The Endless Debt Fret

January 16, 2019

For the more than three decades we have been involved in analysis of the economy, one nagging constant has been pessimistic prognostications over the U.S. debt. Now once again, debt is the news de jour. Consumer, business, and government debt are all at record highs, and, therefore, the theory goes, the economy is tempting fate.

We have some very basic problems with this theory. Debt has been rising for decades, as it usually has since the US was founded more than 200 years ago. But just like debt, assets, incomes and profits have hit record highs too. While it’s true that debt is usually at a record high when a recession starts, debt itself doesn’t cause recessions. And debt itself doesn’t cause growth either. If it did, then Puerto Rico and Greece would be economic powerhouses; instead, they’re basket-cases.

Debt is a transfer of assets from someone who wants to spend less than they earn today, to someone who wants to spend more. When this debt fuels investment in entrepreneurial ventures that boost growth, then debt helps lift the economy. But if spendthrift consumers or governments borrow money for non-productive activities, then debt goes up while production stagnates. That’s a problem, as there are no extra goods and services to offset the cost of larger debt payments as they come due.

The other thing about debt is that it can sometimes spur on more production. Imagine you wake up tomorrow and are $10,000 more in debt. Are you going to work more hours or fewer to pay that off?

In other words, investors should neither be “debtophobes” or “debtophiles.” Instead, investors should be agnostic about debt, looking into the underlying reasons for the debt as well as its sustainability relative to asset levels and income.

Take, for example, the national debt of Japan, which is about 235% of GDP. That’s a lot of debt! But Japan’s interest rates have been hovering around 0% for years, which means the carrying cost of the enormous debt is minimal (for now).

Another example is the US consumer. Household debts are at a record high of $15.9 trillion, beating even the $14.7 trillion record set in early 2008 before the financial crisis and Great Recession. This includes mortgages, home equity loans, student loans, auto loans, credit card debt,…etc. So, the thinking goes, if we had a crisis after the last record high and now we’re even higher, there must be a new crisis lurking around the corner.

The problem with this theory is that it ignores asset values. Back at the old peak in household debt in 2008, debts were 19% of assets; now they’re 12.7% of assets, the lowest share since the mid-1980s. Meanwhile, households’ debt service is the lowest share of after-tax income since at least the 1980s. Corporate debt, too, is low relative to assets in historical comparisons, and interest costs as a percent of profits are well within the normal range.

Faster growth in recent years may have coincided with higher debts in some areas, but it wasn’t caused by higher debts. Growth has picked up thanks to a mix of better policies and entrepreneurship. Bottom line is we don’t see anything about the current level of debt that’s going to cause a recession anytime soon. Let the pouting pundits kick and scream but focus your attention on more important things.

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

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No Sign of Recession

January 8, 2019

Talk about destroying a narrative. On Friday, the Labor Department reported 312,000 new jobs in December, with an additional 58,000 from upward revisions to prior months. Recession talk got crushed.

The Pouting Pundits of Pessimism claim jobs are a lagging indicator, but the pace of payroll growth starts declining well before a recession starts. In the twelve months ending in June 1989 nonfarm payrolls increased a robust 225,000 per month. In the next twelve months payrolls rose a softer 153,000 per month and then a recession officially started in July 1990.

A similar pattern happened before the next two recessions, as well. In the twelve months ending in February 2000, payrolls rose 250,000 per month before decelerating to 137,000 per month in the next twelve months. A recession started in March 2001.

In the twelve months ending in November 2006, payrolls rose 173,000 per month and then slipped to 101,000 per month in the following twelve months. After the financial crisis started, the National Bureau of Economic Research dated the start of the Great Recession to December 2007.

By contrast, nonfarm payrolls are up an average of 220,000 in the past twelve months versus a gain of 182,000 per month in the twelve months before that. On a quarterly basis, from Q2-2017 to Q4-2018, job growth has been 473,000, 553,00, 556,000, 632,000, 634,000, 623,000 and 670,000. In other words, no sign of the kind of slowdown in job creation that normally precedes a recession; instead, job creation appears to be accelerating.

Yes, the unemployment rate did rise to 3.9% in December from 3.7% in November, but that’s because the growth of the labor force was a healthy 419,000. A slower decline in the unemployment rate combined with faster economic growth signals that potential GDP growth has increased, exactly the response we would expect with lower marginal tax rates and deregulation.

If the partial government shutdown continues into the employment survey week, the unemployment rate may rise in January, but that’ll be temporary, unwinding when the political showdown ends.

Perhaps the best part of Friday’s report was that workers’ wages are accelerating. Average hourly earnings rose 0.4% in December and are up 3.2% from a year ago. And that’s excluding extra earnings from irregular bonuses and commissions like those paid out after the tax cut was passed.

Another piece of hard data and good news last week also undermines the recession theory: automakers reported that Americans bought cars and light trucks at a 17.55 million annual rate in December, the fastest pace since November 2017, when sales were still surging in the aftermath of Hurricanes Harvey and Irma. We don’t expect auto sales to stay this strong, but recent strength shows consumers are not under stress.

Yes, the ISM Manufacturing report for December fell short of consensus expectations, but since this is a survey, it’s easier to pick up temporary noise, as human emotion can be a factor over the short term. Still, even at 54.1, it still shows healthy expansion and is well above recession territory. The last three recessions started with the ISM at 46.6 (July 1990), 43.1 (March 2001), and 50.1 (December 2007). In the past year manufacturing jobs are up 24,000 per month, as opposed to the contraction in these jobs usually seen before a recession starts.

Monetary policy is not tight and is unlikely to be anytime soon. Companies are still adapting to lower tax rates, full expensing, and less regulation. Consumers will be surprised with their larger than anticipated tax refunds. A trade deal has been struck with Mexico and Canada and negotiations with Europe and Japan should result in lower tariffs on US exports. The sore spot is China, but the US has lots of leverage given the large trade deficit.

At some point the US will have a recession. But none of the data we’re looking at suggests a recession will start anytime in the near future. In turn, we think profits will continue to grow and that even at the current level of profits, US equities remain cheap.

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

Dow 28,750, S&P 500 3100

January 2, 2019

Early in 2018 we said the US economy has gone from being a Plow Horse to Kevlar. Nothing that has been thrown at the economy since – neither trade conflicts nor tweets, not higher short-term interest rates nor the correction in stocks – is likely to pierce that armor.

A year ago the economic consensus was that real GDP would grow 2.5% in 2018. And yes, that was after the tax cuts were passed. By contrast, we were more optimistic, projecting that real GDP would be up 3.0% in 2018. If we plug in our forecast for 2.0% real GDP growth in the fourth quarter, the economy will have grown 2.9% for the year. If, instead, we use the Atlanta Fed’s estimate of 2.7% for Q4, we’d get 3.1% for the year. Either way, we just about nailed it.

Now, the same consensus that a year ago suggested the economy would only grow 2.5% in 2018 with the tax cuts is saying the economy is going to slow down to a pace of 2.3% in 2019, in part because of the supposed reduction in stimulus related to those very same tax cuts.

Once again, we’re not buying it. The benefits to growth from having a lower tax rate on corporate profits and less regulation are going to take years to play out. Companies and investors around the world have only begun to react to the US being a more attractive place to operate. As a result, we’re forecasting another year of 3.0% economic growth.

Further, we expect the unemployment rate to keep gradually falling, as continued job growth offsets an expanding labor force to push the jobless rate down to 3.3%, the lowest since the early 1950s. Last year the consensus predicted the jobless rate would decline to 3.8% in 2018; we predicted 3.7%. Right now it’s already 3.7% and we think a drop to 3.6% is likely for December when that report comes out January 4.

On inflation, it looks like we’ll finish this year with the Consumer Price Index up about 2.0%, although it would have been higher were it not for what we think is a temporary downdraft in oil prices. The consensus had projected 2.1% and we had been forecasting 2.5%. Look for a rebound in oil prices and ample monetary liquidity to help push the CPI gain to 2.5% in 2019, which would be the largest gain since 2011.

The tricky part is what to expect from the Federal Reserve in 2019. Based on our economic projections, and if the economy were the Fed’s only consideration, we could get as many as four rate hikes in 2019. After all, nominal GDP growth – real GDP growth plus inflation – is up 5.5% in the past year and up at a 4.8% annual rate in the past two years. Raising rates four times in 2019, which is more than any Fed decision-maker projected at the last meeting in December, would only take the top of the range for the federal funds rate to 3.5%, still well below the trend in nominal GDP growth.

But we think the Fed will have a two-part test for rate hikes in 2019. First, as we just explained, the economy itself. Second, the yield curve. We think the Fed will be very reluctant to see the federal funds rate go above the yield on the 10-year Treasury Note and will strive to avoid either an active or passive inversion of the yield curve. An active inversion would be the Fed directly raising the federal funds rate above the 10-year yield; a passive inversion would be raising the federal funds rate so close to the 10-year yield that normal market volatility could send the 10-year lower than the funds rate.

As a result, we think the Fed will want to leave a “buffer zone” between the 10-year and the funds rate of about 40 basis points. So, for example, if the 10-year yield stays near its current level throughout all of 2019, we could end up with no rate hikes at all in spite of economic conditions.

Our projection, though, is that the 10-year yield moves higher to reflect more strength and resilience than the consensus now expects. If the 10-year yield finishes 2019 at 3.40%, as we expect, that would leave room for two rate hikes, maybe three.

For the stock market, we expect a soaring bull market, with the S&P 500 reaching the 3100 we projected for 2018 a year ago. Yes, we know that sounds bold, but our Capitalized Profits Model is screaming BUY.

The model takes the government’s measure of profits from the GDP reports divided by interest rates to measure fair value for stocks. Our traditional measure, using a current 10-year Treasury yield of about 2.75% suggests the S&P 500 is still massively undervalued.

But if we use our forecast of 3.40% for the 10-year yield, the model says fair value for the S&P 500 is 3100. And that leaves room for equities to go even higher if, as we think, profits move higher next year, as well. The model needs a 10-year yield of about 4.35% to conclude that the S&P 500 is already at fair value, with current profits.

The bottom line is that we’re calling for the S&P 500 to finish at 3,100 or higher next year, which would represent a nearly 25% gain from Friday’s close. The Dow Jones Industrial Average should end the year at 28,750.

Yes, this is likely to be one of the most optimistic forecasts you see, if not the most optimistic one of all. But, in the end, we do best by our readers when we tell them exactly what we think is going to happen, without altering our projections so we can run with the safety of the herd. Grit your teeth if you have to; those who stay invested in the year ahead should earn substantial rewards.

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

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Greedy Innkeeper or Generous Capitalist?

December 26, 2018

The Bible story of the virgin birth is at the center of much of the holiday cheer this time of year. The book of Luke tells us that Mary and Joseph traveled to Bethlehem because Caesar Augustus decreed a census should be taken. Mary gave birth after arriving in Bethlehem and placed baby Jesus in a manger because there was “no room for them in the inn.”

Some people think Mary and Joseph were mistreated by a greedy innkeeper, who only cared about profits and decided the couple was not “worth” his normal accommodations. This version of the story (narrative) has been repeated many times in plays, skits, and sermons. It fits an anti-capitalist mentality that paints business owners as greedy, or even evil.

It persists even though the Bible records no complaints and there was apparently no charge for the stable. It may be the stable was the only place available. Bethlehem was over-crowded with people forced to return to their ancestral home for a census – ordered by the Romans – for the purpose of levying taxes. If there was a problem, it was due to unintended consequences of government policy. In this narrative, the government caused the problem.

The innkeeper was generous to a fault – a hero even. He was over-booked, but he charitably offered his stable, a facility he built with unknowing foresight. The innkeeper was willing and able to offer this facility even as government officials, who ordered and administered the census, slept in their own beds with little care for the well-being of those who had to travel regardless of their difficult life circumstances.

If you must find “evil” in either of these narratives, remember that evil is ultimately perpetrated by individuals, not the institutions in which they operate. And this is why it’s important to favor economic and political systems that limit the use and abuse of power over others. In the story of baby Jesus, a government law that requires innkeepers to always have extra rooms, or to take in anyone who asks, would “fix” the problem.

But these laws would also have unintended consequences. Fewer investors would back hotels because the cost of the regulations would reduce returns on investment. A hotel big enough to handle the rare census would be way too big in normal times. Even a bed and breakfast would face the potential of being sued. There would be fewer hotel rooms, prices would rise, and innkeepers would once again be called greedy. And if history is our guide, government would chastise them for price-gouging and then try to regulate prices.

This does not mean free markets are perfect or create utopia; they aren’t and they don’t. But businesses can’t force you to buy a service or product. You have a choice – even if it’s not exactly what you want. And good business people try to make you happy in creative and industrious ways.

Government doesn’t always care. In fact, if you happen to live in North Korea or Cuba, and are not happy about the way things are going, you can’t leave. And just in case you try, armed guards will help you think things through.

This is why the Framers of the US Constitution made sure there were “checks and balances” in our system of government. These checks and balances don’t always lead to good outcomes; we can think of many times when some wanted to ignore these safeguards. But, over time, the checks and balances help prevent the kinds of despotism we’ve seen develop elsewhere.

Neither free market capitalism, nor the checks and balances of the Constitution are the equivalent of having a true Savior. But they should give us all hope that the future will be brighter than many seem to think.

(We’ve published a version of this same Monday Morning Outlook during Christmas week, each year, since 2009.)

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

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No Housing Bubble

December 18, 2018

Last week in the New York Times, Yale economist Robert Shiller wrote we are “experiencing one of the greatest housing booms in United States history.” Given what happened in the aftermath of the last boom – a financial panic and the Great Recession – this will add to investors’ fears about another recession lurking around the corner.

Shiller says that the national Case-Shiller (yes, the same Shiller!) home price index is up 53% since prices bottomed in the housing bust in February 2012 and are now 11% higher than they were at the peak of the boom in 2006. In his mind, these are both signs of a new bubble.

We have great respect for Shiller, who correctly called the internet stock market bubble in the late 1990s as well as the housing bubble in the 2000s.

However, there is a huge difference between housing today and where it was in the last bubble. To assess the “fair value” of homes, we use a Price-to-Rent (P/R) Ratio. We get that by comparing the asset value of all owner-occupied housing (calculated by the Federal Reserve) to the “imputed” rental value of those homes (what owners could fetch for their homes if they rented, instead, 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 60 years the P/R Ratio has averaged 15.22. At the peak of the housing bubble in the previous decade, the Ratio was 20.85, a record high. In other words, prices were 37% above fair value nationally, much more so in hot spots like Fort Myers, FL, Las Vegas, NV, and Scottsdale, AZ.

Then, during the housing bust, the Ratio plunged to 12.96, the lowest on record. At that point, national average home prices were 15% lower than you’d expect given rents. Temporarily, that made sense: prices had to get well below fair value in order to clear the massive backlog of excess homes produced during the bubble.

Today, the P/R ratio is 15.81, so homes are only 4% above their long-term average relative to rents. That’s well within the normal historical range and less than the typical transaction cost when a home is sold, and so no reason to sell.

Shiller is right that housing prices exceed where they were at the peak of the prior boom, but he’s not adjusting for the rent those homes can earn. In the past twelve years, the asset value of owner-occupied homes is up 13% while imputed rent is up 45%.

Another reason to believe we’re not in a bubble is that the pace of home building is substantially slower than during the previous bubble. Builders started 2.07 million homes in 2005 versus an annual need of about 1.50 million based on population growth and scrappage (teardowns, fires, floods, hurricanes,…etc.). So not only did homes get 37% overpriced, they did so when there were plenty of homes to go around. By contrast, this year builders will start about 1.25 million homes, below what we need to just meet population growth and scrappage.

Residential real estate is not in a bubble. Look for moderate price gains ahead, although with the gains tilted toward lower tax states due to tax reform.

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

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The Long-Term Yield Conundrum

December 11, 2018

Last Friday, the 10-year Treasury Note closed at a yield of 2.85%. That’s up from 2.41% at the end of 2017, but down from the peak of 3.24% on November 8th, and well below where fundamentals suggest yields should be.

In the last two years, nominal GDP growth – real GDP growth plus inflation – has run at a 4.8% annual rate. Normally, we’d expect yields to be close to nominal GDP growth, but Treasury yields have remained stubbornly low.

Some analysts are spooked by the recent movement of 3-year yields above 5-year yields, thinking this “inversion” signals a recession. We think this is sorely mistaken. With a lag, recessions have often (but not always) followed periods when the federal funds rate exceeds the 10-year yield. If anything, that’s the inversion to look out for; feel free to ignore the rest. But, at present, the 10-year is yielding about 70 basis points above the funds rate, well within the normal range.

One reason that the 10-year yield has remained below where economic fundamentals suggest it should trade is that the Federal Reserve set short-term interest rates near zero. Longer-term bonds, including the 10-year reflect the current level of short-term rates as well as the projected path of those rates in the future. So, back when yields were essentially zero, and the Fed was signaling they could stay there for a long time, this pulled down longer-term yields. The Fed has now lifted short-term interest rates by 200 basis points from where they were, but investors still don’t believe they will go much higher.

Part of the issue is that many think low rates themselves are the only reason the economy came out of the Great Recession. So as the Fed lifts rates, many investors expect the next recession is a small tip of the scale from returning in force.

If you’re buying 10-year Notes under the premise that a recession will happen sometime in the next ten years – and you also expect the next recession to tie (or beat) ’08-’09 for the title of worst recession since the Great Depression – then the yield on the 10-year Treasury makes a lot more sense.

But we wholeheartedly disagree with your assessment. We think the bond market is anticipating a far weaker economy over the next ten years than the data justifies.

No matter how many believe it, the bond market is not all-knowing. In November 1971, the 10-year Treasury was yielding 5.81%. Over the next ten years, inflation alone increased at an 8.6% annual rate and nominal GDP grew at a 10.7% annual rate. In other words, 10-year note investors got hammered as yields soared. And notice that back in 1971 we had a Republican president (Richard Nixon) leaning heavily on the Fed to maintain a loose monetary policy. Sound familiar?

The next recession is unlikely to be like the last. Our calculations suggest national average home prices were 40% overvalued at the peak of the housing boom – pumped up by government rules and subsidies artificially favoring home buying. Meanwhile overly stringent mark-to-market accounting rules created a once in a 100-year panic. Mark-to-market rules have now changed to allow cash flow to be used to value assets, plus banks are much better capitalized. In other words, fundamentals suggest another panic is not in the cards.

What’s more likely is that, when the next recession hits – and we don’t see one happening until at least 2021 – it will be softer than usual, more like 1990-91 or 2001, than 1973-75, 1981-82 or 2007-09. As investors realize data trumps the rhetoric, we expect bond yields to rise. In the end, math wins.

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

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Scapegoating Powell

December 6, 2018

New Narrative Alert: Fed Chief Jerome Powell is to blame for the volatility in stocks. Back on October 3rd, with stock markets near their record highs, Powell said “we’re a long way from neutral.” That was not long after the Fed had moved the federal funds rate to a range of 2.00% to 2.25%, so the implication was that the Federal Reserve was going to maintain a pace of rate hikes in 2019 similar to 2018.

Then came the correction – which, by the way, seems to have ended the day after Thanksgiving – just a few trading days before Powell adjusted his language and said short-term interest rates set by the Fed are “just below” neutral.

Conventional wisdom says it’s all about the Fed. This thinking began back in 2008/09 when many pundits, analysts and investors decided it was QE and zero percent interest rates that saved the markets during the Great Recession. Forget about entrepreneurship, forget about profits, forget about tax rates and regulation. Just read the Fed tea leaves or listen to those who read them for you.

Count us skeptical. No matter how bullish we’ve been the past several years, we’ve always told investors that it’s about entrepreneurship, profits, and policy, not the Fed. If printing money and low rates were really the answer, European stock markets wouldn’t have under-preformed the US by so much in the past decade. And no one can consistently predict corrections. Investors could save a lot of headache (and a lot of money) simply by focusing on fundamentals rather than trying to time the market.

After a correction happens, plenty of people come out of the woodwork to tell us what caused it, even though they never predicted the correction in the first place. There’s always some explanation – after the fact – that seems to fit the limited data available. So, it’s not surprising some analysts are blaming Powell. Heck, the pouting pundits have been predicting near constant doom and gloom since 2009, and they’ll take any chance they can (no matter how temporary) to pop champagne and gloat.

Regardless, neither of Powell’s statements were out of line. Back in September the “median dot” suggested a neutral rate of 3.0% for federal funds, which is about four rate hikes away or a “long way from neutral.” But the range for neutral extends from 2.5% to 3.5%, possibly only one or two more rate hikes away, consistent with “just below.”

We think the news that really drove the market higher last week was the report that economy-wide pre-tax corporate profits were up 10.3% from a year ago (and up 19.4% after taxes – thank you tax cuts!). Focus on fundamentals, not post-event explanations. The former tell us the trend, the latter are little more than a distraction.

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

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Fake Economics

November 15, 2018

Politics and economics are interwoven. Government grants licenses, enforces contracts and the rule of law, provides fire and police protection, a national defense, and can call on resources to recover from crisis. Without these institutions, activity would slow. No one is building billion-dollar hotels in Syria, Libya, or Iraq; stability and certainty support investment.

The rule of law and stable institutions don’t create growth by themselves, but they do provide the framework. It’s entrepreneurs that see opportunity and reorganize existing resources in a different, more efficient, and more profitable way. That’s how growth happens. Human nature, however, doesn’t change. Politicians want to take direct credit for growth. Remember when Al Gore said he helped “create” the Internet?

One of the greatest myths in all of economics is the “Government Spending Multiplier” sometimes called the “Fiscal Multiplier.” This concept came from a Keynesian, demand-side analysis of the economy that looks at something called the “marginal propensity to save.” Someone who earns $100 but only spends $90 has a 10% marginal propensity to save. In the demand-side world, where consumption drives economic activity, the $10 in savings is seen as a negative. Having $10 less spending means $10 less in demand.

Politicians argue that taking that $10 from the saver, and giving it to someone who will spend it, increases growth. For example, Nancy Pelosi said back in 2013 that “unemployment benefits remain one of the best ways to grow the economy” because it “injects demand into our markets.” She said every dollar spent on unemployment creates up to an extra $2 in GDP.

This is magic, it’s like turning lead into gold. All you have to do is win election, raise taxes, put those taxes in the hands of someone with a 0% marginal propensity to save, and voila, you’ve created your own economic growth.

But clearly, this is a myth. Imagine we redistributed away all the savings in an economy. Without savings there would be no investment, and without investment there would be no long-term growth. That’s why we focus on the supply side of the economy. From a supply-side view of the world, new inventions create growth and new inventions need savings and investment. Demand did not create the cell phone or apps. Before the inventors of Bird or Lime, consumers were not prowling the streets looking for electric scooters to ride.

From 2010-2017, real GDP grew just 2.1% per year, in spite of massive deficits and the largest share of GDP redistributed in the history of the U.S. In the past year, following deregulation and tax cuts, and the number of people receiving unemployment benefits falling to its lowest level since 1973, real GDP growth has accelerated to 3%. This is evidence that the “fiscal multiplier” is a myth.

This brings us to infrastructure spending, which many think will be one of the first things the newly divided government will agree on. Of course, good infrastructure helps promote efficient economic activity. But it won’t create net new jobs. By borrowing or taxing money from the private sector to build the infrastructure, politicians harm growth elsewhere. In the long run it may be positive, but in the short-run, at best, it’s neutral. Beware of politicians saying they can create jobs and speed growth. That’s demand-side thinking, and it hasn’t worked anywhere in the world up to this point.

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

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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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