Second Half Looks Better for GDP

Johnson: Yes. We had a very good import-export number. In fact, probably it's the best quarter in three or four in terms of exports, and imports actually went down. So, we had a thing that's very unusual in a recovery to have net exports be a contributor to GDP, because usually imports are bigger, and they usually move up in tandem. And this time imports went down for some of the reasons I've mentioned, and then oil helped, too. But imports went down at the same time exports went up. I don't think that's going to continue for the rest of the year, but it was certainly a contributor this time around. It supports my thesis that if the world economy slows, it doesn't mean that the U.S. export number is going to collapse immediately.

Stipp: And what about inventories? That's another piece of GDP. So, when inventories are up that makes GDP go up, because those things were produced. How did inventories contribute to the revised number?

Johnson: Well, originally they thought that inventories contributed 0.3% to the GDP number, and now they say it took 0.2% away. So, in other words, inventories were less of a factor, which makes the quality of GDP higher, in my opinion, because we didn't produce extra goods that are now sitting on the shelves somewhere.

Stipp: So, even though inventories subtracted a bit because of this revision, that also means there is some demand that's pulling some of that merchandise out of the warehouse on to the store floors, hopefully to be consumed?

Johnson: Exactly.

Stipp: Let's talk a little bit about the actual number now. So, we see 1.7% for the second quarter, but this is still on a declining trend from what we saw earlier in the year. So, when you look at it sequentially, it still doesn't look that hot. How do you look at the number and how do you see this sequential slowdown? What's the right way to look at it?

Johnson: If you look at the numbers, it looks like 4% in the December quarter, 1.9%-2% in the first quarter, and now 1.7%. Now, the 1.7% looks better than [the original second-quarter GDP reading of] 1.5% in that trend pattern, but it's very deceptive. We've talked about seasonal factors potentially being wrong just because of how going through the recession messed up which quarter things went, and the auto industry keeps changing their shutdown periods. There has been some unusual activity that shifted things around.

So, I like to look at the numbers year-over-year, because then if you have a good quarter, one that's helped, and then the next quarter falls back, it kind of takes some of that out of it. And it also takes the seasonal adjustment factor [out] because hopefully from year-to-year, there isn't much of a shift.

The trend is we've had three quarters in a row with 2% or more growth, year-over-year, and I think that year-over-year methodology is the right way to look at it, because if you look at employment [growth], it's been running about 1.8% to 2% growth year-over-year, on that same basis, and given productivity, it means that you're going to have better [GDP] growth than you have in employment--the numbers are very consistent.

The [idea that] we grew 4% in December really doesn't make any sense to me, and then we collapsed to [a slower growth] rate [in the first and second quarters]; it's just not in any of the numbers that I see. But that's [what happens] when you take this small [quarterly GDP] number and multiply it by four from one quarter to the next, that's much less reliable than looking at the number from the same period a year ago.

Stipp: So, let's take this 2% number that may get some of that noise out of [the reading]. That still feels kind of slow historically speaking. And I think there's a perception that this recovery has been slower or weaker. When you look over longer time periods, what does that 2% number stack up to what we might see in other time periods for a more normalized economic growth rate?

Johnson: I went through and looked at every decade since the 1950s to see what GDP growth has been, and it has ranged from about 3% to, in the 1960s, we had probably 4.5%. But if you look at them, most of them are very central on about 3%. And as I said, we're kind of at 2.3% right now year-over-year. So, we're below the 3% that I'd say, looking at past decades, looks normal. We're doing better than the decade of the 0.9% growth, but certainly nothing like the '60s. But the '60s was an exceptional period.

Then if you adjust for population--in some of those periods, we were growing 1.4% to 1.5% in terms of population and now we're only growing 0.7%--you start to see [how] a number [like] 2.3% [when] population growth was half a percent, six tenths of a percentage point less, gets a little bit closer to the 3% [norm].

I think we're not in quite as dire straits, but what does make it look dire, is that we had a severe recession and we haven't come back, and we've got a lot of people unemployed yet, and that's why this feels so terribly uncomfortable.

Unfortunately, I think the data I look at says we're going to have more growth in kind of this 2% to 2.5% range, so it's still going to take us a while to adjust and absorb all those people.

Stipp: So, the last question for you, then. We can look at the [GDP] data year-over-year and get a better sense broadly, but there still is that sequential trend line that's been down over the last few quarters. So, what I'd like to learn from you is, what do you expect that trend to do? Do you expect it to turn around in the second half of the year, and if so, why? Or should we brace for maybe a little bit more correction still from that high 4% fourth-quarter 2011 GDP?

Johnson: I think we're going to have some acceleration in the second half. I think we will grow at least 2% in the third quarter and maybe even more in the fourth. That will bring us to the full year of 2% to 2.5%.

Stipp: So, what factors are behind that acceleration? What should we be looking for?

Johnson: There are number of things that are helping us here; some of them are kind of obscure. I suppose the biggest one that we've always talked about is housing. Now existing home sales are up in the neighborhood of 10% year-over-year, and if you look at it in terms of dollar values of homes sold, we're actually up 20% year-over-year, which is a pretty astounding number. That is, people are buying more expensive homes, and that means more brokerage commissions, that means they are likely to spend more on furniture, more on hooking up their cable, and the services type of things.

So, the existing home sales are driving things up. And again, it's up nicely. There is not a heck of a lot of inventories, so we're only up 10%. This morning the pending home sales [report] said there is an acute shortage of homes in the California market, for example, in the low price points, especially.

And the new homes--that is, homes you are starting--are up 25% year-over-year, and it takes awhile from when you pour the foundation to when that really starts absorbing all the labor and requires the employment when you do all the drywall and the final electricity and stuff.

So, we've been in fairly good territory in starts for a few months now, and I expect that to start to creep into the numbers, too, and help us dramatically in the second half.

Stipp: So, if we see interest rates still low and we see home prices appreciating slowly, might that also instigate some refi activity, and will that help us out?

Johnson: Absolutely. Anecdotally, it is even [apparent] in our office; the number of people drifting out to go do a closing on a refi has really picked up here in the last couple of months as rates hit a new record low. And as prices of homes moved up a little bit, and they made a few more payments, all of a sudden people that couldn't refinance [before] now can. I think that's a big deal.

Stipp: And what about on the manufacturing side. So, this is an area that a lot of folks pay attention to throughout the cycle. Are we going to get any bumps or boosts for manufacturing?

Johnson: Well, I think, there are two potential things--both we talked about at the end of the year. One is oil out of the United States, particularly out of North Dakota. I was really shocked to see how much the growth in oil has been in North Dakota. We were at 300,000 barrels per day a year ago, and now we're over 500,000-600,000 a day out of North Dakota. So, we've really almost had a doubling of what's come out of there over the last year, and that number is even up big since January. So, I think we're making some progress there, and that's oil that can either be exported, or it's less oil that we have to import. I think that's a huge positive.

The other one that we talked about is Boeing. Boeing continues to ramp up. I think they've made some progress since December, but not a lot. We're still kind of at the 3.5 787s a month. And what's going to help that along is the production in South Carolina. They shipped their first plane from South Carolina in April, and I expect that to continue to ramp up. Then along with a new production line in Washington, they hope to move from 3.5 aircraft per month to 10 in the next 18 months.

Stipp: So, what kind of an impact [does that mean]? This is one company. Obviously, they produce high ticket items. But what kind of an impact might you expect that to have on the economy?

Johnson: Well, it's a big deal, because these obviously are high-paying jobs, and we're talking tripling [production], and in round numbers, list prices, it's something that looked more like $10 billion moving to $30 billion. It's a big number relative to GDP.

Stipp: The last piece I want to talk to you about for the second half is the consumer, and consumer spending power. Inflation has been tame, has been giving a bit of a tailwind recently, especially compared to a year ago. But we also had the drought. There are worries about inflation going up. Is inflation going to help or hurt us in the second half?

Johnson: Well, I don't think it's going to be quite as helpful as it was in the last quarter... Really we had four quarters in a row with essentially no inflation at all. I think we will see some more price increases in the second half, relative to food. Oil is going to be a bit of a wildcard; we don't know. I think a lot of it [will depend on] whether we have a hurricane or not and whether we have a political situation or not ... Oil seems a lot higher than it should be given the strength of the world economy right now; it really does to me. But if it does stay high, it will impact prices in the second half; there is no doubt about that.

But remember, last year we were looking at 4% inflation, and we had used car prices, new car prices, oil, gasoline, food, all moving up dramatically, all at the same time. This time we seem to have a couple of really good weeks for oil and then it goes back up, and then the fresh fruits and vegetables go down and help the food number, and we've seen lower cattle prices, which have helped the numbers a little bit. Probably next year, the cattle prices will be way up, but maybe the grains will be down. So, things have been offsetting this time around, so that we're not getting this general everything-is-up-at-once type of [inflation].

Stipp: All right, Bob. It sounds like the [GDP] trend has been down over the last couple of quarters, but we have some hopes that that trend will turn around a little bit. When you take a step back and look at it, we're kind of lower historically than we've been on GDP, looking at a year-over-year basis, but some population changes might explain some of that. So, we could be better, but we could be a lot worse than we are right now.

Johnson: Absolutely. And I am optimistic about the second half.

Stipp: Okay, Bob. Thanks for joining me today with those insights.

Johnson: Thank you.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.