There is a wide range of forecasts for fourth-quarter GDP--set to be released Friday morning--but anything below 1.8% will give the market fits, says Morningstar's Bob Johnson.
Jason Stipp: I'm Jason Stipp for Morningstar. The government is going to give us its first read on fourth-quarter GDP in a report to be released on Friday. Here with me to give us some sense of how to read that number is Morningstar's Bob Johnson, director of economic analysis.
Thanks for joining me, Bob.
Bob Johnson: Great to be here.
Stipp: The GDP report is a very important one because it's so comprehensive. Why is this one such a key report to keep your eye on?
Johnson: I think this one is important because it's going to be continuing a trend. For the full year, when we get this report, I think we'll end up somewhere between 1.8%-2% GDP growth, and that's compared to 2.8% that we saw in 2010, which is kind of a rebound year. Certainly, the tsunami and a few things hurt this year's number that brought it down into that kind of 1.8%-2.0% range.
Stipp: What was the trend that we saw throughout the year, because as you said there were some things that really messed with the GDP number as 2011 proceeded?
Johnson: Yes, and the pattern there looks pretty. I mean we had only 0.4% growth in the first quarter, then we got up over 1% in the second quarter, and then we got 1.8% in the [third], and now we're thinking we'll get somewhere between 2% and 3% here in the fourth quarter.
Stipp: So, we saw GDP start to move up, and you hope to see then--and you said 1.8% in the third quarter--you're hoping that fourth-quarter will be above that 1.8%? Is that what people are expecting?
Johnson: That's the absolute key thing to watch. We could talk about why the number is very, very hard to calculate this time, but the range of expectations is between 2% and 3.5%. But the magic number is that everyone wants [4Q GDP] to be higher than September's 1.8% number. If it's below that, Katy bar the door in terms of the market. I think it will be received by all of us badly.
Stipp: So, 1.8% the key number that people are expecting or hoping that will be better. So, let's dig into the report and what might cause the report to be higher or lower. Consumer, a big chunk of what this report will show us on Friday. What do you expect? The consumer seems like it maybe disappointed a little bit recently at the end of 2011. What are you thinking there?
Johnson: I think that the consumption number will be a little bit weaker than it has been, maybe in the 1.5%-2% range instead of over the 2% that we saw in the third quarter. I think some of the big bounce-back moves were over, and certainly the retail sales report at the very end was a little bit soft. So, that gives us all a little bit of fear that that number may come in not as strong as it has been. You'd like to see the GDP number and the consumption number about the same, but we're going to be just a little bit less on consumption this time, I'm afraid.
Stipp: You said the consumer is a very important thing to watch right now. Do you see this as just a moderation or is this a reason to really start to worry about a consumer trend of weakness?
Johnson: Well, I think that consumption is always something to worry about, and it is 70% of our GDP. I wish the number were a little bit stronger at the end. Certainly, some of it's the housing-equivalent rent and a couple of machinations are going on; the retail sales are probably pretty good, but some of the service categories and some of the things that are calculated relative to housing might look a little bit weaker in the report.
Stipp: So, if consumer might be a bit weaker, what about business spending? Are we seeing that we could get a boost from business spending in GDP.
Johnson: Well, unfortunately, there I think we've had a couple of good quarters. I think we were close to 15% in sequential growth, annualized, in the third quarter. I think we'll be less than that unfortunately in the fourth quarter.
Again, we saw businesses panic maybe even more than consumers in July and August. First of all, businesses adjusted their inventories. Now, as we get into the fourth quarter, they adjusted some of their capital spending thinking Europe was going to be weak.
So, unfortunately, I don't think [business spending is] going to be as big an add as it was in the previous quarters. I think it will still be OK. It will still be a positive number, but it's certainly not going to be as big as it has been.
Stipp: OK, you mentioned inventories there, so that's an important piece of GDP. And it may be a little bit difficult for people to understand how inventories work and they'll view it in different ways.
Johnson: Yes.
Stipp: What's the inventory trend? How do inventories actually affect that GDP number?
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Johnson: Let's talk about inventories, and why they are in there. Now, GDP, it's gross domestic product. So it means what we've produced, and whether we produce that good and it goes in inventory or it gets sold, we don't care because it takes people, and we like to measure production. So inventory gets put in there. If you produce goods for inventory, that's just as good as selling it, at least according to the headline GDP number.
Stipp: So if inventories go up, that helps GDP.
Johnson: Absolutely.
Stipp: But some people will look at that and say, inventories are going up, that means that demand isn't there, because warehouses are starting to fill up?
Johnson: Right. That is an interpretation that's certainly possible, but I think a lot of the inventory gain--and you asked earlier about the trend--I think we saw a decent first quarter [and] throughout most of the year, actually, inventories have hurt the number, which is kind of unusual at this stage. [Inventories] were a relatively big subtraction from GDP in the third quarter. In the fourth quarter, I think they will be an addition.
I think autos will be a decent part of that. Remember, with all the tsunamis, everybody kind of drew down their inventories and sold what they had. And ... in the third quarter they did the ramp-up of production, and in the fourth quarter we finally built a little inventory in autos.
I think there are a couple of categories where production may have increased a little bit, and we built a little bit of inventory, which, given that they were unusually low, is not at all bad thing. But inventory will add about a percent to GDP, in my forecast.
Stipp: A broader question about inventories. We've heard a lot that companies are leaner and meaner, and they run more efficiently. Have you seen a trend overall that inventories maybe have been a declining contributor to GDP just because companies are more efficient and so they are not keeping things in inventory for as long?
Johnson: Well, you know the long-term secular trend in inventories as compared to sales has been down, and it's been down for 10-15 years. As we go to more just-in-time inventory, locating things nearby, I think that's certainly been a trend that's out there. I think that inventories probably did that again this time, but they've got a little bit of the offsetting of some of the things going on in autos.
The other thing I would say is that inventories are probably still, despite the fact they grew overall, I think, that they certainly may have been short a little bit in December in the retail sales channel. Truck tonnage in December was just off the charts, as was rail shipments, indicating that maybe there was some last-minute shipping around going on in terms of the inventory adjustment.
Stipp: Another line item related to business, construction. What do you see on the construction front? Are we seeing some improvement there?
Johnson: Well, the Architecture Billings Index is back over 50 again, and has been for a couple of months. Some of the construction spending has actually been up. We had some favorable weather, so [companies] worked a little longer on projects. I'm looking for a little help there, too, on the construction side. So business construction should look a little better. I think even residential construction may be a bit of an adder to the GDP number this time after many, many months of being negative.
Stipp: Something that has been a wildcard in past GDP reports is the import/export number, and that could really cause a big swing. What are you expecting to see for the fourth quarter?
Johnson: Well, I’m afraid if you’ve added the numbers I've said so far, we add up to more than what I’m forecasting overall. The reason is I think import/export could actually be a negative and maybe even a meaningful one this time.
We have a month of the report. We’ve got the October import/export data, which was not good. It ballooned surprisingly. Since they don’t have final numbers for the other two quarters, they are going to have to do some estimating, and unfortunately, they may just trend-line the bad number we've already seen.
Stipp: So when we are importing more than we are exporting, that's going to be to the detriment of GDP. Can you talk a little bit about inflation and how that might impact the reporting, and what you're hoping to see there, or expecting to see there?
Johnson: Well, I think that’s going to make the report very complicated to interpret this time, because ... it's fine if every good is moving about the same trend and the trend has been the same this year and last year--then it's kind of easy, and you don’t have to think about it. I think of the retail sales report; it's a great projector of consumption.
But now you get tricky things both up and down. You've got things like gasoline that are moving in different directions than say computers, and electronics was a huge negative in the retail sales report because of the prices were down, not because the units were down. In fact, we saw some great number out of Apple that suggest unit sales were just fine, thank you. But the pricing was really the big contributor to some of the negatives there.
So the report ... when I talk about all of these numbers, I talk about inflation adjusted. So because inflation is bad in some categories and good in the others, it makes it very hard to put the report together. That's why the range is from 2% all the way up to 3.5% for the report tomorrow.
Stipp: All right, Bob, we are going to you on the spot then. I don’t want you to get away with a range of 2% to 3.5%. Where do you think it’s going to fall?
Johnson: I think it will fall in 2.5% to 3% range. If you make me pick a single number, I'll say 2.8%.
Stipp: Okay. 2.8%. So you mentioned a couple of weeks ago that you were expecting to see some softness in GDP or in the economy, maybe over the first couple of quarters. What do you expect, then, to see as the year progresses, if you're expecting around 2.5%-2.8% here [for Q4]?
Johnson: I think that probably what we'll do is we'll drop back again in the first quarter. I think that some of the inventory build in the autos will be over. I think that some of the great growth we've seen in employment will probably stabilize just a little bit. We’ll have a little bit of a pause.
So, I would think that we are going to fall back to the 1.5% to 2% range in the first quarter. But that’s not all that surprising. Remember, last year we started out at 0.4% and worked our way all the way up throughout the year, and maybe we'll get a similar pattern this year. And in fact we are already seeing some numbers that maybe look a little weaker in January, and January and February are going to look weak.
Stipp: All right, Bob, I know that you are going to pick apart of the GDP number in your Saturday column, but thanks for giving us a preview and all the insights around this very important report today.
Johnson: Thank you.
Stipp: For Morningstar, I’m Jason Stipp. Thanks for watching.
