Implications:  No matter which way you slice it, industrial production finished 2024 on a surprisingly strong note. Activity jumped 0.9% in December, beating even the most optimistic forecast of any economics group surveyed by Bloomberg.  Meanwhile, data from prior months were revised up as well, and when included brought the headline gain to 1.2%. At first glance it is easy to chalk this up to one-off effects from the long-anticipated resolution of the Boeing strike. However, the Federal Reserve points out that only 0.2% of today’s headline gain came from the machinists going back to work. Given that this report represents the month immediately after the Presidential election, there may be a “Trump Bump” showing up in the December data as businesses got certainty on the election results and can look forward to an easier regulatory environment in the next four years, as well as lower tax rates on profits.  The details in today’s report were also strong.  Overall, manufacturing output rose a 0.6%.  However, production in the volatile auto sector actually fell 0.6% in December. That means that non-auto manufacturing (which we think of as a “core” version of industrial production) drove activity, increasing a very healthy 0.7% in December. One notable bright spot in this “core” measure came from the production in high-tech equipment which rose 1.1% in December, likely the result of investment in AI as well as the reshoring of semiconductor production.  High-tech manufacturing is up 8.0% in the past year, the fastest for any major category.  The mining sector was also strong in December, rising 1.8%.  Gains in oil and gas production and the extraction of other minerals and metals more than offset a decline in the drilling of new wells.  Look for more gains in that sector in 2025 as the incoming Trump Administration takes a more aggressive stance with permitting.  Finally, the utilities sector (which is volatile and largely dependent on weather) also posted an increase in December, jumping 2.1%.

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Implications:  Housing starts finished 2024 on a high note in what was otherwise a rather dismal year for homebuilders.  Starts rebounded in December, surging 15.8% to a 1.499 million rate, topping even the most optimistic forecast from any economics group surveyed by Bloomberg.  Looking at the details, the gain in starts was broad-based, with both single-family and multi-family increasing, and three out of four regions contributing.  However, the often-volatile category for multi-family homes was the main driver of the increase, rising 61.5% in December, but still down 8.4% in the past year.  Meanwhile, overall housing starts are down 4.4% in the past year, with single-family starts down 2.6%.  It appears that part of the reason why starts have lagged this year is due to homebuilders focusing on completing projects.  Housing completions declined 4.8% in December but ran at a 1.626 million rate in 2024: the fastest pace for a calendar year since 2006.  With strong completion activity and tepid growth in starts, the total number of homes under construction continues to fall, down 14.8% in 2024.  That type of decline is usually associated with a housing bust or recession, but we don’t see it happening any time soon.   Homes were started at a 1.365 million rate in 2024, well below the 1.5 million plus pace we believe is needed to keep up with population growth and scrappage (due to both voluntary knockdowns as well as disasters like fires, floods, hurricanes, and tornados.)  And with the brief exception of COVID, the US has consistently built too few homes almost every year since 2007.  As a result of the shortage of homes, we think housing is far from a bubble, and expect housing prices to continue higher in 2025 in spite of some general broader economic headwinds.  In other words, look for modest improvement in housing in the year ahead even as the rest of the US economy slows down.  For more on the housing market, please see this week’s Monday Morning Outlook.  In other recent housing news, the NAHB Housing Index (a measure of homebuilder sentiment) ticked up to 47 in January from 46 in December.  A reading below 50 signals a greater number of builders view conditions as poor versus good.

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Implications:   Retail sales missed expectations in December, rising 0.4% for the month.  The good news: when factoring in revisions, sales rose a consensus expected 0.6%, and the advance  was broad-based, with ten out of thirteen categories moving upward.  The bad news: much of the rise in December can be attributed to inflation; “real” (inflation-adjusted) retail sales rose just 0.1%.  Looking at the details of the report, the gain in December was led by a 0.7% increase in autos, which followed jumps of 3.1% and 2.2% in the previous two months.  Auto sales were up 8.4% in 2024, the biggest advance for a calendar year since 2021. This was partially offset by a 2.0% drop for building materials, the largest decline for the category since January.  We like to follow “core” sales, which strips out the often-volatile categories for autos, building materials, and gas.  That measure rose 0.5%  in December and was revised higher in previous months.  These sales were up at a solid 5.6% annual rate in the fourth quarter versus the Q3 average.  Within the core sales grouping, sales at restaurants and bars dropped 0.3%, the first decline in nine months.  Restaurant and bar sales were up 2.4% in 2024, a notable slowdown from the 11.4% increase in 2023.  We will be watching this category closely since it is the only glimpse we get at services in the retail sales report, which suffered heavily during the COVID years but have since returned to the forefront of the US consumer.  As a whole, retail sales are up 3.9% on a year-to-year basis.  “Real” inflation-adjusted retail sales are up 1.0% in the past year but still down from the peak in early 2021.  This highlights the ugly ramifications of inflation: consumers are paying higher prices today but taking home fewer goods than they were three years ago.  And while the Fed has cut interest rates a total of 100bps since September, it is not at all clear that inflation problems are behind us.  We hope they have the resolve to stomp out the embers of inflation even if economic troubles come.  In other news this morning, initial jobless claims rose 14,000 last week to 217,000, while continuing claims dropped 18,000 to 1.859 million.  These figures are consistent with continued job growth in January, but at a slower pace than the year before.  On the manufacturing front, the Philadelphia Fed Index, a measure of factory sentiment in that region, jumped to 44.3 in January – the highest level since April 2021 – from -10.9 in December.  Finally on the trade front, import prices rose 0.1% in December while export prices rose 0.3%.  In the past year, import prices are up 2.2% while export prices are up 1.8%.

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The stimulus bills approved by Congress starting in 2020 led to the largest surge in government spending in history, coinciding with a sharp rise in inflation. This has led many to assume that government spending itself caused inflation. But is that assumption correct? In today’s “Three on Thursday,” we explore whether government spending inherently leads to inflation.

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Implications:   Inflation picked up in the last month of 2024, proving that the Federal Reserve’s battle is still far from done.  Consumer prices jumped 0.4% in December (+4.8% annualized), matching expectations, while the twelve-month reading rose for a third month in a row to 2.9%.   The rise in December was led by energy prices, which rose 2.6% due to a 4.4% jump in gasoline prices.  However, it’s important to note that rising energy prices are not what’s kept inflation from returning back to the Fed’s 2.0% target; energy prices were down 0.5% in 2024.  Stripping out energy and the other often-volatile category for food does not improve the inflation picture.  “Core” prices rose 0.2% in December, below the consensus expected +0.3%, but that’s still a 2.7% annualized rate, meaning the pace is still above the Fed’s target.  Core prices were up 3.2% in 2024 versus a 3.9% gain in 2023.  The main driver of core inflation has been housing rents, which rose 0.3% in December.  Some analysts – including those at the Fed – have argued that housing rents have artificially boosted the inflation picture due to the way it’s measured and the lags at which those changes are reflected in the monthly reports.  But a subset category of prices the Fed used to tell investors to watch closely but no longer mentions – known as the “Supercore” – which excludes food, energy, other goods, and housing rents, rose 0.2% in December and are up 4.2% in the last year, worse than the 3.9% reading in 2023.  No matter which way you cut it, inflation is still running above the Fed’s 2.0% target.  And yet, the Fed has cut rates a total of 100bps since September, while the embers of inflation continue to burn.  It remains to be seen whether the Fed will have the resolve to keep monetary policy tight until inflation reaches 2.0% or less on a consistent basis.  In other news this morning, the Empire State Index, which measures manufacturing sentiment in the New York region, dropped to -12.6 in January from +2.1 in December.

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Implications:  Producer prices ended 2024 on a calmer note, but a trend higher in year-ago comparisons will have inflation front and center for the Fed once again in 2025.  Producer prices rose 0.2% in December, coming in below expectations, but – at 3.3% higher than a year ago – remain notably above the Fed’s 2% inflation target, and are also running above target when looking at three-month and six-month annualized rates.  The rise in December was led by energy prices, which jumped 3.5% in December due to a 9.7% surge in gasoline prices, while food prices declined 0.1% following a jump in November.  The food and energy categories have played an outsized role in recent months, and when you strip out these historically volatile components, “core” producer prices were unchanged in December but are up 3.5% in the past year, a notable acceleration from the 1.8% reading for the twelve months ending December 2023.  Diving into the details of today’s report shows “core” prices saw a mix of offsetting activity.  Within services, prices for transportation and warehousing services rose 2.2% in December, but were offset by declines in margins received by wholesalers.  On the goods side, prices outside of energy were muted, with little to no movement across a broad range of goods.  Further back in the supply chain, prices in December rose 0.3% for intermediate demand processed goods and jumped 3.2% for unprocessed goods.  The direction of inflation moving forward is very likely to be dictated by 1) the services side of the economy, which suffered heavily during the COVID shutdowns but has since returned to the forefront and 2) changes in the money supply, which, after surging in 2020-21, peaked in early 2022. Although the M2 measure of money has been rising gradually since last December, it’s still down from the peak in April 2022.  An epic battle to stem government spending is likely to unfold in Washington this year, and there is a very real risk that the Fed could get overly aggressive in cutting rates if a pullback in federal spending temporarily results in slower economic growth.  In turn, lower interest rates could fan the embers of inflation, re-igniting the fire that the Fed has spent the last three years trying to extinguish.

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If you’re going to remember one important fact about the housing market, it’s that with the brief exception of COVID, the US has consistently built too few homes almost every year since the housing bust got rough in 2007.

For the first few years during the housing bust the underbuilding of new homes made perfect sense.  We built way too many homes during the housing boom, generating a massive amount of “malinvestment” in response to perverse government incentives that included having Fannie Mae and Freddie Mac buying enormous amounts of subprime debt.

But the underbuilding continued long past the point when the excess inventory was gone.  Back in November, the most recent reported month, builders started homes at a 1.289 million annual rate, well below the 1.5 million plus rate that we believe is needed to keep pace with population growth and scrappage (due to both voluntary knockdowns as well as disasters like fires, floods, hurricanes, and tornados.)

As a result of the shortage of homes, we expect housing prices to continue higher in 2025 in spite of some general broader economic headwinds.  The national Case-Shiller index for home prices was up at a 3.7% annual rate in the first ten months of 2024 (through October) and we expect a similar pace of increases again in 2025.

In terms of construction, housing was a mixed bag in 2024.  Single-family housing starts were probably up about 6% last year versus 2023 (we will get December figures on Friday morning), but multi-family starts plummeted about 25-30% to the slowest pace in about a decade.  However, it’s hard to see multi-family starts continuing to drop in 2025 – they’re already so low!  We expect a slight rebound in multi-family and continued gradual increase in single-family starts.

In turn, some more construction should help boost new home sales modestly, as well.  New home sales were up 2% in 2024 versus 2023 and we foresee a similar modest gain in 2025.

Existing home sales, however, run on different dynamics and should just tread water versus the roughly 4.05 million annual rate of 2024.  Builders of new homes can shift to lower-priced models with fewer features in the face of higher mortgage rates or economic weakness.  But existing homes are already built and often have to be priced high enough to entice homeowners who borrowed money at rock-bottom mortgage rates in 2020-21 to sell.

To summarize, housing is far from a bubble. And there are so many other factors affecting housing that we think the sector would even weather a recession.  Put it all together and we have a recipe for modest improvement in housing even as the rest of the US economy slows down.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:  The labor market finished 2024 on a stronger note, with more jobs, lower unemployment, and solid growth in wages.  The problem is that the continued strength in job growth suggests monetary policy wasn’t tight enough for long enough to consistently bring inflation to the Federal Reserve’s 2.0% target.  That, in turn, means investors should not expect any more rate cuts for at least the next few months and potentially much longer.  Nonfarm payrolls rose 256,000 in December, beating the consensus expected 165,000.  We like to follow payrolls excluding three sectors: government, education & health services, and leisure & hospitality, all of which are heavily influenced by government spending and regulation (that includes COVID lockdowns and re-openings for leisure & hospitality).  This “core” measure of jobs rose 100,000 in December, besting the 45,000 monthly average of 2024.  Meanwhile, civilian employment, an alternative measure of jobs that includes small-business start-ups, rose 478,000.  This growth in employment, which outstripped a 243,000 increase in the labor force (people who are either working or looking for work) helped push the unemployment rate down to 4.1% in December from a previous 4.2%.  Average hourly earnings rose 0.3% in December bringing the gain in 2024 to 3.9%, while total hours worked rose 0.2% in December and 1.0% for 2024.  Combined, more hours and more earnings per hour translate into more purchasing power for workers as a whole.  One key question is the gap between the payroll and civilian employment surveys.  Payrolls are up 2.2 million in the past year while civilian employment is up only 0.5 million.  This gap may be related to the surge in immigration in the past few years; the payroll survey would pick up a worker using a fake ID but that same worker would be reluctant to answer the employment survey which goes to households (if the government even knows about that household’s presence in the US).  However, the gap could also be a sign that the payroll survey has overestimated job growth and a harbinger of slower job growth or even a contraction in jobs ahead.

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This week’s edition of “Three on Thursday” looks at the S&P 500 Index in 2024. For 2024, the S&P 500 Index delivered a total return of 25.0% coming on the back of a 26.3% gain in 2023. Serving as a benchmark for the broader stock market, many investors found themselves disappointed as their portfolios did not experience comparable growth last year, falling short of the 25% Index return. For more insights, click on the link below.

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Implications:  After a shaky first half the ISM Services Index closed the year on a solid note by beating consensus expectations and rising to 54.1 in December.  The continued resilience in the service sector represents a stark contrast to the manufacturing sector which has been limping along the last two years.  Looking at the details of the report, fourteen out of eighteen major service industries reported growth in the month while three reported contraction (Mining, Real Estate, and Educational Services).   The rise in the overall index was driven by higher business activity and new orders, as both of these categories rose in December and sit firmly in expansion territory, at 58.2 and 54.2, respectively.  The majority of survey comments impart a positive outlook for the year ahead, while some report they are holding off on capital projects until they have a better idea of future policy from the incoming Trump administration.  Meanwhile, hiring in the service sector appears balanced, with the employment index little changed at 51.4, and an equal number of industries (five) reporting an increase versus a decrease in employment for the month.  Finally, and perhaps most important, inflation remains a major problem.  The highest reading for any major category was once again the prices index, which rose to 64.4 – the highest level since early 2023. Survey comments continue to voice concern over potential tariffs and uncertainty with how that will impact future pricing.  But it’s important to remember inflation was already a problem before any new tariffs; case in point, fourteen major industries reported paying higher prices in December while just one reported paying lower (Agriculture, Forestry, Fishing & Hunting). And while monetary policy is tight (the M2 measure of the money supply is down 1.3% from its peak in early 2022), it is less tight than it was before the Federal Reserve began cutting rates in September.  We believe there are serious risks that an overly aggressive path of cuts and/or the Treasury dipping into the Treasury General Account in response to the debt ceiling (more here) could bring with them a pickup in the M2 measure of money, and with it a return of higher inflation. As for the economy, the service sector continues to be a lifeline for growth.

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