One thing we must remember when looking at economic data, is that everything is distorted. The US (in fact, much of the world) panicked in 2020. COVID caused governments around the world to implement unprecedented policies. The US borrowed, printed, and spent its way through the lockdowns. We believe, and we don’t think it’s hard to understand, that the economic bill for these policies, is soon coming due.
We don’t expect a recession like in 2020, or a repeat of the Great Recession in 2008-09, but the unemployment rate will eventually go up, job growth will go negative, industrial production will fall, and so will corporate profits. At that point we won’t have a big debate about whether we’re in a recession; everyone will know it.
In the meantime, before a real recession sets in sometime in 2023 or early 2024, many people will believe the recession is already here. Especially, as the shift away from goods and toward services gathers steam.
Right before COVID started, in February 2020, “real” (inflation-adjusted) consumer spending on services was 64% of all real consumer spending. With the economy locked down, services fell to 59% of spending by March 2021. That five percentage point decline represented roughly $700 billion of spending. Consumers have clawed some of that back with services now up to 62% of total spending, with big recoveries in health care, recreation, travel, restaurants, bars, and hotels. And, we expect this trend to continue.
Yes, companies like Peloton and Carvana, where investors apparently projected COVID-related trends to persist, have gotten hammered. Some look at layoffs at these companies, and others in similar straights, as a sign that recession is already here. But these aren’t macro-related developments; they are a realignment of economic activity from a distorted world to a more normal one.
Another distortion from COVID policies was a big drop in labor force participation, which is the share of adults who are either working or looking for work. The participation rate was 63.4% in 2020 but now, even though the unemployment rate is back down to the pre-COVID low of 3.5%, participation is only 62.1%.
Part of the problem might be inflation. “Real” hourly earnings are lower than they were pre-COVID. So fewer people might be participating, despite low unemployment, because they (correctly) realize the real value of work is less than it used to be. Another problem is that big-box stores and Amazon stayed open, while many small businesses in certain states were closed. Whether this represents a permanent shift in employment and productivity, or a temporary one, remains unclear
Yet another shift is in housing. Home prices soared during COVID, with the national Case-Shiller home price index up a total of 41.4% rate in the past 27 months (through May 2022). That’s the fastest increase for any 27-month period on record, even faster than during the “housing bubble” of the 2000s. Meanwhile, with the government preventing landlords from evicting tenants, rent payments grew unusually slowly during the first eighteen months of COVID.
But now rent payments are catching up. Expect a major transition in the next few years, with rents continuing to grow rapidly while home price gains slow to a trickle by late this year and then home prices remain roughly unchanged in the following few years.
What a fiasco. More employment at large firms, less at small firms. More renters, fewer owners. Lower inflation-adjusted incomes. Distorted economic data. The costs of the lockdowns, one of the biggest policy mistakes in US history, are absolutely immense.
Voters will react, and at least one house of Congress is likely to go the opposition party this November, meaning legislative gridlock for the next two years as the nation sorts all of this out
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Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security
With less than three months left before the 2022 mid-term elections, it is officially silly season when it comes to interpreting economic reports. For many analysts it’s pretty much all politics all the time, with data seen through a political lens first, and with real unbiased economic analysis coming maybe second, if ever.
It started off with those saying we’re in a recession because, at least based on the most recent reports, real GDP declined in both of the first and second quarters of the year. Never mind that the unemployment rate has dropped 0.4 percentage points so far this year. Never mind that payrolls are up an average of 471,000 per month, while industrial production is up at a 5.2% annual rate over the first six months of the year. Never mind that “real” (inflation-adjusted) gross domestic income was up in the first quarter (we’re still waiting for Q2 data) and has just as good of a track record as real GDP.
The Federal Reserve raised short-term interest rates by three-quarters of a percentage point (75 basis points) on Wednesday. The day before, the Fed had released M2 money supply data for June and it fell slightly, the second decline in three months. At his press conference after the rate hike, Fed Chairman Jerome Powell was vague about the Fed’s future intentions on rates, but was not asked one single question about the money supply.
For now, with the federal funds rate at 2.375%, the futures market is leaning toward a rate hike of 50 bps in September. The Fed has apparently abandoned “forward guidance” partly because it has already pushed rates close to what many Fed members said is “neutral.”
Meanwhile, the 10-year Treasury yield has fallen from north of 3.4% to under 2.7% suggesting the market thinks the Fed will either slow down rate hikes, or maybe even cut them next year. Unless, inflation falls precipitously, this makes no sense. “Core” PCE inflation is closing in on 5% and a “neutral” interest rate should be at least that high, or higher. The Fed has never managed policy under its new abundant reserve system with inflation rising this fast. No one, even the Fed, knows exactly how rate hikes will affect the economy under this new system. (See MMO)
Many think the economy is in recession already, because of two consecutive quarters of declining real GDP. But this is a simplified definition. Go to NBER.Org to see the actual definition of recession. A broad array of spending, income, production and jobs data rose in the first six months of 2022. GDP is not a great real-time measure of overall economic activity for many reasons. Jerome Powell does not think the US is in recession, and neither do we. What we do know is that inflation is still extremely high and the only way to get it down and keep it down is by slowing money growth.
And that does look like it’s happening. So far this year, M2 is up at only a 1.7% annual rate, after climbing at an 18.4% annual rate in 2020-21. By contrast, M2 grew at a 6.2% annual rate in the ten years leading up to COVID.
Slow growth (or even slight declines) in M2 is good news. The problem is that the Fed never talks about M2 and the press never seems to ask. Moreover, slower growth in M2 may be tied to a surge in tax payments – when a taxpayer writes a check to the government, the bank deposits in M2 fall. Data on deposits at banks back this up. However, banks have trillions in excess reserves and total loans and leases are growing at double digit rates. At this point, it is not clear that the new policy regime can persistently slow M2. Will higher rates stop the growth of loans? This looks to be happening in mortgages, but it appears to be demand-driven, not supply-driven.
The bottom line is that the Fed seems determined to bring inflation down but thinks raising short-term interest rates, all by itself, can do the job effectively, even at the same time that it is willing to hike more gradually when inflation is well above the level of rates. This is not a recipe for confidence in the Fed. Expect rates to peak higher than the market now expects and keep watching M2.
To view this article, Click Here.
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
To many investors, this week’s GDP report is more important than usual. The reason is that real GDP declined in the first quarter and might have declined again in Q2. If so, this could mean two straight quarters of negative growth, which is the rule of thumb definition many use for a recession.
We think these investors are paying too much attention to the GDP numbers; the US is not in a recession, at least not yet. Industrial production rose at a 4.8% annual rate in the first quarter and at a 6.2% rate in Q2. Unemployment is lower now than at the end of 2021. Payrolls grew at a monthly rate of 539,000 in the first quarter and 375,000 in Q2. If we were already in a recession, none of this would have happened. That’s why the National Bureau of Economic Research, the “official” arbiter of recessions, uses a wide range of data when assessing whether the economy is shrinking.
In addition, it’s important to recognize that once a year the government goes back and revises all the GDP data for the past several years. That happens in July, including with the report arriving this Thursday. Given the strength in jobs and industrial production, it wouldn’t surprise us at all if Q1 is eventually revised positive.
In the meantime, we are forecasting growth at a +0.5% annual rate in Q2. Here’s how we get there.
Consumption: “Real” (inflation-adjusted) retail sales outside the auto sector grew at a 2.2% annual rate, and it looks like real services spending should be up at a solid pace, as well. However, car and light truck sales fell at a 19.7% rate. Putting it all together, we estimate real consumer spending on goods and services, combined, increased at a modest 1.2% rate, adding 0.8 points to the real GDP growth rate (1.2 times the consumption share of GDP, which is 68%, equals 0.8).
Business Investment: We estimate a 5.5% annual growth rate for business equipment investment, a 7.5% gain in intellectual property, but a 4.0% decline in commercial construction. Combined, business investment looks like it grew at a 4.4% rate, which would add 0.6 points to real GDP growth. (4.4 times the 14% business investment share of GDP equals 0.6).
Home Building: Residential construction looks like it contracted at a 4.0% annual rate. Mortgage rates should eventually become a headwind, but, for now, it looks like an increase in spending on construction was more than accounted for by inflation in construction costs. A decline at a 4.0% rate would subtract 0.2 points from real GDP growth. (-4.0 times the 5% residential construction share of GDP equals -0.2).
Government: Remember, only direct government purchases of goods and services (and not transfer payments like unemployment insurance) count when calculating GDP. We estimate these purchases – which represents a 17% share of GDP – were roughly unchanged, which means zero effect on real GDP.
Trade: Exports have surged through May while imports, after spiking late in the first quarter, have remained roughly flat so far in Q2. That means a smaller trade deficit. At present, we’re projecting net exports will add 1.0 point to real GDP growth, although a report on the trade deficit in June, which arrives on July 27, may alter that forecast.
Inventories: Inventories look like they grew at a slower pace in the second quarter than they did in Q1, suggesting a drag of about 1.7 points on the growth rate of real GDP. However, just like with trade, a report out July 27 may alter this forecast.
Add it all up, and we get 0.5% annual real GDP growth for the second quarter. Monetary policy will eventually tighten enough to cause a recession, but that recession hasn’t started yet.
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
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Are you getting a tax refund this year? Plenty of folks are. Much like trivia, running through the IRS data is always interesting…at least for those who love diving into the minutiae. So here are some tax facts for the 2022 season:
But, getting back to our title, how might you best “spend” your lump sum. Maybe a better question we can ask is how might you best “invest” your cash windfall?
Not everyone will receive a refund or a large check from the IRS. But ideas I’ll put forth can be used when receiving any gift, bonus, or unexpected cash windfall.
Before we dive in, I want to quickly add: If your children, a relative or close friend has talked about their refund, feel free to forward these suggestions to them.
7 smart ways to invest your tax refund
1. Do you have a rainy-day fund? Is if fully funded? You understand the importance of reserves. Whether it’s a home repair, auto repair, a layoff or unexpected bill, having cash set aside will ease the financial burden.
I recommend three to six months of readily accessible savings in the event of an emergency. If you don’t have a rainy-day fund, don’t procrastinate; get started today.
2. Get out of debt. Years ago, I saw a quote that went something like this. “The road to poverty is paved by high interest rates.” I don’t know who coined the phrase, but too many people run up high-rate debts and struggle to pay them off.
Pay down or pay off high-rate credit cards or unsecured loans. You might start off with the card with the lowest balance first. Wiping the slate clean on a card or cards is a big psychological win and will encourage you to stay in the battle until you are out of debt.
3. Tackle your student loans. Can the president simply wave his hand and forgive your student loans? If he could (and maybe he can; the jury’s still out on this one), would you receive a 1099 for debt that’s forgiven (the devil is always in the details)? Or, for that matter, should you wait for the bureaucracy to solve your problem?
If you have an emergency fund and credit card debts are low, consider tackling your student loans. Sure, they helped you get through college, but they are a burden hanging over your financial future.
4. We reap what we sow. If you don’t sow into a retirement plan, there will be no harvest come retirement. For example, if you take the hypothetical $3,263 tax refund and stash it in a Roth IRA, you’ll have $32,834 in 30 years, assuming an 8% annual return. Plus, you’ll pay no federal income tax when you take a qualified withdrawal from a Roth IRA.
At 10%, you’ll have $56,937, and at 6%, you’ll have $18,741. Of course, returns aren’t guaranteed and may vary, but trading one’s natural inclination for instant gratification for a future payoff can pay you a handsome reward.
5. Invest in the future of your child, grandchild or yourself. There are various options, and we can point you in the right direction to help get your started.
You might consider an education savings account of a 529 plan for your kids. While you won’t get a tax deduction for contributions into the accounts, these vehicles allow you to grow the nest egg tax-free, and they can be withdrawn for qualified expenses without a tax liability.
Have you decided that you would like to invest in yourself? Do you want to ascend to the next level? Certifications and college classes can help sharpen your skills. Even if you are not career-oriented, investing in your hobbies can bring added enjoyment.
6. Gifting your refund. You may decide that you don’t need the money. I know folks who gave away their stimulus checks to their kids or charity. What puts a smile on your face? That may be the appropriate strategy for your refund.
7. Have some fun. As we said, the average refund check so far has been $3,263. You may take one of my ideas to heart and earmark the lion’s share toward that goal. But don’t be afraid to save some for yourself.
Whether it’s a nearby weekend trip, a day trip to the spa, or that expensive restaurant you have always wanted to try, it’s OK to take care of yourself.
These suggestions are just food for thought. But be strategic. Think long-term. And take some time to consider what you might do with your refund or any windfall you may receive. A lack of planning and impulsive decisions can be costly. And remember, I’m always here to assist you.
The year 2021 was a banner year for investors. The broad-based S&P 500 Index, which is made up of 500 larger U.S. companies, finished the year up 26.9%. If we included reinvested dividends, the index advanced 28.7%, according to S&P Dow Jones Indices
Much better-than-expected corporate profits (Refinitiv), which were powered by an expanding economy, plus a super easy monetary policy compliments of the Federal Reserve, deserve much of the credit.
Low interest rates, low bond yields, and rising profits easily offset worries about the lingering pandemic and much higher-than-expected inflation.
But we are now looking ahead into 2022. What might the new year bring? After last year’s strong advance, what might be in store for this year?
Since 1950, there have been 26 years in which the total annual return of the S&P 500 Index exceeded 20%, according to data provided by the NYU Stern School of Business. In the following year, the S&P 500 Index advanced 20 times, or 77% of the time, in line with the long-term average.
The average up year was 18.1%, while the average down year was 6.4%.
It’s an interesting exercise, but let’s always remember that past performance is no guarantee of future performance. Each year will have its own distinctions.
We could add one more wrinkle. The total return of the index has doubled over the last three years, according to Dow Jones Indices.
What dictates the market’s direction will likely be the economic fundamentals and whatever impacts those fundamentals.
For example, what might the Federal Reserve do with interest rates? At the beginning of 2021, the Fed expected no rate hikes in 2022. However, it failed to anticipate last year’s surge in inflation.
As the year ended, the Fed’s new projections, which it released after its December meeting, reflected a forecast of three quarter-percentage-point rate hikes this year.
Are those potential rate hikes already being discounted by investors? If inflation fails to ease--or worse, accelerates--could the Fed take a more aggressive posture?
Let’s take this point one step further. Longer-term bond yields have remained very low in the face of a less dovish Fed, high inflation, and robust economic growth.
Will we get a reset in 2022? Or have there been fundamental changes in the bond market that are holding yields low? Or do bond investors simply believe inflation and economic growth will slow?
Corporate profits are also a key driver of stock prices. Consider this: If you were to purchase or sell a small business, wouldn’t recent and projected profitability play a big role in the sales price? It absolutely would. The same principle holds for publicly traded companies.
How will the pandemic play out? We’ve seen Delta and we’re now seeing a surge in cases tied to Omicron. The economic impact of Delta was limited, and thus far, investors have side-stepped economic worries about Omicron. But what does 2022 hold?
We’ve posed several important questions that don’t offer easy answers. We may see a pullback in 2022, and we recognize that downturns are a part of investing.
Based on your goals, circumstances, and risk tolerance, we craft portfolios that help manage risk, but we can’t eliminate risk.
If we trade the fear of a sell-off for the so called safety of a savings account, we won’t participate in the long-term upside that stocks have historically offered. Conversely, take on too much risk when the market has been strong, and you may experience sleepless nights in a swift downturn.
If life events have forced you to rethink your goals, let’s talk. Financial plans are not set in stone.
Yet, adherence to one’s financial plan and a long-term focus have historically been the straightest path to reaching your financial goals. We may see volatility this year. But predictions are simply educated guesses. As we’ve seen in the past, sell-offs, when they occur, are followed by rebounds. Keep this in mind as we navigate the New Year together.
I trust you’ve found this review to be educational and helpful. If you have any questions or would like to discuss any matters, please feel free to give me a call.
As always, I’m honored and humbled that you have given me the opportunity to serve as your financial advisor.