The Plentiful Job Market

November 6, 2018

Growth is determined by a perpetual tug-of-war between entrepreneurship and government redistribution. When President Obama was in office, we believed incredible technological innovation would allow for economic growth in spite of Obamacare, greater redistribution, higher taxes and increased regulatory burdens. We thought it would be a Plow Horse Economy, and that things would get better if we did not grow government so much.

From mid-2009 through early 2017, real GDP grew at a 2.2% annual rate, with plodding growth in wages. It certainly wasn’t an economic boom, but it wasn’t recessionary either. For us, this meant we were shunned by both sides of the press.

We consistently repeated that the economy would grow faster with a better set of policies. So we became pariahs: liberal commentators didn’t want to hear about the free market policies we thought would improve economic growth; while conservative commentators didn’t want to hear about the economy being anything other than awful.

Now, thanks to the long-awaited corporate tax cut and deregulation, policies are more pro-growth.

In the past year, nonfarm payrolls are up 210,000 per month while civilian employment, an alternative measure that includes small-business starts-ups, is up 200,000 per month. Some say, “hey, that’s not any faster than recent years” and that’s true, but the longer expansions go, the tougher it is to sustain rapid job growth as the pool of available workers shrinks. In other words, today’s job growth is more of an achievement than it was during earlier stages of the recovery.

More important is the acceleration in workers’ paychecks. Average hourly earnings are up 3.1% from a year ago, the fastest wage growth for any 12-month period dating back to 2009. Factor-in robust gains in the total number of hours worked, and total cash earnings for workers are up 5.5% in the past year (even excluding one-time bonuses and commissions, like those paid after the tax cut was enacted late last year). That’s the fastest growth in cash earnings since recording began in 2006.

Meanwhile, the Employment Cost Index, a different measure of workers’ earnings, has also accelerated. Wages and salaries for private industry workers are up 3.1% from a year ago, the fastest pace since 2008. A year ago, in the third quarter of 2017, this measure of wages was up 2.6%. The ECI holds the weight of each industry and occupation the same over time, so the boost to wage growth is more likely to reflect faster pay increases for workers at the same job, rather than pay increases due to a shift in the mix of jobs towards those already paying higher wages.

Here’s the best part. A survey from the Labor Department on workers’ usual weekly earnings shows the fastest wage growth is for the bottom tenth of earners.

Rising wages appear to be drawing more workers back into the labor force, with the number of people either working or looking for work up 162,000 per month in the past year, even as the US continues to face the demographic headwind of an aging Baby Boom generation.

It wasn’t that long ago that some analysts were complaining about too much of the job growth coming from part-time jobs. We never bought into that argument, and the data supporting it was weak. The number of people working part-time for economic reasons peaked at about 9.2 million in 2010 and now it’s down to 4.6 million. In the past eight years, part-time jobs in the economy are down 56,000, while we have added more than 17 million full-time positions.

So, now, some argue that faster job growth is due to multiple job holders. But the data don’t show that, either. Multiple jobholders are 5.2% of all workers, which is lower than it was, on average, in both the prior economic expansion (2001-07) and the expansion of the late 1990s.

If someone tortures the data enough, we’re sure they could twist it into some new argument claiming things aren’t as good as they seem. And we stand ready to keep reviewing their claims to see if they make sense. So far, they haven’t. We don’t expect that to change anytime soon.

Better policies lead to faster economic growth. Faster economic growth leads to a plentiful job market.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist

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Economy Rising

October 31, 2018

A solid 3.5% real GDP growth rate reported for Q3 wasn’t enough to appease the doomsayers. They say inventories boosted growth and that can’t last. Plus, they say, business investment was soft.

What the pessimists miss is that the surge in inventories in Q3 was a rebound from the unusual outright decline in Q2. Inventories subtracted 1.2 percentage points from real GDP growth in Q2 and then added 2.1 points in Q3. This was close to a mirror-image of what happened with net exports, which added 1.2 points in Q2 and then subtracted 1.8 in Q3.

Yes, real business investment grew at only a 0.8% annual rate in Q3, but we’ve had tepid quarters before, including as recently as the end of 2016, without signaling an impending recession. And don’t be surprised if the recent figures get revised up in the next two months.

Meanwhile, evidence keeps building that something happened in 2017 that changed the nature of the economic recovery. “Potential” GDP growth continues to accelerate.

Potential growth is a term economists use to mean how fast the economy would grow if the jobless rate remains steady. We calculate it by using “Okun’s Law,” which says that for every 1% per year the economy grows faster than its potential rate, the jobless rate will drop by 0.5 points.

Working backward from the unemployment declines of recent years shows that potential GDP growth has picked up. From mid-2010 thru mid-2017, potential real GDP grew at just a 0.6% annual rate. But, since then, potential GDP has risen to a 2.2% annual rate. (It was 2.0% when we wrote about this topic three months ago.)

Faster potential growth undermines the Keynesian argument that it’s just a demand-side boost from bigger budget deficits. What makes more sense is that reductions in tax rates and full expensing of business investments for tax purposes have enhanced incentives while less regulation encouraged business activity.

Right now, the biggest threat is the path of government spending, which shows no sign of slowing. If unaddressed, higher spending and unreformed entitlements (Medicare, Medicaid, and Social Security) may eventually convince entrepreneurs and investors that taxes will go up in the future, which could limit the economic benefits of last year’s tax cuts.

And, while we are honest enough to admit that, we also think investors should not focus on that eventuality. Profits are rising and will likely continue to rise for at least the next 18 months. Moreover, if spending does undermine growth, it won’t happen for years. The recent turmoil in markets is another buying opportunity.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist

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Robust Growth Continues

October 23, 2018

Economic growth continued at a robust rate in the third quarter, supporting the case for both a continued bull market in stocks and further rate hikes from the Fed.

While we might make minor adjustments when we get Thursday’s data on durable goods, international trade, and inventories, right now our model forecasts real GDP expanded at a 3.6% annual rate in Q3. If so, the real economy grew at a 3.1% pace in the past year, a roughly 50% acceleration from the 2.1% growth rate that defined the Plow Horse Economy from mid-2009 through early 2017. It’s clear that cutting tax rates and slashing red tape have boosted economic growth. And there is room to run. We don’t see a recession coming for at least the next two years, and potentially much longer.

But that won’t stop the pessimists, who are likely to assert that inventories artificially boosted Q3 growth. Yes, it’s true that the pace of inventory accumulation was fast, but that simply makes up for the unusually large drop in inventories in the second quarter. A similar story holds true for net exports, which will be an unusually large drag on growth in Q3 after pushing growth higher in Q2. In other words, inventories and trade are just swapping the roles they played in Q2.

Here’s how we get to our 3.6% real growth forecast:

Consumption: Automakers reported car and light truck sales declined at a 4.8% annual rate in Q3. Meanwhile, “real” (inflation-adjusted) retail sales outside the auto sector grew at a 4.4% annual rate. Most consumer spending is on services, however, and real service spending looks like it climbed at about a 3.0% annual rate. Putting it all together, it looks like real personal consumption (goods and services combined), grew at a 3.1% annual rate, contributing 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: Another quarter of solid growth in business investment, with our estimates showing equipment growing at an 8.5% annual rate, commercial construction growing at a 3% rate, and intellectual property growing at a 4.5% pace. That would mean total business investment grew at a 6.0% rate in Q3, which should add 0.8 points to real GDP growth. (6.0 times the 14% business investment share of GDP equals 0.8).

Home Building: Residential construction slowed in Q3, although we think the home building recovery that started back in 2011 will revive in the quarters ahead. For now, it looks like real residential construction declined at a 2.6% annual rate in Q3, which would subtract 0.1 point from the real GDP growth rate. (-2.6 times the residential investment share of GDP, which is 4%, equals -0.1).

Government: Public construction projects soared in Q3 while military spending slowed modestly. As a result, it looks like real government purchases rose at a 1.2% annual rate, which would add 0.2 points to the real GDP growth rate. (1.2 times the government purchase share of GDP, which is 17%, equals 0.2).

Trade: At this point, we only have trade data through August. Based on what we’ve seen so far, net exports should subtract 1.8 points from the real GDP growth rate. However, an advance glimpse at September trade figures arrives Thursday, which could shift this key estimate.

Inventories: We’re also working with incomplete figures on inventories. But what we do have suggests companies accumulated inventories at a rapid clip in Q3, making up for last quarter’s reductions. This should add 2.4 points to the real GDP growth rate.

Add it all up, and we get 3.6% annualized growth. Not every quarter is going to be as fast as the last two – remember, real GDP grew at a 4.2% annual rate in Q2 – but we still expect an average growth rate of 3%+ for both 2018 and 2019. More growth, in turn, means higher profits, which should help send the stock market higher as well.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist

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Heartburn, Not a Heart Attack

October 18, 2018

Not long ago, many investors were kicking themselves for not investing more when the stock market was cheaper. But when stocks fall, like they did last week, many investors have a hard time buying for fear stocks may go lower still.

Who knows, maybe they’re right. We have no idea where stocks will close today, nor at the end of the week. Corrections (both small and large) happen from time to time. In hindsight, many claim they knew it was coming, but we don’t know anyone who has successfully traded corrections on a consistent basis – we certainly won’t try.

We’re also skeptical when analysts try to attribute corrections to a particular cause. It’s a basic logical flaw: post hoc ergo propter hoc. Because the correction happened after a certain event, that event must have been the cause. But important news and economic events happen all the time. Sometimes the market goes up afterward, sometimes down, and similar events at different times have no discernible impact.

Now some are blaming the Federal Reserve, and specifically statements from Chairman Powell, for the recent downdraft in equities. But, according to futures markets, the outlook for monetary policy has barely changed. The markets are still pricing in a path of gradual rate hikes and continued reduction in the size of the Fed’s balance sheet.

Let’s face it, fretting over the Fed is as old as the Fed itself. In recent years alone, we faced the “Taper Tantrum” and calls for a fourth round of quantitative easing. And remember when the Fed first raised rates and then announced it would reduce its balance sheet? Each time, analysts predicted the apocalypse was upon us – that a recession and bear market were right around the corner. How did those calls pan out?

Exactly, they were wrong, and this time looks no different. QE never lifted stocks, taking it away won’t hurt; and interest rates are still well below neutral. The biggest pain has been felt by those who followed the false prophets of doom.

The odds of a recession happening anytime soon remain remote, we put them at 10%, or less. And a recession is what it would take for us to expect a full-blown bear market. In other words, the current downdraft is just heartburn, not a heart attack.

We’ll publish a piece next week about our exact forecast for economic growth in Q3, but it looks like real GDP rose at about a 4.0% annual rate. Profits are hitting record highs and businesses are still adapting to the improved incentives of lower tax rates and full tax expensing for business equipment. Home building is still well below the pace required to meet population growth and scrappage (roughly 1.5 million units per year). Household debts are low relative to assets and debt service payments are low relative to income. These are not the ingredients for a recession.

That’s why we love Jerome Powell’s response to the recent gyrations in the market. Many pundits were calling for him to back off his tightening and his “hawkish” language, but he didn’t take the bait. He’s focused on monetary policy, and the economy and won’t be pushed around by hysterics or market gyrations. The S&P 500 fell about 6% from its intraday all-time high to Friday’s close. This isn’t earth-shattering, and the Fed shouldn’t respond. Investors need to stop obsessing about the Fed. Instead, they should focus on entrepreneurship and profits. The fundamentals are what matter.

Meanwhile, some investors are concerned about President Trump tweeting or speaking out on the Fed and monetary policy. If this were any other president, we’d be concerned, as well. But we all know Trump isn’t the kind of president to hold his opinions close to the vest on any topic. If he thinks it, he says it. Please take his comments on the Fed in that context. That certainly seems to be what Jerome Powell is doing.

The bull market in equities that started in March 2009 isn’t going to last forever. But we don’t see anything that’s going to bring it to a screeching halt anytime soon.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist

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Powell Moves Markets

October 10, 2018

Federal Reserve Board Chairman, Jerome Powell, who has been remarkably quiet as he adjusts to his new role at the Fed, finally roiled markets last week. He made comments on Wednesday, during the Atlantic Festival at a session moderated by Judy Woodruff of the PBS News Hour.

Powell said, “The really extremely accommodative low interest rates that we needed when the economy was quite weak, we don’t need those anymore.”

He added, “(I)nterest rates are still accommodative, but we’re gradually moving to a place where they will be neutral. We may go past neutral, but we’re a long way from neutral at this point.” [Our emphasis added.]

The reaction of the markets was swift and dramatic. The 10-year Treasury note rose from 3.06% on Tuesday to 3.23% on Friday, its highest yield since 2011. From their intraday highs on Wednesday to Friday’s close, the Dow Jones Industrial Average fell 1.8%, the S&P 500 fell 1.8%, and the NASDAQ Composite fell 3.3%.

To begin with, we agree completely with Mr. Powell. There are a number of models that purport to measure a “neutral” interest rate – a federal funds rate which does not hurt growth, but also does not lift inflation. Rates above neutral hurt the economy, rates below neutral lift inflation.

One model is the “Taylor Rule,” which is based on setting separate targets for real GDP growth and inflation and then adjusting short-term interest rates when these data deviate from the targets. For example, if inflation and economic growth are above the target, then the “neutral” rate should move higher. If the economy or inflation fall, then so should the neutral rate. There are multiple versions of the Taylor Rule and right now these versions suggest a neutral federal funds rate somewhere between 3% and 5%.

While we very much like a rule-based monetary policy, and think the Taylor Rule is a fine rule, we try to simplify things even more. We think the growth rate of nominal GDP (real growth plus inflation) is the best target. Nominal GDP (or total spending in the economy) is a measure of the average growth rate of all business plus government. When interest rates are below this average growth rate there’s an incentive for business to borrow even for projects that return less than average. This can cause distortions in the market. When rates are above this average, it can shut down activity.

Our model uses a two-year moving average of nominal GDP growth to avoid the volatility of shorter time frames. In the past, when the Fed has lifted the federal funds rate above two-year nominal GDP growth, recessions have occurred. It happened in 1969, 1973-74, twice in the early 1980s, 1990-91, 2000-01, and 2007-08.

Right now, nominal GDP growth over the past two years has been 4.6%. Looking back, a federal funds rate of roughly 50 to 75 basis points below nominal GDP growth is roughly neutral. As a result, we currently estimate a neutral rate around 4%. Moreover, we believe real GDP will keep growing at least 3% annually, while inflation continues to rise by 2% or more. In other words, the “neutral” rate is rising. And likely moving toward 4.5%.

This is why we agree with Chairman Powell. At the same time, we think the stock market has over-reacted, while the bond market is finally bowing to the reality that longer-term rates are heading much higher.

We have never believed that long-term rates were being held down by recent slow growth or low foreign rates. We believe they have been held down by the Fed’s policy of low short term rates and the market belief that the Fed would hold them low. That has now changed.

And, yes, higher interest rates do reduce the fair value of equities. But even with current earnings, it would take a 3.7% 10-year yield to make current equity values “fair.” With earnings likely to grow 20%+ this year and 10%+ next year, the market can handle higher interest rates and continue to rise. Higher rates are coming, but that doesn’t mark the end of the recovery or the bull market.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist

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No Looming Recession

October 3, 2018

As far as Harvard economist Martin Feldstein is concerned, we’re all doomed.

Feldstein says that the low interest rates of the last several years have created a stock market bubble rivaling the housing bubble that precipitated the last crisis. As interest rates keep rising, he says, the stock market bubble will eventually burst, sending the economy into another “long and deep downturn.” But, unlike in the prior recession, with interest rates still relatively low, the Federal Reserve will have less room to respond to a weaker economy.

We have to admit to feeling a little awkward disagreeing so strongly with Feldstein. He’s been a long-time advocate of lower tax rates and less government spending, policy positions near and dear to our hearts.

But, when it comes to forecasting what the economy will do in the next few years, we think he’s laid an egg.

Why? Let’s start by looking back. We like to assess fair value in residential housing by comparing the asset value of owner-occupied homes to the annualized rent these homes could earn. Using historical averages, our calculations suggest home prices were about 40% above fair value at the end of 2005. With US homes valued at about $21 trillion, that meant an overvaluation of about $6 trillion. (Note: When an asset is priced 40% too high, it takes a loss of 28.6% from the overvalued level to bring the price down to fair value.) For perspective, GDP was $13 trillion that year.

By contrast, the stock market is not even close to that kind of overvaluation. At present, the price-to earnings ratio on the S&P 500 is 22.3. The average in the past 40 years is 20.2. So even if you accept the P-E ratio as the gospel (and we don’t), equities only appear about 10% over-valued.

Except the current P-E ratio only reflects two quarters of the tax cut so far. The forward P-E ratio is 16.9, which leaves room for a 20% rally in equities just to get back to the 40-year average of 20.2 (assuming earnings estimates are accurate.) Moreover, the average P-E ratio of 20.2 over the past 40 years was established when the yield on the 10-year Treasury Note was averaging 6.26%, not the 3.06% it’s at today. In other words, bonds were a much more attractive alternative to equities in the past than they are today.

The basic problem with all this is that if you want to sound smart – and if you want media attention – it’s better to be a pessimist. Warn people about impending doom and they hang on every word. And let’s be honest, telling people the bull market has room to roam is not the best way to get published.

We’re sure the economy will eventually face another recession. It may even be a deep one, although our best bet is that the next recession will be mild compared to the last. When it happens, the pessimists will tell you how they got it right all along. But getting it right, briefly, at least a few years from now is not worth losing out on the gains to be made in the meantime. Those who stay long equities will be rewarded.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist

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Previewing the Fed

September 25, 2018

The Federal Reserve meets on Wednesday and there’s one thing we know for sure: it’s going to raise rates by another 25 basis points, lifting the federal funds rate to a range from 2.00 to 2.25%.

Why are we so confident? Two reasons. First, the market in federal funds futures is putting the odds of a September rate hike at 99%. For the Fed to let those odds get so high without pushing back forcefully with speeches and leaks to friendly reporters means the Fed is fully on board.

Second, and much more important, it’s the right thing to do. Nominal GDP – real GDP growth plus inflation – is up 5.4% in the past year and up at a 4.6% annual rate in the past two years. An economy growing at that pace calls for higher short-term rates.

But the meeting is not only about changing the level of short-term rates; it’s also about signaling the path of future rate hikes as well as the continued reduction in the size of the Fed’s balance sheet, which became bloated during and after the financial crisis a decade ago.

Back in June, the last time the Fed issued economic projections, it forecast that real GDP would be up 2.8% this year and 2.4% next year. But, given the momentum in the economy, we think the Fed may lift these forecasts. It may also want to reconsider its projections for inflation now that its favorite measure of inflation – the PCE deflator – is already up 2.3% from a year ago

In turn, that should translate into a more aggressive “dot plot,” as well. In June, the consensus at the Fed – the “median dot” – showed a total of four rate hikes this year, with one more hike in September and a last one in December. But almost half of the voters at the Fed had the Fed stopping at the third rate hike this year or maybe even stopping at two in June. That’s going to change substantially on Wednesday and we expect a large majority at the Fed projecting a fourth rate hike in December.

Our best guess is that the median dot will still show three rate hikes in 2019, but that may change in December, by which time the Commerce Department will have reported strong real GDP growth for the third quarter.

In the end, we expect four more rate hikes in 2019. That would take the federal funds rate to a range of 3.25 to 3.5%. Right now, that’s not what the market expects. The market is putting the odds of four rate hikes or more next year at 5%. As the economy continues to impress, look for those odds to soar over the next several months. In turn, that means long-term Treasury yields keep trending higher, as well.

The Fed may also consider using Wednesday’s meeting to change some wording that’s been in every Fed statement since December 2015, which was the first time the Fed raised rates after the financial crisis. The language is “The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.”

Some at the Fed may think Wednesday’s rate hike means monetary policy is no longer accommodative. That would be a mistake. But others may want to rightly change the wording because inflation already exceeds 2%. As a result, the Fed needs to start considering how tight it may eventually have to get to keep inflation from staying above 2%.

Just remember, though, that nothing the Fed does on Wednesday is worthy of obsession. Just because the financial media dwells on every word from the Fed, doesn’t mean investors should. Instead, focus on profits, which, continue to point to a robust bull market.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist

Approved For Public Use

The Growing Deficit

September 19, 2018

The U.S. federal government reported last week that it ran a deficit of $214 billion in August, the fifth largest deficit for any single month in US history.

The Congressional Budget Office thinks these numbers are consistent with a budget deficit of about $800 billion for Fiscal Year 2018, which ends September 30. If so, that would be the largest annual deficit in raw dollar terms since FY 2012. This deficit is roughly 4.0% of GDP, which would be the highest since FY 2013.

For many, this growing deficit is a dagger to the heart of the tax cut enacted in late 2017. They say the tax cut was irresponsible. However, economic growth has picked up because of the tax cut, and growth is the key to higher fiscal receipts down the road – in fact tax receipts are still hitting record highs.

Between 2010 and 2017, the U.S. passed two large tax hikes, yet the deficit was still $665 billion in FY 2017, which was not exactly a model of fiscal purity. As a result, we call “politics” on all those now fretting about deficit spending only when a tax cut is involved.

It’s important to recognize that the tax cut has, so far, reduced revenue compared to how much the federal government would have collected in the absence of the tax cut. But, total federal receipts are likely to end the current Fiscal Year up slightly from last year and at a record high. Next year, according to the CBO, revenue should be up 4.6% and at another record high.

In other words, the tax cut didn’t lead to an outright reduction in revenue, it just slowed the growth of revenue.

Spending is the problem. Total federal spending will rise about 4% this year and is scheduled to rise about 8% next year. In spite of an acceleration in economic growth, government spending is rising faster than GDP.

While this is a long-term problem, it will not turn the U.S. into Greece overnight. No fiscal crisis for the nation is at hand. Last year, net interest on the federal debt amounted to 1.4% of GDP. The Congressional Budget Office projects that net interest will hit 2.9% of GDP before some of the tax cuts theoretically expire in the middle of the next decade.

That is a large increase, but net interest relative to GDP hovered between 2.5% and 3.2% from 1982 through 1998. The U.S. paid this price and the economy still grew more rapidly than it has in the past decade. The U.S. didn’t become Greece.

Compare two economies of equal size. One spends $500 billion, but with zero taxes, the other spends $2 trillion, but taxes $1.5 trillion. Both have $500 billion deficits, but the first economy would be more vibrant and could finance the debt more easily. It’s not that deficits don’t matter, but deficits alone are not a reason for investors to run for the hills.

And when deficits are partly caused by more federal spending on interest payments you know who will hate it the most? The politicians.

Here’s why. Politicians like to deliver things their constituents are grateful for, things that make voters more likely to vote for them rather than someone else. Tax cuts help politicians get more votes, at least from those who actually pay taxes. Government programs can also help incumbents corral votes. Pass out government checks and you can get more votes, too. But bondholders have no gratitude for politicians when they receive the interest they’re owed on Treasury securities.

Higher net interest payments will eventually “crowd out” future tax cuts and government programs, making it tougher for incumbents to get re-elected. As net interest payments rise, more politicians will start obsessing about the deficit again, just like in the 1980s and 1990s.

The true threat to long-term fiscal health is spending. If left unreformed, entitlement programs like Social Security, Medicare, and Medicaid will take a ceaselessly higher share of GDP, leading to a larger and larger share of American production being allocated according to political gamesmanship rather than individual initiative, in turn eroding the character of the American people.

Unless we change the path of spending, last year’s tax cuts – and the boost to economic growth they’ve already provided – risk getting overwhelmed in the long run. But, for investors, this isn’t an immediate problem. After all, deficit fears have been around for decades and equities still rose. Stay bullish, for now.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist

Approved For Public Use

Wage Growth Steps Up

September 12, 2018

Friday’s jobs report finally included what appears to be evidence of the long-awaited acceleration in wage growth.

Average hourly earnings grew 0.4% in August, which meant they were up 2.9% from a year ago, the largest 12-month increase since the economic recovery started in mid-2009. By contrast, these wages were up 2.6% in the 12-months ending in August 2017. Moreover, this measure of wages doesn’t include extra earnings from irregular bonuses and commissions, like those paid out since the tax cut was passed late last year.

Total wages, which factors in both average hourly earnings as well as the total number of hours worked, are up 5.1% in the past year, meaning consumers have plenty of earnings to keep increasing spending.

Nonetheless, many still argue that the 2018 corporate tax cut didn’t help workers. Nothing could be further from the truth. In December 2017, figures on average weekly earnings as well as private payrolls suggested private-sector workers were earning wages at a $6.0 trillion annual rate. In August, those total wages had increased to a $6.2 trillion annual rate – a boost of $200 billion per year. By contrast, corporate profits – which have also grown rapidly – were up by just $100 billion annualized from the end of 2017 through the second quarter. Workers have taken home two times more than companies!

When hit with this data, the anti-tax cutters argue that this increase in wages has been concentrated at the top of the pay-scale. The rich are getting richer and the tax cuts haven’t helped lower to middle income workers. Guess what? This isn’t true, either.

Usual earnings for the median full-time wage & salary worker grew 2.0% in the year ending in the second quarter this year. But these earnings grew 3.9% for workers at the bottom 10th percentile, while workers at the top 10th percentile had their usual earnings grow only 1.2%. Usual earnings for people who never finished high school are up 7.6% in the past year, faster growth than for any other educational category.

Put it all together and we have a labor market that is already tight and set to get tighter. Back in June, the Federal Reserve projected an average unemployment rate of 3.6% in the fourth quarter of this year and 3.5% in the fourth quarter of 2019 and 2020. The projection for this year sounds about right, but we’re forecasting a jobless rate of 3.2% by the end of 2019 and 3.0% in 2020. Either way, wages are likely to keep growing at an accelerating pace in the next few years.

That means the Fed will likely remain more aggressive with their rate hikes than the market is now projecting, but don’t fret. Even with our more aggressive forecasted path of two more 25 bps rate hikes this year and four next year, the Fed will still not be “tight.”

Tax cuts and deregulation have turned the Plow Horse Economy into a Kevlar Economy for the foreseeable future. And if we get trade deals that reduce tariffs along with some real focus on limiting government spending, the strength of this economy could make Superman jealous.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist

Approved For Public Use

The Week Ahead

September 6, 2018

In spite of woeful prognostications to the contrary, the US economy seems to be wearing Kevlar. Rate hikes, tariffs, Turkey, you name the fear, the economy remains unscathed. Case in point, through all the supposed turmoil, the U.S. grew at a 4.2% annual rate in the second quarter and looks set for a similar pace in Q3.

We get a boatload of economic data this week, including the ISM indexes for both manufacturing and services, as well as data on construction, auto sales, and, of course, Friday’s employment report. While we expect the data to continue painting a picture of robust economic growth, data are, as we all know, volatile.

While today’s ISM Manufacturing report was white-hot – the highest so far this expansion – we also expect gains in the Services index later this week, and car and light truck sales to be so-so, clocking in at a 16.8 million annual pace in August versus a 17.3 million pace in the past year.

The one piece of data we think could disappoint is the headline employment number out Friday. In recent years, August employment data have been prone to disappointment, with the initial report leading to unnecessary fears of an economic slowdown.

Back in September 2011, for example, we got a payroll report that showed zero nonfarm payroll growth for August. That’s right: a big fat goose-egg. The S&P 500 fell 2.5%. Some even talked openly of entering the long-awaited “double-dip” recession. But just two months later, the report was upgraded to 104,000. Now, after multiple annual revisions, the government says 112,000 jobs.

And 2011 wasn’t an anomaly. August payroll growth has fallen short of consensus expectations for seven years in a row. And just about every time, the pouting pundits have taken it as a bearish economic signal.

The jobless rate shows some seasonal distortions, as well. The unemployment rate finished 2009 at 9.9%. Since then it’s dropped to 3.9%, down 6.0 points, or an average of 0.06 points per month. So take any calendar month over the past 8½ years and the unemployment fell on average 0.5 points. But for August, the unemployment rate has dropped a grand total of only 0.1 point – we’re not sure why, but that’s the data.

As a result, our forecast is that payroll growth for August will be a little softer than the consensus expects (and will be revised higher in the months ahead) and the jobless rate is going to stay unchanged at 3.9%, versus consensus expectations of a drop to 3.8%.

The key thing to remember is that if we’re right – and, obviously, we hope the report is better than we expect! – you shouldn’t get caught up in any pessimistic story you hear from the doomsayers. For the time being, the US has strengthened from a Plow Horse Economy to the Kevlar Economy, and none of these reports are likely to change that one iota.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist

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