Hey Government: It’s Time To Get Serious!

Brian Wesbury, Chief Economist at First Trust Portfolios, does a nice job in the commentary below comparing and contrasting the difference between the private sector (which is doing well) and the public sector (with governments of all sizes in precarious financial positions).  This divergence is a risk factor; the next crisis could erupt from the public sector.  Fortunately it is likely a decade or more away at the Federal level although the upcoming debt ceiling debate could create some pain.  In the meantime, the private sector looks poised to keep making progress and driving stock prices higher in the process.

Hey Government: It’s Time to Get Serious!

At eight years, the current economic recovery is the third longest on record.  Personal income, consumer spending, household assets, and net worth, are all at record highs.  Stock markets are at record highs.  Corporate profits are within striking distance of their all-time highs.  Federal tax receipts are at record highs.

So, how is it possible that the federal budget, along with some state and local budgets, still look like they’re in the middle of a nasty recession?

The answer: Government fiscal management is completely out of control.  Politicians find time to fret about Amazon’s purchase of Whole Foods and won’t stop bashing banks, but they’ve lost their ability to deal with their own fiscal reality.

The federal government is projected to run a nearly $700 billion deficit this year, and long-term forecasts suggest trillion dollar deficits as far as the eye can see.  Illinois and the City of Chicago are running chronic deficits, while New Jersey and New York are fiscal basket cases.

This makes the politicians of the 1990s look downright responsible.  In 1999, after a 10-year recovery, these entities were all running surpluses. But even if this recovery lasts 12 years, deficits will persist.  And what happens if there’s another recession?

Politicians have claimed intellectual support for their fiscal irresponsibility from John Maynard Keynes.  He believed in deficit-spending to help cure the problems of weak consumer spending in a recession.  As a result, the Panic of 2008 gave cover to grow government, and they did so in spectacular fashion.  But that “emergency” spending then morphed into permanent overspending and chronic deficits.

Tax rates are higher today than in 1999, and the economy is bigger, but governments have consistently outspent the ability of taxpayers to fund it.

Even Keynes thought the government should roll back spending and get budget deficits under control in better economic times.  But politicians are long past seeking his intellectual support.  They love to lecture business-people about greedy human nature, yet can’t turn that analysis on themselves.

Businesses and entrepreneurs create new things and build wealth.  Politicians redistribute that wealth.  And while some of what government does can help the economy, like providing defense or supporting property rights, the U.S. government has expanded well beyond that point.  Politicians have never been this reckless or fiscally irresponsible.

Whenever we say this, people ask; “what would you cut from the budget?”  And then, if you are actually brave enough to answer, you get attacked for “not caring.”

This needs to stop.  Illinois is in a death spiral.  Tax rate increases will chase more productive people out of the state, while ratcheting spending higher.  And just like Detroit and Puerto Rico, the state will go bankrupt.

The U.S. government is on this path, but, because it has the ability to fund itself with the best debt in the world, a true fiscal day of reckoning is still 15-20 years away.

Government spending needs to be peeled back everywhere.  It’s no longer a case of picking and choosing.  And until that happens, the fiscal irresponsibility of the government is the number one threat to not only America, but the world.

No matter what politicians tell us, any pain caused by private sector greed will pale in comparison to the mayhem that collapsing governments can create.  Just look at Venezuela or Greece!  It’s time to reset America’s fiscal reality.  And if that means debt ceiling brinkmanship, shutting down the government, or moving to a simple majority on spending decisions, so be it.  It’s time to get serious!

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

Approved for public use.  Thanks and have a great week!

Debt-Laden Companies? #FakeNews?

The following commentary is from Brian Wesbury, Chief Economist at First Trust, an innovative exchange traded fund (ETF) provider I use in some of my investment strategies.  I have found much of Brian’s commentary over the year to be helpful,  so I am sharing his most recent “Wesbury’s Comments”.  I hope you find it helpful too – Brian Dightman

Debt-Laden Companies? #FakeNews?

Remember the weak May payroll report – just 138,000?  Didn’t think so.  But, back then, that first report on May was reported as a massive economic slowdown that should stop the Fed from further rate hikes.

But the weak May number was due to a calendar quirk that led to an undercount of college kids getting summer jobs.  Payrolls jumped 222,000 in June, were revised up for May and, now, the two month average is 187,000.  That’s exactly the same as the average in the past twelve months and almost exactly the same as the 189,000 average in the past seven years.  In other words, the negative story from a month ago was misleading.

So, guess what?  The Pouting Pundits of Pessimism are pivoting!  It’s not jobs anymore, now it is “high debt levels among nonfinancial corporations.”  They say this happens near the very end of an economic expansion, so brace yourself.

It is true that nonfinancial US corporation debt is at a record high of $18.9 trillion.  It’s also true this debt is the highest ever relative to GDP.  But these companies don’t pay their debt with GDP.  They hold debt against assets and incomes.

Since 1980, nonfinancial corporate debt has averaged 44.9% of total assets (financial assets, real estate, equipment, inventories, and intellectual property).  Right now, these debts total 44.5% of assets, or slightly less than average.  The record was 50.6 in 1993.  Think about that, 1993 was right at the beginning of the longest economic expansion in US history.

Some say that the value of corporate financial assets is inflated by financial alchemy.  So, let’s take financial assets, which include record amounts of cash, out of the equation.

Before we do that, please realize that the financial assets of nonfinancial companies exceed total debts by $1.4 trillion, a record gap.  But let’s look at ratios without them, anyway.  The debt-to-nonfinancial asset ratio is at 85%.  This is right in the middle of the past 25-year range – roughly 74% to 95%.

Debt relative to the market value of these companies has averaged 82.2% since 1980 and currently stands at 80.0%.  If you calculate net worth using historical costs for their nonfinancial assets (instead of market value), the debt-to-net worth ratio is 121%, but has averaged 128% since 1980, 125% since 1990, and 119% since 2000.  Again, nothing abnormal.

What about interest payments?  The most recent data show that interest and miscellaneous payments are 11.2% of these companies’ profits versus an average of 13.2% since 1980, 12.2% since 1990, and 11.6% since 2000.  What happens if interest rates keep rising?  Less than you think.  Only 28% of the debt is short-term versus an average of 44% in the 1980s, 41% in the 1990s, and 33% in the 2000s.

None of this means the economy is safe forever.  Another recession is inevitable.  It’s just not coming anytime soon.  In the meantime, beware of stories that take one simple measure – like corporate leverage – and spin it pessimistically.

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

Approved for public use.  Thanks and have a great week!

Q1 Earnings Surprise

Q1 earnings are expected to come in much better than expected and upside revisions and upside earnings surprises are the primary drivers for Q1’s earnings growth rate.  The blended rate (combines actual results with estimated results not yet reported) of 12.5% as of Friday, April 28th for the S&P 500 is coming in well ahead of the 9% expected at the end of March.  Take a look at the report from Factset for more details.

Q1 earnings reports contrast with economic data for Q1 which remained soft in some areas.  The Big Four Economic Indicators was updated Monday, May 1st with the most recent (and very important) Personal Income data.  After adjusting for inflation the real number for Personal Income during March rose 2.8% year over year, which is near the high end for the last year.  The biggest improvement in the Big Four Indicators over the last year, however, has come from Industrial Production.  After peaking just over two-years ago the indicator entered a prolonged slide that flatlined 13-months back.  Only in the last 4-months have we seen it reverse course and move higher.

There was no question the economy was at risk of slipping into a recession as we approached the fall elections and it is reasonable to point out the economic improvements have been mild.  A soft Q1 real GDP growth of just 0.7% was disappointing.  It wasn’t all bad, looking at Core GDP which removes inventories, government spending and trade with the rest of the world, grew at 2.2% in Q1 and is up 2.8% from a year ago.

In terms of stock market performance, the last week of March was the strongest since January which sent the Nasdaq index to a new all-time high which is now over 6,000.  The race may be on for the Nasdaq to break-through the 10,000 level or the Dow to top 30,000. Maybe it will be the S&P hitting 3,000 first.  It will take some time and there is a chance we will have a recession or some other surprise event that will send stocks much lower before we reach the next big milestone for these indexes; it is also entirely possible that market will only experience normal corrections between now and new target levels.

We are also hearing a lot about an expensive and “toppy” stock market.  For those that hold this view they may find themselves watching this market move much higher before prices fall to “attractive” levels.  There is little evidence suggesting we are on the verge of a 2000 or 2008 type event.  There are issues with credit markets to be mindful of and there is always the risk a black swan event could materialize but a big market correction does not appear imminent.  That does not mean there aren’t clouds on the horizon.

What is apparent is the inability for Washington DC to get its act together.  There are huge problems with the U.S. Federal debt level and ongoing deficit spending is unsustainable.  Eventually something is going to give unless they get their house in order which seems more unlikely with each passing congress.  The percent of federal expenditures needed to make interest payments is an important area to watch.  The Wall Street Journal recently published an article highlighting how rising interest payments are already showing up in the federal fiscal year.  We are a long way from them being problematic but with ongoing deficit spending and interest rates slowly moving higher the clock is counting down.

Negligent politicians aside, one of the more exciting driving force in today’s economy and stock market is the amazing array of new innovation and scientific discoveries.  Entrepreneurs are busy delivering new solutions to our health, travel, and entertainment needs and creating new business in the process.  There is a new innovation index out that may be a promising investment for those looking to invest in companies targeting high-growth areas like web-based data & services, IT infrastructure software, consumer data and services, finance software & services, specialized semiconductors and more.  The investment currently holds 100 companies delivering a nice combination of diversification and focus and has a weighted market cap of only $30 billion which, compared to the $169 billion weighted average market cap of investments tied to the S&P 500 index, represents much smaller companies but still primarily in the large cap category.   Let me know if you are interested in learning more.

While the stock market is rising some categories of stocks might represent better long-term opportunities based on structural changes in the economy.  If this is something you have thought about but not acted on, let’s have a conversation.