Wed, 17 Jul 2013
Negative second-quarter GDP growth is not out of the question, says Morningstar's Bob Johnson, but the third and fourth quarters should rebound.
Jason Stipp: I'm Jason Stipp for Morningstar.
Recent data suggests that second-quarter GDP could look quite weak, and might even be negative. Here to explain the data and how you should view a bad GDP number is Morningstar's Bob Johnson, our director of economic analysis.
Thanks for being here, Bob.
Bob Johnson: Great to be here.
Stipp: We got some data this week that, for you anyway, suggest we could see a real headwind on second-quarter GDP. This comes also on [top of] some general worries that GDP would be lower in the second quarter than the first quarter. What did we see this week though that suggests even more pressure?
Johnson: Well, there were several things. There was the retail sales report on Monday, and it suggested that retail sales were considerably below expectations. We grew 0.5% instead of the expectation of 0.9%. It was still a relatively healthy number, but it was indeed driven a lot by the auto industry. So that's really helped the number along a little bit. So that was certainly the one piece of data that we got that was a headwind.
Stipp: And that's for June?
Johnson: That's for the month of June.
Stipp: We also got inflation data that added some further worry about that retail sales number.
Johnson: The 0.5% [growth in retail sales] sounded OK, fine--I didn't get my 0.9%, but 0.5% sounds pretty good. Well, it looked a lot less good on Tuesday when we got the CPI report. The CPI showed that inflation grew 0.5% in the month, and so if you put the two numbers together, it means we really didn't have any retail sales growth in the month of June.
Stipp: And housing, which so many folks are holding great hope for, also might not be as big of a help for GDP as we would've anticipated.
Johnson: There were some issues there, too, which really came as quite a surprise. The housing starts and permits came out [Wednesday] morning, and those numbers were really quite a bit weaker than everybody thought. It's going to be hard now to get to our 1 million target for housing starts for the full year, because we were so much below. Now, some of that was volatile apartment buildings, but the single-family [starts are] not racing to offset the difference. It's kind of staying relatively steady-state.
Stipp: So let's talk about how bad that second-quarter GDP number could look. First quarter we had 1.8% GDP. Consensus for the second quarter is below 1%, and you're saying it could even be pretty far below 1%, possibly even negative. So let's talk about how we get there. The first one, the biggest [component] of GDP is consumption. We had 2.4% consumption growth in the first quarter, and we're expecting it to be less than that in the second quarter.
Johnson: As I look at the numbers, putting the retail sales numbers and the inflation number together and having relatively limited retail sales in June, it looks like consumption growth will be around 1.5%, somewhere in the band of probably 1.4% to 1.6%.
Now you have to apply to that, as you mentioned, [consumption] is about 70% of the economy, so when you do that, … if the only thing in [second-quarter GDP] that moved was consumption, we'd be at about 1%, maybe 1.1% GDP figure.
Stipp: Then we move on to the second component, which is business investment, and here you say the news is mixed. We could have some things that help that number and then some things that hold that number back.
Johnson: On the business investment side, the news is really not so good. The construction numbers have been in a little bit of a plateau and maybe have even backed off a little bit. Part of it is because … spending on retail stores [has been lackluster]; [retailers] have been generally decreasing, not increasing, the number of stores they have, and mall building certainly isn't lighting the world on fire right now. So … the numbers for commercial real estate are going to be off a little bit, and that will depress GDP.
And even spending on capital goods and equipment and software will not look particularly robust. It's not a particularly good part of the product cycle right. There isn't a new operating system, a brand-new computer that you have to own, and business confidence isn't exactly at an all-time high with what's going on in Europe and now even China slowing.
So I would suspect that you're not going to get much positive or negative from business investment spending, net, when you add it all up.
Stipp: Then inventories is also wrapped up in business investment, and that can sometimes be a wildcard.
Johnson: That's what started the fire last week for everybody to reduce their [GDP forecasts], because in the way that GDP is calculated, it's meant to be a production number. Instead of asking each factory how much they produce, they ask consumers how much they buy, and then they subtract out the difference, the change in inventories. So that's why inventories, even though it sounds like a weird category to count, it's very important to count if what we're trying to measure is production, and production is what drives employment. So that's why it's so important to do that. Certainly, what we've seen so far is not particularly good [for inventories].
Stipp: So business investment is 15% of GDP, and it looks like there could be a mixed picture there.
Moving on to government, which is 20% of GDP, I don't think anyone's expecting government to really be a big contributor.
Johnson: No, but it was a huge detractor in the first quarter. I think there is a lot of hope that that number would bounce back to at least zero in the second quarter. And I tell you, I don't see it in what I've seen so far.
In last week's video we talked at length about the budget deficit, and we indicated there was a lot more tax collection and also less government spending. Now, the seasonal adjustment factors, especially on the government data, are really hard to calculate. But it sure doesn't look to me like we're going to get a lot better than the 0.9% subtraction that we had the last time around. Really the last time around we hadn't seen huge impacts from the sequester yet. So I'm very worried about that. Remember, if consumption was only going to grow 1% [in the second quarter], and we're talking somewhere between minus 0.5% and 1% on government, that's how you can potentially get to the negative number.
Stipp: Then the last piece is imports and exports, and the balance of trade, which in May did not look good; it was a detractor potentially from GDP there. So, we don't have the June numbers, but it could be a wildcard. If it looked similar to May, that's one of the things that could push us into negative territory potentially for the quarter?
Johnson: That's exactly right, and May was just a pretty terrible-looking number. It was weird stuff that really may not impact the real production capability of the U.S. economy. It was a lot of gold, diamonds, artwork type of stuff that kind of blew up the number. But nevertheless, we did see a huge increase in the deficit, and that would indicate to me that exports could take off 0.2%-0.3% from the GDP report. So certainly not any help there. Now, the last June estimate is not available from the Census Department yet. So the other government departments have to estimate what it is, and so what they estimate for the June month is going to be critical, and nobody knows what they're going to estimate.
Stipp: So we're going to get this first read on second-quarter GDP at the end of the month. If it looks bad, how should we interpret that number? You've walked through some of the factors that could be behind it. Is this is a soft patch, bad-looking number, or is this a number that we really need to be worried about where the economy is headed if it falls pretty far below that 1%?
Johnson: With the payroll tax [increase] and a number of things, I think the second quarter is going to end up being the key quarter for pressure on the consumer. I think everybody thought it was going to be right away in January, and people forget it takes a while for all of the effects to seep through. So I think it is probably going to end up being the worst effect on consumption. I really think it is, and I think that we'll probably bounce back after that.
I think we're still in the trend line of 2% growth, but this is going to be one quarter that's going to fall slightly below that, and somewhere we'll have one that runs slightly above that. There are a few statistical things, so forewarned is forearmed. As I mentioned, there were some unusual things in imports/exports that may relatively quickly reverse themselves. If it was buying machinery or buying farm products, I might be a little bit more worried. But being that [it was] volatile gold and artwork type of things that were moving the number around [in May], it could bounce back just as quickly, or at least be less negative. So that has a better outlook for the second half of the year.
Stipp: You say the consumer is soft. We are seeing softness in consumer spending. But it might not be as bad as the second-quarter GDP report might suggest.
Johnson: It's probably going to be a tough-looking number, for the reasons that we had talked about earlier: the high inflation rate compared to a relatively decent top-line number. Unfortunately, that inflation number was a little bit inflated. We got that [inflation data] this week, and two-thirds of it was driven by an increase in gasoline prices, and we really didn't have an increase in gasoline prices. It's just the seasonal factors took a no-change in gasoline prices and said, aha, there was a 6% price increase if you take the normal seasonal pattern. And I think that seasonal pattern is a bit skewed and probably a bit off. And I think that we're going to quickly reverse that in July. So that's why I say the numbers aren't quite as bad as they look, and I have some reasons about why I think we can get a little better in the second half. But the idea that the Fed is using a 2.4% growth [rate] for the full year is clearly off the table right now, as far as I'm concerned.
Stipp: All right, Bob, as you say forewarned is forearmed, so we'll brace for a potentially bad-looking [second-quarter] GDP number. I'm sure that we'll get your take when that data comes out. Thanks for joining me today.
Johnson: Thank you.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.