Implications: Existing home sales continued to struggle in April, eking out a small gain but remaining near the lows of the past several years.  Looking at the big picture, sales remain at roughly the same pace as in the aftermath of the Great Financial Crisis and are well below the roughly 5.250 million annual pace pre-COVID (let alone the 6.500 million pace during COVID).  The main issue remains affordability which has taken a turn for the worse recently due to the war on Iran raising energy costs and having an upward impact on inflation.  The result has been a rapid increase in 30-year mortgage rates, which now sit around 6.4%. Higher inflation also takes further rate cuts from the Federal Reserve off the table for at least the near future. Buyers also face an ongoing headwind from tight inventories; the months’ supply of homes (how long it would take to sell existing inventory at the current very slow sales pace) was 4.4 in April, below the benchmark of 5.0 that the National Association of Realtors uses to denote a normal market.  Many existing homeowners also remain reluctant to sell due to a “mortgage lock-in” phenomenon, after buying or refinancing at much lower rates before 2022.  This means potential buyers will have to continue to deal with limited options.  Existing home sales also face significant competition from new homes, where in many cases developers are buying down mortgage rates to compete and move inventory. One piece of good news is that the median price of an existing home is up only 0.9% versus a year ago. Aggregate wage growth (hourly earnings plus hours worked) has been consistently outpacing median home price gains over the past year for the first time since 2023, which improves affordability. Considering these cross currents, and the fact that existing home sales have been stuck in low gear since the end of the COVID pandemic, we expect 2026 to likely be more of the same.

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The stock market is on an absolute tear, with the Nasdaq up 5% last week and nearly 13% year-to-date.  The proximate causes include a cease-fire somewhat holding with Iran, a 28% surge in S&P 500 corporate profits in the first quarter, and some consensus-beating economic reports, like Friday’s payroll numbers.

We have been cautious on this market…and overly pessimistic up to this point.  So, should we rethink that? Should we become more optimistic about stocks?

The optimistic case was summed up in an X post by James E. Thorne at Wellington Altus who said there is a “systematic underestimation of an AI-driven productivity revolution…a Cap Ex Super Cycle, [an administration that is] letting the economy run hot, and multiple expansion [due to] a Peace Dividend.  History suggests that when productivity waves coincide with supply-side policy and geopolitical de-escalation, as in the 1990s, both earnings and multiples expand beyond historical norms.”

Let’s go through this list one item at a time.  1) Is AI really driving a productivity boom?  According to McKinsey, 88% of companies say they use AI in at least one business function, but just 7% say they have expanded its use enterprise wide.  As far as we know, there are little data showing a direct correlation between AI and profitability.  While many could surmise this, it remains a forecast.  And, while, capex is growing, it is concentrated in (or related to) data centers.  Excluding that, investment is weak.  A Super Cycle is an exaggeration.

Events in the Middle East are certainly promising.  Having the UAE exit OPEC is a big deal.  It suggests a more “go it your own way” free market world, not one divided into factions.  However, Iran seems a long way from being willing to accept this reality and we are not convinced a “peace dividend” is really in the cards.  We hope and pray that it is, but we haven’t seen a Peace Dividend or full-blown geopolitical de-escalation yet, just hope.

Finally, are we really in a Supply Side revolution?  Well, Reagan cut the top income tax rate from 70% to 28%.  Other than tax cuts for tips, social security, and overtime, the top tax rate is the same today as it was last year, and will be next year.  Overall government spending has been flat, which means it is declining as a share of GDP, but Congress has yet to pass a budget that promises continued spending restraint in the future.

Regulation has been reduced, but could be expanded again if a more pro-regulation president gets elected in 2028.  Virginia is a perfect example…the new governor is trying to reverse the direction of policy put in place under the previous governor.  Recent spending and regulatory restraint don’t pre-commit future presidents and congresses to the same policies.

So, while many positive developments are taking place, the idea that we are entering into a long-term secular bull market seems a stretch.  The PE ratio on trailing earnings of the S&P 500 is currently near 29.  When Reagan entered office and cut both tax rates and spending, and broke the back of inflation, the PE ratio was 8.  Even if policies today were equally as good, the same kind of boom should not be expected.

We aren’t pessimistic even though it might sound that way.  The US (as it has done for 250 years) is pushing back against feudalism in all its forms.  At the same time, AI is a transformative technology.  But it will take time for these things to fully play out, and we think markets are underestimating the time, energy, and volatility it will take.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications: Solid labor market, but not without some blemishes.  Nonfarm payrolls rose 115,000 in April and 99,000 including downward revisions for prior months – either way beating the consensus expected 65,000.  Meanwhile, the unemployment rate remained at a relatively low 4.3%.  The job gains in April itself were led by health care & social assistance, transportation & warehousing, and retail.  Total hours worked in the private sector rose 0.3%.  We like to follow payrolls excluding government and health care & education (which are often driven by government policies), which rose 77,000 in April.  Notably, federal payrolls were down 9,000 in April.  Compared to January 2025, federal payrolls excluding the Post Office and Census are down 337,000, or 14%.  Leaving out the end of the Census every decade, the decline in federal payrolls in the past fifteen months has been the steepest since the wind-down from World War II. Over time, we think a smaller federal government will help boost growth in the private sector.  However, not all the details were as robust as the headlines.  For example, although they rose in April, payrolls excluding government and health care & education are down 107,000 from a year ago.  Civilian employment, an alternative measure of jobs that includes small-business start-ups, dropped 226,000 in April.  That series can be volatile month-to-month but is worth watching.  Yes, the unemployment rate was steady, but that was due to a 92,000 decline in the labor force (people working or looking for work), which ticked the participation rate down to 61.8%, the lowest since 2021.  Average hourly earnings rose a tepid 0.2% in April, which is very likely below the pace of inflation for the month.  Put it all together and we expect continued jobs gains in the months ahead but at a noticeably slower pace than the headline 115,000 for April.  In other recent news, initial jobless claims rose 10,000 last week to a still-low 200,000; continuing claims declined 10,000 to 1.766 million, also low.  Construction increased 0.6% in March after a 0.2% dip in February, with the net gain for those two months led by single-family home building.  Productivity (output per hour) increased at a 0.8% annual rate in Q1 and is up 2.9% from a year ago, a good sign versus the long-term trend of about 1.5%.  Unit labor costs increased at a 2.3% rate in Q1 but are up a mild 1.2% in the past year.  

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In Fiscal Year 2025, a staggering 69% of federal spending was allocated to payments to individuals, near the highest share ever recorded. In this week’s “Three on Thursday” we look at the composition and evolution of federal spending over history, and how the Federal Government has become not much more than the world’s largest money transferring machine. For deeper insights, click the link below.

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Implications: We got another double dose of data on new home sales this morning, and it looks like activity has bounced back sharply since January when severe winter weather caused the largest monthly decline since 2013. Sales rose 8.9% and 7.4% in February and March, respectively, and now sit at a 682,000 annual rate.  However, the overall trend in sales remains around pre-pandemic levels, which has been a ceiling of sorts for activity the past couple of years.  Unfortunately, the Iran War and its expected impact on energy prices and inflation have introduced new challenges. First, financing costs have recently spiked in response, with the average 30-yr fixed mortgage rate up roughly 30 basis points since the start of the conflict.  Second, despite a new Chairman at the Federal Reserve, further rate cuts are likely on hold for the time being. But while buyers are unlikely to get much help from interest rates, the good news is that prices have been trending lower for new builds in the past several years. Median sales prices are down 16% from the peak in October 2022.  The Census Bureau reports that from Q3 2022 to Q4 2025 (the most recent data available) the median square footage for new single-family homes built fell 9.7%. So, while part of the drop in median prices is due to smaller/lower-cost homes, there has also been a drop in the price per square foot.  This is partially the result of developers offering incentives to buyers in order to move inventory. Supply has also put more downward pressure on median prices for new homes than existing homes.  The supply of completed single-family homes is up 300% versus the bottom in 2022 and is currently at the highest level since 2009. This contrasts with the market for existing homes, which continues to struggle with convincing current homeowners to give up the low fixed-rate mortgages they locked-in during the pandemic to list their homes. While financing costs remain a headwind, less expensive options and an abundance of inventories may give home sales a modest boost in 2026.

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Implications:  Activity in the service sector expanded once again in April, although at a slightly slower pace than in recent months, as the ISM Services Index declined to 53.6 from 54.0. The slowdown was largely due to a retreat in new orders as elevated input prices stemming from the conflict in Iran have encouraged service companies to suspend purchases until stability returns.  Looking at the details, growth broadened in April with fourteen out of the eighteen major service industries reporting growth (compared to thirteen in March), while three reported contraction and one remained unchanged. The major measures of activity were mostly higher. The business activity index rose to 55.9 from 53.9, while the new orders index retreated to 53.5 after climbing to its highest level in more than three years in March.  That said, both the business activity index and the new orders index have shown expansion in at least eleven out of the last twelve months. Although growth continues at a solid pace, survey comments reveal caution surrounding higher input costs being passed through to service companies.  As a result, companies which began to increase hiring efforts at the start of the year have since brought hiring efforts to a standstill. After starting the year in expansion, the employment index fell to 45.2 in March, but rose in April to 48.0 – still contractionary, but at a more modest pace.  Unfortunately, the highest reading of any index was once again the prices index, which remained at 70.7 in April, matching the highest level since October 2022. Though the index remains elevated, it is still well below the worst we saw during the COVID supply-chain disruptions, when the index reached the low 80s. While the ongoing war in Iran is expected to affect input prices in the short-term, we will continue to monitor the M2 money supply – which has grown slowly over the last 3+ years – for whether these signals turn into long-term inflationary pressure.

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Implications: The trade deficit widened slightly to $60.3 billion in March, continuing its break of volatility that dominated trade reports for much of last year.  Despite the small movement in the deficit, there was plenty of activity behind the scenes: exports rose by $6.2 billion, led by crude oil and other petroleum products, as domestic producers moved to fill the void left by the war-driven closure of oil flows through the Strait of Hormuz.  The increase in exports was more than offset by a $8.7 billion increase in imports, led by autos and computer accessories. We like to focus on total volume of trade, exports plus imports, as it shows the extent of business and consumer interaction across the border. That measure increased by $14.9 billion in March but remains roughly flat from a year ago.  While total trade volumes have seen little change over the past year, the mix has improved for domestic producers, with exports rising 13.3% and imports falling 9.0% over the past year.  Meanwhile, the landscape of global trade continues to evolve. China, once the dominant exporter to the U.S., has slipped to a fourth place behind Mexico, Canada, and now Taiwan, with exports to the U.S. down 40.7% in the first three months of 2026 compared to the same period last year.  Accelerated demand for high tech equipment to fuel the massive AI investment stands out in the data with imports from Taiwan up 97.9% over the same period.  Also in today’s report, the dollar value of U.S. petroleum exports once again exceeded imports, with the U.S. posting its largest petroleum surplus on record in March, marking the 49th consecutive month of America being a net exporter of petroleum products.  Keep in mind petroleum products include refined products like gasoline, diesel, and propane – all of which the U.S. exports in large volumes. When looking at crude oil alone however, the U.S. remains a net importer (although not as much as in prior decades), largely due to domestic refinement capabilities.  In other recent news, cars and light trucks were sold at a 15.9 million annual rate in April, down 1.5% from March and 7.1% below the level from a year ago.

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Kevin Warsh wants to make some big shifts in monetary policy at the Fed.  Unfortunately, unless and until soon-to-be former Chairman Jerome Powell steps down from his regular seat on the Federal Reserve Board, Warsh will be Chairman in Name Only.

One new policy Warsh wants is to shorten up the maturity structure of the Fed’s assets, getting it out of the business of holding longer-term securities.  Another is to shift away from holding mortgage-backed securities and focus on Treasury securities only.

Even more important, Warsh wants the Fed to unwind Quantitative Easing, a policy he originally supported back in 2008-09 in the midst of the so-called Global Financial Crisis, but apparently later came to oppose – or at least oppose to the extent the Fed has made it a permanent feature of monetary policy rather than a temporary measure.

To successfully unwind QE it’s likely the Fed would also have to end the policy of paying banks interest on reserves, which means a Warsh chairmanship holds out the hope of eventually taking us back to a monetary regime where policy is implemented through scarce reserves rather than abundant reserves.  

The problem is that even though Warsh will become Chairman soon, Powell has announced he will keep his board seat for at least the time being.  Reports suggest he is only doing so temporarily but will depart that seat – which would open-up another position for President Trump to fill – as soon as the Administration commits with “finality and transparency” to ending the Justice Department’s investigation of the Fed. 

But as long as Powell stays it will be tough for Warsh to shift policy at the Fed, either the long-term policies we outlined above or even shifts to short-term interest rates.  The Fed bank presidents would still be the old Powell-approved presidents and likely with him on policy, not with Warsh.  And the Powell faction at the Fed would still have four votes on the Board versus only three for Warsh.

Which brings us to another reason Powell may end up trying to stick around longer, maybe even all the way until January 31, 2028, when his term as a board member fully runs out.  If Powell leaves before then and Trump replaces him on the board, the Trump-appointed board majority could then threaten to fire Fed bank presidents who oppose them.  Yes, the courts have made it tough for Trump himself to fire board member Lisa Cook, but the courts would have a tougher time protecting bank presidents from a board majority.

In the meantime, Warsh, as official chairman, could try to speed Powell’s departure by making his life at the Fed uncomfortable: maybe take away his parking space and staff plus put his office in the basement.  But the decision to leave would still be Powell’s until January 2028.   

Based on Powell’s statements about trying to protect Fed “independence” from politics, preventing Trump from getting a board majority may be an ulterior motive for Powell to stay, which means the policy shifts supported by Warsh could be on the back burner for some time to come.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications: Activity in the manufacturing sector continued to expand in April, matching the pace from the previous month at 52.7, which is the fastest since 2022. The expansion comes in spite of numerous headwinds facing the industry, such as elevated prices and longer supplier delivery times due to the closure of the Strait of Hormuz. While we were cautious the improved performance to start 2026 would be a “head-fake” similar to what we had in 2025, this is now the fourth straight month of expansion in manufacturing, signaling solid underlying growth in the sector. Looking at the details, growth remained broad in April, with thirteen out of the eighteen major manufacturing categories reporting expansion, while three reported contraction, and two reported no change.  The major measures of activity were mixed: the index for new orders rose to 54.1 from 53.5, while the production index declined to 53.4 from 55.1, but both remain in solid expansion territory, signaling growth.  It’s important to remember that order books have been very weak since 2023, and manufacturers had to rely on their order backlogs to keep production going.  The great news is that backlogs started growing again 2026, with the index sitting at 51.4 in April – now the fourth consecutive month in expansion territory – when before it had contracted for 39 straight months going back to September 2022.  Despite the meaningful improvement in demand, it has not been enough to spark increased hiring efforts in the industry. The employment index fell once again to 46.4 in April, now the 31st consecutive month of contraction. Even worse was the acceleration of pricing pressures, with the prices index jumping up to 84.6 – significantly higher than the 59.0 registered in January, and nearing the peak following the post-COVID inflation surge, where the index reached the low 90s. With the ongoing conflict in Iran and the February Supreme Court ruling against many of the Trump Administration’s tariffs, followed by their replacement by other tariffs, we expect volatility to continue in this category in the months ahead.

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Even though the United States is often described as “energy independent” and remains a net exporter of petroleum products, that hasn’t shielded American consumers from rising gasoline prices amid the conflict with Iran. In today’s “Three on Thursday,” we take a deeper look at the reasons behind this. For more insight on this topic, click the link below.

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