

The attached information was developed by First Trust, an independent third party. The opinions are of the listed authors at First Trust Advisors L.P, and are independent from and not necessarily those of RJFS or Raymond James.  All investments are subject to risk. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Individual investor's results will vary. Past performance does not guarantee future results. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. Any information provided is for informational purposes only and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

S&P 500 Index 1H

First Trust Economics

Three on Thursday

Brian S. Wesbury - Chief Economist

July 11, 2024

This week’s edition of “Three on Thursday” focuses on the S&P 500 Index’s performance in the first half of 2024. As a widely respected barometer for the overall stock market, the S&P 500 Index tracks the performance of 500 of the largest companies listed on U.S. stock exchanges. The Index uses a market-cap weighting approach, giving a higher percentage allocation to companies with larger market capitalizations, adjusted for the number of publicly traded shares. In the first half of the year, the S&P 500 Index achieved a remarkable total return of 15.3%, reaching all-time highs 31 times during this period, with a maximum drawdown of only 5.8%. An exceptional first half, indeed! Below are three insightful charts that provide a deeper understanding of the events that shaped this extraordinary first half of the year.

The “Magnificent 7” companies – Apple, Nvidia, Microsoft, Amazon, Tesla, Alphabet, and Meta – which currently hold a combined 29.5% weighting in the S&P 500 Index, accounted for 59.6% of the Index’s 15.3% total return in the first half of 2024. Nvidia stood out with an impressive 149.5% increase, leading the group in contribution. However, not all members of this elite cohort saw positive growth; Tesla experienced a decline of 20.4%, detracting 0.39 percentage points from the market’s overall performance and slipping to the eleventh position by market capitalization, with Berkshire Hathaway replacing it in the seventh slot. If Berkshire Hathaway replaced Tesla in the Magnificent 7, the new group’s contribution to the overall market return for the first half of 2024 would increase to 63.7%.

Although the S&P 500 Index gains have been predominantly driven by the Magnificent 7, it is essential to also consider earnings. Over the past year, the Magnificent 7 have contributed 86.7% to the S&P 500 Index’s earnings growth but only 59.6% to its price gain. Five of these seven companies have seen a higher contribution to the Index’s earnings growth compared to their share of S&P 500 Index price gain. For example, Amazon accounted for 19.3% of the S&P 500 Index’s earnings growth over the past year but only 6.2% of its price gain. While the market gains have been narrow, the concentration in earnings growth has been even more pronounced.

In 2023, market advances were very concentrated, with a mere 27% of firms within the S&P 500 Index surpassing the Index’s performance. The first half of 2024 showed even further narrowing with just 24% of companies in the Index outperforming the overall Index. The proportion of companies surpassing the Index is the lowest going back to 1995 and significantly below the 29-year average of 48%, indicating that the market remains unprecedentedly narrow. However, with earnings expected to accelerate outside of the “Magnificent 7” in the second half of the year, there is hope for some market broadening on the horizon.

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.

How Strong is the Labor Market?

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

July 8, 2024

We aren’t naturally cynical about economic data, but there are things that don’t add up about the job market.

On the surface, Friday’s report was solid, with nonfarm payrolls up more than 200,000 in June, another good month. However, downward revisions to the prior two months reduced the net gain in total payrolls to just 95,000, with a net gain of only 50,000 for the private sector.

Now for the strange parts. Nonfarm payrolls are up 2.6 million versus a year ago. But civilian employment, an alternative measure of jobs that includes small business startups is up a grand total of only 195,000 in the past year! Not 195,000 per month, but a total of just 195,000 over the past twelve months. Weird, right?

It's entirely possible that one of the major reasons for this gap is the recent surge in immigration. Immigrants who get jobs at one of the companies included in the payroll survey should be counted because it is filled out by employers. But the civilian employment figures (the weak one) are based on a survey of individual households and it’s hard to survey households in the US that are brand new or that are skittish about filling out a survey sent by the government, particularly if they are here illegally.

It's also important to point out that a gap between the two surveys this large may be highly unusual, but it has happened before. As a share of the labor force, the gap was briefly larger in the mid-1980s, the late 1990s, in 2013, and during COVID.

Another oddity is the consistent negative revisions for the past few years. Back in 2022, the third report for payrolls for a particular month averaged 6,000 less than the initial report for that month. For 2023, the revisions averaged -30,000. So far this year they’ve averaged -49,000. In the past few decades, negative revisions are more likely to happen around recessions than when growth is strong. So maybe it’s a symptom of weakness to come.

But there’s also a more benign explanation. Remember, the payroll report is based on a survey of employers. In the ten years prior to COVID, the government was getting an on-time response rate of 75% from the employers it surveys; but in the past three years the timely response rate has averaged only about 65%.

So maybe the companies that don’t fill out the survey on time for the first payroll report are having more business trouble than their peers (compared to normal). A struggling company would have more important issues to deal with than filling out a government survey. Eventually, the statisticians will get used to that pattern and make adjustments, but the data are looking funny in the meantime.

Another oddity is the gap between full-time and part-time jobs. The civilian employment report shows full-time jobs down 1.6 million in the past year while part-time is up 1.8 million. That kind of loss of full-time positions is normally linked to a recession and declining payrolls, not continued strong economic growth.

Do these anomalies show the government is cooking the books? We wouldn’t go that far. If the Labor Department is cooking the books, presumably for political reasons, then why are they letting the unemployment claims reports show an increase and why don’t they cook the civilian employment report to show more job gains closer to what the payroll report shows?

The problem is that it’s hard to argue at this point that government officials haven’t abused their authority to advance a narrative they’ve found useful, including the “slam dunk” case for Iraq having Weapons of Mass Destruction, or COVIDs “six-foot” rule, school closings, and masks, or even whether the measure of deaths from COVID were “from” COVID or “with” COVID. It’s not just the CDC and NIH that have lost luster in the eyes of average investors, but other government agencies as well. More people are skeptical of government reports than we have seen in our careers.

Putting it altogether, we think the job market is poised somewhere between the still strong picture painted by the payroll report and the soft reports on civilian employment. No recession yet, but some early signs of a slowdown.

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.

America's 3.5-Second Miracle

First Trust Monday Morning Outlook

Brian S. Wesbury - Chief Economist

Robert Stein, CFA - Dep. Chief Economist

July 1, 2024

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

He, obviously knew about the Magna Carta (1215) and the English Parliament’s Bill of Rights (1689), which created a separation of powers between the King and elected representatives. What he didn’t pay much attention to was how the United States had improved upon these documents or he would have seen a country of entrepreneurs that had freedom and property rights along with a constitution so well thought out that it has only been amended twenty-seven times in 235 years. No one puts it better than Ronald Reagan; the excerpt below comes directly from his Commencement Address at the University of Notre Dame back on May 17, 1981.

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

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

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

America has proven that men and women not only can make their own history, but they can make it as they please, with circumstances chosen by themselves. Happy 4th of July to you all. Let’s take time this week to step back and realize just how fortunate we are to live in a time and place where the fire of invention still burns hot, course corrections (however messy they may be) still take place, and the future remains as bright as ever. May we continue to honor the legacy of those who came before us by striving to uphold the principles that have made this country a beacon of hope and freedom for the world. (We first published a version of this same Monday Morning Outlook in celebration of July 4th, 2023.)

The attached information was developed by First Trust, an independent third party. The opinions are of the listed authors at First Trust Advisors L.P, and are independent from and not necessarily those of RJFS or Raymond James.  All investments are subject to risk. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Individual investor's results will vary. Past performance does not guarantee future results. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. Any information provided is for informational purposes only and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

Historic Highs: U.S. Net Interest Payments Skyrocket

First Trust Three on Thursday

Brian S. Wesbury - Chief Economist

June 27, 2024

In this week’s installment of “Three on Thursday,” we take a look at the surge taking place in net interest payments on treasury debt securities. Each year, when the U.S. incurs a deficit, it contributes to the growth of our national debt. The current outstanding federal debt has surpassed a staggering $33.6 trillion. However, what truly counts is the government’s ability to meet all the interest payments on this accumulating debt. In the last 12 months through May, federal net interest payments have soared to an unprecedented total of $836.1 billion. This figure represents the highest level ever recorded in our nation’s history. It’s important to note that as long as interest rates remain elevated and the government continues to accumulate new debt while refinancing old debt at higher interest rates, this number is poised to rise even further. To provide further insight, we’ve included three informative charts below.

For fiscal year (FY) 2024, ending on September 30th, the OMB estimates that interest on Treasury debt securities will reach $1.144 trillion. However, a more accurate measure of the financial burden of debt servicing is net interest on the federal debt, which excludes the interest payments the government pays itself as part of an accounting gimmick used for trust funds and other government accounts. These intragovernmental interest payments are designed to give the beneficiaries of these programs more confidence that their benefits will be paid in the future, but these interest payments do not affect the overall budget deficit. For FY 2024, the federal government is expected to pay itself $255.0 billion in interest income, making the net interest payments for the year an estimated $888.6 billion.

Net interest payments on government debt, projected at $888.6 billion for FY 2024, would set an all-time high, marking a 35% increase from the previous year, 136.9% over the past five years, and 288.1% over the past decade. Net interest’s share of total federal government spending is estimated to reach 12.8% in FY 2024, the highest since 1999 and nearly matching 2024 FY defense spending, which is projected at 13.1% of government spending. With interest rates elevated compared to the past 20 years and massive deficits forecasted ($1.87 trillion estimated for FY 2024 alone), net interest payments are expected to continue growing, occupying a larger portion of government spending over the next decade.

In the late 1970s, rising national debt and higher interest rates led to a significant increase in interest costs, peaking at 18.4% of federal revenues in 1991. However, smaller budget deficits and lower interest rates caused this ratio to decline over the following decade. From 2003 to 2018, interest outlays remained at or below 10% of federal revenues, despite substantial borrowing, due to low interest rates. Recently, the combination of rising interest rates and mounting debt has pushed net interest as a share of revenues to 17.5% in FY 2024, the highest level since 1992.

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.

What's Driving the Massive Deficits?

First Trust Three on Thursday

Brian S. Wesbury - Chief Economist

June 20, 2024

A prominent senator was on CNBC Tuesday morning and when asked about the issues with government spending in America today, responded it’s unfair “that someone like Jeff Bezos pays taxes at a lower rate than a Boston public school teacher… Those at the top have to pay their fair share of taxes” and in regard to the severe deficit problem, “It’s because we’ve done tax cuts and they’ve reduced our revenues sharply…What did Donald Trump’s tax cuts do? They pushed the deficit up even higher. So part of what we’ve got to do is get our revenue back in balance with our expenditures.” For today’s Three on Thursday, we test these claims by examining recent trends in government spending and revenues as well as the share of taxes the rich have been paying. For more detail please find the three charts below.

Looking back to 1950, government revenues have averaged 17.3% of GDP. During this time frame, the top marginal tax rate has exhibited significant fluctuations, ranging from a peak of 92% to a low of 28%. The best year for revenue as a share of GDP was 2000 when the highest marginal tax rate stood at 39.6%. Yet over this same period government spending has averaged 20.0% of GDP, hitting a record high of 30.8% of GDP in 2020. Since 2018 when the Trump tax cuts went into effect, revenues have averaged 17.0% of GDP, slightly below their historical average. Conversely, spending over the same period has averaged 24.8% of GDP, easily exceeding the historical average. The issue remains firmly on the spending side.

The most recent IRS data from 2021 underscores the highly progressive nature of the federal income tax system. Individuals in the top 1% (those with an adjusted gross income of $682,577 or higher) paid an average of 25.9% of their income to the Federal government. Meanwhile, those in the bottom 50%, (earning less than $46,637) had an average income tax rate of 3.3%. This significant difference shows that the top 1% pay an average federal income tax rate that’s 7.8 times higher than the bottom half of all taxpayers.

The top 1% is comprised of roughly 1.5 million income tax returns, and make 26.3% of total adjusted gross income, but they shoulder a significant 45.8% of the overall federal income tax burden, the highest percentage on record! Conversely, the bottom half, consisting of nearly 77 million income tax returns, make 10.4% of total adjusted gross income, yet their federal income tax burden is comparatively light at 2.3%. It’s worth noting that the bottom 98% of taxpayers, accounting for approximately 150.5 million tax returns and 68.1% of the adjusted gross income, collectively bear 46.2% of the total federal income tax load, basically matching the share carried by the top 1%.

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.

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.