Yes, There Was a Housing Bubble, But Not Now

February 24, 2020

One of the worst bipartisan policy decisions in the past generation was the aggressive government push in the 1990s and 2000s to promote homeownership, beyond what the free market could handle.  Policymakers encouraged Fannie Mae and Freddie Mac to gobble up lots of subprime debt, in turn boosting lending to borrowers who couldn’t handle their loans.           

But now a bizarre idea is making the rounds that, looking back on it, maybe there wasn’t a housing bubble at all! 

The theory is that home prices are already up substantially from where they were at the prior peak during the “bubble,” so maybe those “bubble” prices were not that high after all.  Compared to the prior peak in 2007, the national Case-Shiller index is up 15%, while the FHFA index, which measures the prices of homes financed with conforming mortgages, is up 24%. 

But a great deal has changed since the prior peak, which makes it much easier to justify the higher prices of today.  To assess the “fair value” of homes, we use a Price-to-Rent (P/R) ratio, which compares the asset value of all owner-occupied homes (calculated by the Federal Reserve) to the “imputed” rental value of those homes (what owners could fetch for their homes if they rented them, as calculated by the Commerce Department).  Think of it like a P/E ratio: the price of all owner-occupied homes, compared to what those same homes would earn if they were rented. 

For the past 40 years, the median P/R ratio is 16.0.  At the peak of the housing bubble, the ratio hit a record-high of 21.4.  In other words, prices were 34% above fair value.  During the housing bust, the ratio plunged to 14.1, meaning national average home prices were 12% lower than you’d expect given rents.  Temporarily, that made sense: prices had to get below fair value to clear the excess inventory.                    

Today, the P/R ratio stands at 17.0, which means home prices are 6% above their long-term average relative to rents.  That’s well within the normal historical range, and no reason to sell.

Comparing home values to replacement costs shows a similar pattern.  That median ratio in the past forty years has been 1.58, compared with 1.59 today (almost exactly fair value) and 1.94 at the peak in 2005 (23% above fair value).

Either way you slice it, bubble era home prices really were far in excess of what you’d expect given rents and replacement costs, while prices today look reasonable. 

We expect home prices to keep moving higher, but not as fast as in the last few years.  Meanwhile, the climb in average home prices will diverge at the local level.  Due to the limit on state and local tax deductions, expect high tax states to show flat home prices (on average), while low-tax states experience stronger price gains.    

One of the reasons we remain optimistic about economic growth in general is the continued recovery in home building. 

Housing starts bottomed in 2009, when builders began just 554,000 homes, 73% below the 2.073 million pace at the peak of the housing boom in 2005.  Since 2010, the number of housing starts has increased in every year, hitting 1.300 million in 2019. 

Starts have been much higher in recent months due to the unusually mild winter weather throughout much of the country.  And while we may see a pullback in the coming months as weather patterns return to normal, we anticipate at least a few more years of gains in home building.  Given population growth and scrappage (knock downs, fires, floods, hurricanes, tornadoes…etc), builders have simply started too few homes since the bust.  Now it looks like they need to overshoot to make up for lost time.  In turn, expect new home sales to follow starts higher.  

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist      

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Lessons from Japan?

February 21, 2020

Thirty years ago, many in the US were in fear that a rising power in Asia was on the verge of eclipsing the US.  Now it’s China, back then it was Japan.

Back in the late 1980s Japan had become the second largest economy in the world after the US and seemed like a juggernaut that couldn’t be stopped.  Many center-left economists thought that the post-World War II experience of Japan proved that industrial policy could work, with the government picking winners and losers and making sure favored industries and companies always got the credit they needed to grow.  They were eager to bring that approach to the US. 

History, however, had other plans.  Japanese government policies bottled up capital in favored industries and pulled it away from widespread entrepreneurship.  This meant the massive savings generated by Japanese workers were misallocated into a limited pool of domestic assets, with capital gains tax rates that favored listed stocks and drove up real estate prices.  The result was dual massive bubbles, with stocks far more overvalued than US stocks were in 2000 while Japanese real estate was far more overvalued than the US was in 2005.  As a sign of how large that bubble was, the Nikkei is still about 40% below the high set in 1989. 

That peak in asset prices also coincided with a dramatic slowdown in economic growth that has lasted thirty years.  To put an exclamation point on that, Japanese real GDP fell at a 6.3% annual rate in the fourth quarter of 2019.  This was before any impact from the coronavirus and the largest quarterly decline in six years.  While pandemics are serious and scary, the real cause of the drop was a national sales tax hike from 8% to 10%.  Real GDP is now down 0.4% from a year ago.

It’s deja vu.  Japan keeps trying over and over again to boost economic growth with government policy – a combination of high government spending, high budget deficits, high taxes, quantitative easing, and, beginning in 2016, negative interest rates.  Sounds exactly like what policymakers in Europe have tried, but more of it and for longer.

None of this has worked, and it won’t work in the US, either.  Not now, and not if we eventually go into a recession, which, thankfully we don’t foresee anytime soon. 

In contrast to Japan, the US has lower taxes, lower (but still too high) government spending, a central bank that maintains positive short-term interest rates, and a much healthier economy, with equities at or near record highs while the jobless rate heads toward what could be the lowest unemployment rate since the Korean War.  

Instead of more of the same, we think Japan would benefit from shifting the mix of policies toward the supply-side, with big tax cuts on business investment and profits, and ending negative interest rates like Sweden just did.  And, given a falling population, this could be coupled with much larger tax deductions for parents.

Meanwhile, instead of raising the sales tax, with long-term interest rates at essentially zero, Japan should take a page from Great Britain’s history and convert their debt into “perpetual” securities (called “consols”), paying whatever interest rate the market demands (near zero!) but without the need to repay principal.

Don’t hold your breath waiting for this kind of policy shift.  Instead, Japan looks poised to continue to muddle through continuing to believe that government can manage economic growth and not trusting entrepreneurs and freedom.  Unless Japan starts trusting supply-side policies instead of demand-side fallacies, they will continue to be doomed to make the same mistakes.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist     

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Jobs, Coronavirus, and the Budget

February 13, 2020

In January, US payrolls expanded by 225,000, not only beating the consensus forecast, but also forecasts from every single economics group.  Since January 2019 (12 months ago), both payrolls and civilian employment – an alternative measure of jobs that includes small-business start-ups – are up 2.1 million.  The labor force – those who are either working or looking for work – is up 1.5 million, while the jobless rate fell to 3.6% from the 4.0%.

The labor force participation rate (the share of adults who are either working or looking for work) increased to 63.4% in January, the highest reading since early 2013.  Participation among “prime-age” adults (25 to 54) hit 83.1%, the highest since the Lehman Brothers bankruptcy in 2008.   

Meanwhile initial claims for unemployment insurance hit 202,000 in the last week of January, and initial claims as a percent of all jobs are at the lowest level ever.  In other words, the job market and the economy look strong.

Only a few months ago, some analysts were saying that the inversion of the yield curve – with short-term interest rates above long-term rates – was signaling the front edge of a US recession.  Now a recession seems nowhere in sight.

Lately, financial markets have become very jumpy on any news – good or bad – regarding the coronavirus.  We aren’t immunologists (or doctors) and would never make light of a virus that has killed more than 900 and infected over 40,000, but data released by the World Health Organization (WHO) cautiously suggests a positive turning point has been reached.

So far, the virus has had minimal impact outside of China, and the growth rate of new cases worldwide has slowed.  Yes, these numbers must be taken with a grain of salt, given that the news is coming from China.  But China’s leaders have an interest in limiting the spread of the virus and the economic damage it causes, and they have allowed the WHO access.

China’s President Xi Jinping has been able to accumulate more power than any leader since at least Deng Xiaoping, perhaps since Mao.  We assume he is well aware that a major failure to contain the virus could give his political opponents an opening to vent their frustration with the current leadership, and perhaps push for change.

It’s true that the Chinese economy has slowed precipitously, and this is affecting many companies’ sales and production.  However, we do not believe that this will damage global growth in a significant way, and the US stock market suggests that global investors agree.

Meanwhile President Trump is presenting his budget plans to Congress this week, and early reports suggest some proposals to rein in entitlement spending.  We wouldn’t hold our breath waiting for these policies to get implemented.  No matter who controls Congress, the one bi-partisan thing DC is able to do is spend more taxpayer money.  And even with a slowdown in spending growth for entitlements, the President’s budget proposal still won’t balance the budget until 2035.

To be clear, we do not think deficits are the proper tool to use for economic forecasting.  What matters is spending, and federal spending has grown to be too large a share of US GDP.  The bigger the government, the smaller the private sector.

In 1983, according to the OMB, federal spending was 22.9% of GDP.  In 1999, under President Clinton, it had fallen to 18%, and from 1983 through 1999, real GDP grew 3.7% at an annual rate.  This trend was reversed with government spending rising to 21.1% of GDP in 2019, and from 2002 to 2019, real GDP grew just 2.1% annualized.  Bigger government leads to slower growth.

Taking all of this together, no recession on the horizon and improving news about the coronavirus suggests corporate profits will continue to grow in spite of moderate growth.  Stay bullish! 

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist           

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No Need for Fed Rescue

February 4, 2020

Fears about the coronavirus knocked down equities last week, while a flight to safety brought the yield on the 10-year Treasury down to 1.51% at the Friday close versus 1.69% the week prior and 1.92% at the end of 2019.

The consensus in the futures market is that the Federal Reserve will cut the federal funds rate by 50 basis points this year.

We think that is ridiculous.  The economy doesn’t need rate cuts.  Rate cuts won’t fight uncertainty, and certainly won’t stop a virus.

Last Thursday’s GDP report showed that the economy grew at a 2.1% annual rate in the fourth quarter, in spite of an unusually large slowdown in the pace of inventory accumulation.  Real GDP was up 2.3% versus a year ago.  This morning, the January ISM manufacturing index rose back into expansionary territory, suggesting that the recovery is on solid footing. Auto sales, too, look healthy, and our early read on Friday’s jobs report is that nonfarm payrolls will be up a respectable 165,000.

We repeat, none of these data suggest a need for rate cuts.  Investors – as well as the Fed – need to realize that rate cuts aren’t going to “fix” economic growth.

Europe went to negative interest rates and more QE, and not only did economic growth fall behind the US, but so did stock market returns.  From October 2015 through September 2019 the Fed shrank its balance sheet while the European Central Bank became even more accommodative.  What happened? The S&P 500 rose 55% over that period while the Euro Stoxx 50 was up just 16%.  In other words, it’s clear that negative rates and more QE don’t help the economy create growth!

While we doubt politicians and the Fed actually understand that reality, we do think worries about global growth will subside and the Fed will most likely keep the stance of monetary policy steady, with neither rate hikes nor rate cuts, while it gradually lifts the size of the balance sheet like it did (but didn’t need to) late last year.

That said, it is not the Fed that will drive stocks in the year ahead, but profits, which continue to grow. US equities looked cheap to us a month ago, and higher profits have them looking even cheaper today.  It’s another great buying opportunity.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist    

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Look for Steadiness from the Fed

January 28, 2020

The Federal Reserve is set to make its first policy statement of the year on Wednesday, so this is as good a time as any to reiterate our view that the Fed is likely to keep short-term interest rates steady through 2020 and, while pressures will build, the Fed seems content to hold them steady next year, as well.

We still think monetary policy is far from tight, and the economy could easily withstand higher short-term rates.  Nominal GDP – real GDP growth plus inflation – is up 3.8% from a year ago, and up at a 4.8% annual rate in the past two years, figures consistent with higher short-term rates. 

But the Fed is very unlikely to raise rates given its fear of an inverted yield curve, its desire to see a period of inflation in excess of 2.0%, and its propensity to always find something going on elsewhere in the world that could, at least theoretically, lead to slower growth.  Last year it was political wrangling over Brexit, fears of a trade war with China, and slower growth abroad.  This year it could be Brexit again, and perhaps the coronavirus coming from China.            

Meanwhile, with equities so much higher than a year ago and the economy growing at a moderate pace, the Fed will lack a justification for cutting rates.

In the background, the Fed is likely to continue to gradually increase the size of its balance sheet via repurchase operations after having (temporarily) ended Quantitative Easing in October 2014 and reducing the balance sheet (Quantitative Tightening) starting in late 2015.  The Fed restarted QE (without calling it that) near the end of last year, but even with the recent increases, the balance sheet finished 2019 at $4.13 trillion, still below the $4.45 trillion it hit during QE3. 

And yet the S&P 500 is up 66% since the end of QE.  By contrast, the Euro STOXX 50 is up only 25%. 

What makes this so important is that it flies in the face of the theory that QE is behind the increase in equity prices.  While the Fed pulled back, the European Central Bank continued expanding its balance sheet and even implemented negative interest rates in an attempt to stimulate the Eurozone economy.  If QE and negative rates were so powerful, it should be US equities that lagged, not European equities.

It also suggests the Fed doesn’t need to be gradually expanding its balance sheet again.  There were still $1.49 trillion in excess reserves in the financial system at the end of 2019, and the banking system is far better capitalized than it was before the financial crisis.

When short term interest rates started periodically spiking upward in mid-September, the Fed had three possible courses of action.  First, it could have let the free market work.  No banks were going bust because of a temporary lack of liquidity; it just meant those in need of liquidity had to pay a high price so they wouldn’t run afoul of tough financial regulations. Maybe some financial institutions needed to unwind positions that ate up cash.  

Second, the government could have adjusted the very stringent liquidity regulations put in place after the financial crisis. These rules lead to temporary shortages of reserves when companies remove deposits to make large tax payments, participate in large Treasury auctions, or, when hedge funds attempt to borrow more money from banks.  Loosening the rules would have quickly made more cash available!

Or third, the Fed could decide to start increasing its balance sheet again because that would increase its power.

Of course, the Fed picked Door #3.  In the end, it behaved in just as self-interested a way as people do in the private sector.  Except policymakers are doing it with other people’s money, not their own. We don’t agree with more QE, but the Fed will not get in the way of a continued economic recovery.          

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist                                

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Blame the Overweight Jockey

January 7, 2020

The longest economic recovery on record continues, with January being the 128th consecutive month of growth.  The first seven years, from mid-2009 through 2016 saw average real GDP growth of 2.2%.  Since the start of 2017, US real GDP growth accelerated, to an average annual growth rate of 2.6%, while the unemployment rate now stands at the lowest level in 50 years (and is likely headed lower).

We attribute the acceleration to a combination of better regulatory policy and lower tax rates.  These changes reduced impediments to growth, kind of like putting a lighter jockey on the horse.  Steps forward for sure, but it could be better.  The US grew at a 3.1% annual rate during the 1980s and a 3.4% rate in 1990s, both decades that saw recessions.

What gives?  The US has not grown more than 3.0% for any calendar year (Q4/Q4) since 2005.  Larry Summers, former Treasury Secretary, former head of the National Economic Council, and a possible Fed chief if the Democrats take the White House, says it’s “secular stagnation.”  Summers thinks the US and other economies are in a long-term funk because of slower population growth, more inequality and low investment – which in economic terms means a shortage of demand.

The best way to address this, according to the secular stagnationistas, is to keep monetary policy loose and run large budget deficits.  So, Summers was OK with the Fed’s cuts in short-term interest rates in 2019, and, although he opposed the Trump tax cuts, he has not loudly opposed budget deficits.  Those who claim we’re in secular stagnation support more government spending on things like infrastructure, for example.

To sum it all up, secular stagnation theory means we should inject the economic horse with government-provided steroids.

An alternate theory comes from economists Carmen Reinhart and Kenneth Rogoff, who, in their book “This Time is Different,” argue that, after financial crises (such as 2008-09), economies grow slower.  But here we are 11 years later, with consumer and corporate balance sheets in much better shape, and inflation and growth have still not returned to normal.  The economic effects of the financial crisis should be past us by now.

We never believed this theory and to see it fail isn’t a surprise.  After all, the S&L crisis, Latin and South American debt defaults, and oil and ag bank problems, hit in the 1980s.  In fact, adding up all the losses (and bank failures) from that period shows it to be worse than the 2008 crisis.  But Reinhart and Rogoff ignored it because it didn’t fit their theory – the economy grew rapidly in the 1980s.

The reason their model didn’t work in the 1980s is because, contrary to other crises, President Reagan’s administration did not respond with massive increases in spending, regulation and easy money.  Rather, the US cut tax rates, regulation, and non-defense spending, while running a tight money policy.

The economic horse accelerated, not by jacking it up with steroids, but by making the jockey (the size of government it must carry) lighter.

Looking at it this way explains slow growth in the past decade.  Federal spending (excluding national defense and net interest) averaged 13.3% of GDP in both the 1980s and the 1990s.  But in the 2000s, it averaged 14.2% of GDP and in the 2010s it averaged 16.2%.  Every one of the additional dollars the government spent sucked resources out of the private sector, allocating them the way politicians wanted, rather than through voluntary private exchange.  That made the economy less efficient and less able to grow.

In other words, the jockey got fat and weighed down the horse.  If they truly want faster growth, policymakers need to focus on slimming down the government, not growing it under the guise of boosting “aggregate demand.”  Tax cuts and regulatory relief help.  More spending, more bank regulation and negative interest rates have failed to produce results.  If we want 3-4% real growth in the future, spending restraint is the answer.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist 

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Good News is Good News

December 12, 2019

A year ago, conventional wisdom became convinced that a stock market correction was really the beginning of a “bear market,” and a sure sign that recession was on its way.  Oops.  Conventional wisdom was wrong again.

The Pouting Pundits still talk about ISM surveys being weak, and fret that a trade war is brewing.  But, the S&P 500 is up 25% this year, and Friday’s report on the labor market ought to be the last nail in the coffin for the idea that the US economy is in trouble.

Nonfarm payrolls grew 266,000 in November, easily beating consensus expectations, and exceeding even the most optimistic forecast from any economics group.  Meanwhile job growth was revised up for prior months, bringing the net gain to more than 300,000.

Yes, the end of the UAW strike obviously boosted these numbers; payrolls in the manufacturing of motor vehicles and parts fell 43,000 in October and then rebounded 41,000 in November.  That net turnaround of 84,000 accounted for most of the acceleration of overall payroll growth, which went from 156,000 in October to 266,000 in November.  But the average gain in the past two months was 211,000 – very impressive.  Especially with the unemployment rate below the 4.2% rate the Fed thinks our economy can sustain.

The jobless rate dropped back down to 3.5% in November, tying the lowest level in 50 years.  The U-6 unemployment rate, which some call the “true” unemployment rate (it includes discouraged workers and those who work part-time but say they want full-time jobs), fell back down to 6.9%, tying the lowest mark since the peak of the internet boom in 2000.

Recent economic reports have also made a huge difference for fourth quarter GDP projections.  In mid-November, the highly respected Atlanta Fed’s “GDP Now” model was projecting real GDP growth at an annual rate of only 0.3% in Q4, which would have been the slowest growth for any quarter since 2015.

The GDP Now model is a solid model, but we surmised at the time that it was putting way too much weight on the ISM Manufacturing reports, which were being held down by negative sentiment about the economy rather than a slowdown in the actual pace of growth.  Instead, we stuck to our view that the economy was growing at about a 3.0% pace in Q4.

We still have plenty of economic reports to go before we see the first official glimpse on Q4 real GDP at the end of January.  But the most recent run of the Atlanta Fed’s model now says 2.0%, not 0.3%.  Getting closer!

It’s no wonder that the stock market liked what it saw on Friday, a robust job market and healthy economy, and lifted the S&P 500 to its second highest close on record, just off the November 27 all-time high.  Only sixteen trading days remain this year (including today) and, as of Friday’s close, the S&P 500 is only 3.3% off our target of 3,250 for year-end.

And it’s not hard to find the catalysts that could help it get there, like a meeting of the minds between the Trump Administration and China, or one between Speaker Pelosi and the Trump Administration on the updated version of NAFTA. Then again, even without these agreements, the US economy is still in the longest sustained period of economic growth on record, while record high corporate profits continue to support a bull market that is almost 11-years old.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist 

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Don’t Worry About the US Consumer

December 3, 2019

During the next couple of days you’re going to see lots of stories about the strength of consumer spending.  Early reports say Black Friday on-line sales hit a record high, up 14% from a year ago, following a 17% increase on Thanksgiving Day itself.  Black Friday sales at brick and mortar stores were up 4.2% from a year ago.  So much for the theory that brick and mortar is dead or the economy is in trouble.

This shouldn’t surprise anyone who’s paying attention to underlying data on workers.  The unemployment rate is hovering near a 50-year low, job growth remains robust, wage growth is solid, and wages are growing faster for low-income workers than high-income workers.  Overall, private-sector wages and salaries are up 5.2% from a year ago.   Meanwhile, we think the end of the GM strike means a sharp rebound in payroll growth in November.

In addition, consumers are in solid financial shape.  Consumer debts are the lowest relative to assets since 1984.  Household debt service relative to after-tax income is tied for the lowest on record (data go back to 1980).

However, it’s important not to let all the media attention on consumer spending distort the view of the way the economy really works.  People can’t consume something until it’s been produced.

Yes, according to conventional statistics consumer spending is 68% of GDP.  But GDP doesn’t count all economic activity; it uses the sales value of all goods and services (consumption and investment) to estimate production.

By contrast, economy-wide “gross output” includes not only business-to-consumer sales and investment but also what is not included in GDP, which is intermediate business-to-business sales, as well.  Consumer spending is only 38% of economy-wide gross output.  In other words, consumer spending is a much smaller part of total economic activity than GDP suggests.

That’s why, as much as we like to see solid numbers on consumer spending, we see this as an effect, not a cause of our bounty. The primary cause is the innovation and risk-taking of entrepreneurs.  Which is why, if you want to know when the next recession is going to start, you need to pay careful attention to the environment for innovation and risk-taking, not how much people are spending.

Yes, when the next recession comes – and we don’t see one for at least the next couple of years – consumer spending will likely falter.  But that doesn’t mean slower consumer spending caused the recession.  It’s just the natural and eventual consequence of a less healthy environment for businesses, small to large.  Less production would mean fewer workers and, in turn, less purchasing power.

So enjoy the good news you see the next couple days, but keep in mind that healthy growth in consumer spending is exactly what you should expect in an economy where tax rates are relatively low, business regulation has slowed, and monetary policy isn’t tight.  If we’re right, we should see more of the same kinds of headlines for at least the next couple of years.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist   

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Giving Thanks

November 27, 2019

What an incredible time to be alive!  We stand just five weeks from the end of a decade that saw prosperity spread far and wide.  Some don’t see it that way, as pouting pundits and rancorous politics skew our visions.  But, if we simply step back from the day to day noise and take in the magnitude of progress around us, there is a great deal to be thankful for.

For starters, the US macroeconomy – the big picture – is in solid shape.  The unemployment rate is 3.6%, just a tic above September’s 3.5% reading – the lowest since 1969.  What some people call the “true unemployment rate” (known to the Labor Department as the “U-6” rate), which includes discouraged workers and part-timers who say they want full-time work, currently stands at 7.0%, and recently touched lows not seen since the peak of the first internet boom nearly twenty years ago.

Average hourly earnings are up 3.0% from a year ago, compared to an increase in 1.8% in consumer prices.  In fact, “real” (inflation-adjusted) earnings are likely to be up again for the year, making this the seventh consecutive year of higher real wages.

Importantly, the benefit of earnings growth has been widening out.  In the past year, median usual weekly earnings for workers age 25+ with less than a high school diploma are up 9.0%.  In the year before, these wages were up 6.5%.  This is faster growth than for those with college and graduate school degrees.  Making jobs plentiful is still the best way to raise living standards.

Meanwhile, US equities have recently hit all-time highs, pushing IRAs, 401ks, pension funds, and retirement wealth higher.  Both workers and investors have good reason to be grateful.

But it’s not only the big picture that looks good.  The day-in, day-out lives of people the world over have improved because of the grit and determination of inventors and entrepreneurs.

A decade ago, how many of us had instantly ordered a car to pick us up via our phones (now more like pocket computers), and then watched its progress toward us in real time, not left to wonder when and if the car would ever show up?  How many of us could optimize our travel routes with free apps that tell us the best time of day to take the route in question, or where to turn to cut travel time?

Think about the standardization of car and truck technology that used to be reserved for the upscale, like adaptive cruise control or blind-spot warnings, even self-parking cars.  Backup cameras now come standard!

But it’s not just the day-to-day, innovation is also helping save lives in crisis situations.  This includes the 3D printing of body parts…skin cells, lungs, and soon partial livers.  Yes, livers!  We are on the cutting edge of gene therapies that are being used to treat cancer.  Cancer death rates have dropped consistently for decades, and new technology promises further improvement.

Think about the advances in energy production.  The average price of a barrel of oil (West Texas Intermediate) was $78 in November 2009, a decade ago, and that was when the jobless rate was around 10% and the global economy in the doldrums. It’s now down to $58.  Natural gas was trading around $3.70 per mmbtu, now $2.67.  Lower prices are a direct result of the combination and widespread use of horizontal drilling and fracking.  As a result, Americans can heat and cool their homes and businesses and travel for much less than they used to.

Put it all together and if we’re honest we have so much to be thankful for.   There has quite simply never, in the history of mankind, been a better time to be alive.  Our ancestors could find faults in some things in the world today, but they’d be left speechless at our abundant (and growing!) opportunity.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist 

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Long Live the Bull Market

November 22, 2019

Last December, almost 12 months ago, we set our year-end 2019 target for the S&P 500 at 3,100.  Many thought we were way too bullish, but our model for the stock market suggested 3,100 was well within reach.  We believed the bull market had plenty of room to run.

Now, with six weeks to go until year-end, the stock market has already closed above our initial target.  As of Friday, the S&P is up 24.5% year-to-date, and up 32.7% since its Christmas Eve low.  And that’s without including dividends.      

We were so confident there wouldn’t be a recession – and that the market was still cheap – that we raised our target to 3,250 in the middle of 2019.  That’s only 4.2% above last Friday’s close.

With one possible (and very unlikely) exception, nothing we see on the horizon suggests the bull market is nearing an end.   We’re forecasting moderate economic growth for the foreseeable future, and see continued corporate profit growth as margins stay high.

Monetary policy is not tight, far from it, and we don’t see any hikes to short-term interest rates through at least 2020.  And after many years of 6% M2 money supply growth, M2 has accelerated, growing at a 9.2% annualized pace in the past six months.

Corporate America is still adapting to a much more favorable tax environment.  And trade policy is more likely to get better going forward, rather than worse.

The “new NAFTA” looks likely to pass by early next year, in part because as the Democrats target President Trump with impeachment, it becomes more important for them to reach some bipartisan goals.  House Speaker Nancy Pelosi recently described a political deal on the trade pact as “imminent.”  Mexico and Canada are the US’s #1 and #2 trading partners.  A deal with #4, Japan, is being worked out and is already benefiting the US.   Meanwhile, news reports suggest a deal with China (#3) is approaching.             

Want more reasons for optimism?  The ball and chain of regulation continues to ease around the ankles of entrepreneurs.  And a surge in the appointment of federal judges who believe in legislation, not administrative regulation, will make it tougher for the administrative state to hamstring innovation.

In addition, consumers have plenty of purchasing power, both from wage growth and relatively low financial obligations.  Home builders still need to raise the pace of construction just to keep up with population growth and the scrappage of homes (including voluntary knock-downs, fires, floods, tornadoes, and hurricanes).

Notice, too, that the US isn’t alone in the stock market rally.  The Euro Stoxx 50 is up 19.4% in dollar terms so far this year (as of the Friday close) while Japan’s Nikkei is up 18.2%.

We think those gains, at least in part, reflect investors looking ahead and expecting better policies.  By cutting tax rates and regulation, the US has become more competitive.  Eventually, the political pressure on other countries is to follow suit.  When Regan and Thatcher cut tax rates in the 1980s, many other countries took the cue, which led to a global boom.

One thing that could throw a monkey wrench into the bull market would be a shift by voters toward less growth-oriented policies of more government spending, expanded entitlements, and higher tax rates.  This would take a sweep of the White House, House, and Senate with politicians willing to pass the votes.  We put the odds of that happening at roughly 5%.  We know investors are worried about this, but it’s way too early – and way too unlikely – to change investment strategies at this point.  Think about it: if a sweep like this would cut the stock market by 25%, but has only a 5% chance of occurring, that’s a drag of only 1.25% on the market (5% of 25%). 

A year ago, we were in the distinct minority in remaining bullish while so many were predicting the supposed “sugar high” was over and a bear market had begun.  We didn’t see it that way then, we still don’t now.

Stocks are still cheap, the economy is not slipping into recession.  The policy environment is tilted more toward growth than it was three years ago, even though it could be better.  And that means the bull market should continue.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist                                                          

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