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Johnson: Brightest Spots and Biggest Worries for the Economy

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar.

It's Ideas Week on, and we are starting out big picture. We are going to talk about the U.S. economy with Morningstar's Bob Johnson, director of economic analysis. He is going to tell us a little bit about the pros and cons for the economy today.

Thanks for joining me, Bob.

Bob Johnson: Thank you.

Stipp: So, first question for you, I want to start out on the negative side and get the cons out of the way. Your biggest concerns are actually kind of international focused for the U.S. economy. Let's start with the first one, it involves some recent news that we had out of Korea. Why is that a concern and what's on your radar on that front?

Johnson: Well, always geopolitical concerns, because they come out of blue and tend to scare people psychologically, they are very important. And certainly the Korean situation, with the artillery fire on [Yeonpyeong] island has certainly upset the balance there. And not only does that affect just the thoughts that we may have war there, but it also may cause problems with China. China is much closer to Korea, and certainly it creates all sorts of diplomatic problems as we go through that, and the last thing we need is some type of trade situation with China as a result of Korea.

Stipp: So, one of the effects here is that, this upsets the market; markets tend to trade down when this news comes out, and that obviously can have an effect, just a general wealth effect on U.S. investors when they see that their portfolios are declining because of these concerns.

Johnson: Correct.

Stipp: Okay. So, you mentioned China there, so let's just talk a little bit about China, because one of the concerns that we had recently in the news was how heated their economy was getting and the signs that the Chinese government might want to tap the brakes a little bit or maybe even a little bit more, what are the implications of that for the U.S. economy and the world economy?

Johnson: Well, certainly they have seen more inflation there, and I think that's a trend in India and other emerging markets as well. And in the case of China, we've talked about the 4.4% inflation number and the government is trying to keep it under 3%. So, clearly, they've stepped over the limit there. And inflation is very important there, because 30% to 40% of their indexes are tied to food. So you are talking about people and food issues when these prices are up, and that's certainly something that's not a good political situation.

So I am very worried about inflation there, and it may affect the ... European economies more, because as China steps on the brakes, China has been an engine of growth for the world economy, especially the European economies, and Germany in particular, little less so for the United States, but we're all connected.

Stipp: So, what sort of things might we see decline, then, if China slows down a little bit? What are we exporting to them and could there be a major impact or is this more of a global impact that might affect us indirectly?

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Johnson: Well, certainly you've got some of the indirect effect, but we do export a lot of food products to China, and certainly those are things where the demand is going to continue I think over time, especially given the world crop situation. So, we may not be as drastically affected as Germany, who may send some type of capital good over there that they can cut back.

Stipp: Okay. And speaking of Germany and the European Union in general, you mentioned that they could have a larger-scale effect if China slows down a little bit, but Europe also has its own problems with the sovereign debt issues, which certainly roiled the markets earlier this year.

Johnson: Right

Stipp: And it kind of crept back up recently again. What effect might those negatives have on the U.S. economy?

Johnson: Well, Europe is a trading partner of ours, relatively small, but I think the biggest effect is psychological, and we saw that this spring. Just when the consumer was coming out and we saw some really good retail sales numbers and we were really excited about the economy--probably a little too excited--but then when we had the European debt crisis develop, at the same time we had the flash crash situation, we lost hundreds of points in a mere matter of hours, really spooked the consumer and he pulled back. And it's that psychological effect that's really the thing that I'm worried about with Europe.

Now, this time around, so far, the U.S. consumer said, "You know, I saw this last spring and nothing bad really happened, so maybe I'm not so scared this time." And even the Europeans, when you look at their own consumer sentiment numbers, despite all the debt crisis, their consumer sentiment has actually picked up over the last couple of months. So the biggest effect I think is psychological.

The Irish economy, for example, is a quarter of one percent of all worldwide GDP. So the whole thing could go away and would have no direct effect, but because people lend money to them and because of the psychological effects, it does become important and then maybe, well, Portugal is next and maybe Spain is next.

Stipp: But at least recently people seemed to had slightly calmer nervous about some of the headlines that we saw over there, which is a good sign.

So, I want to move then to the pros that you see for the U.S. economy. And I think the news here really is all about the consumer, this is, as you've mentioned before, the point in the economic cycle where the consumer really takes center stage. So a lot of the positive things you see about the U.S. economy are consumer related. So let's start just talking about what the consumer has been doing recently and why you see that as a positive in those trends?

Johnson: There are two sets of numbers I really like to look at for consumers. One is the monthly retail sales data as it comes from individual stores and reported by the International Council of Shopping Centers, and that number for many years has been pretty steady-Eddie at about 3% growth. We had a big spike up in March and then a big decline in April that kind of washed each other, but overall about 3%.

Now, here in November, the number that was just recently reported, we saw 5.8% growth. So the consumer clearly appears to be back, based on that metric. And then if you want to look a little bit more broadly, I look at the consumption component of GDP, which is only given out quarterly, but we've seen a strongly accelerating trend there, too, where we were at 1.9% and then 2% and then 2.2% and then 2.8%, and I think will be over 3% here in the fourth quarter on consumption growth. So I think we are starting to see some real improvement in consumer spending.

Stipp: Now, do you think some of those trends are sustainable; so, we are entering the holiday shopping season, people may be spending a little bit more around this time. We saw promotion start a little bit earlier, so some of that demand might have been pulled forward into November. Do you expect to see that kind of 5% trend continue or might we see some moderation over the next few months?

Johnson: Well, I think you could see a little moderation. I think we're probably set though – I think a lot people aren't very far along in their shopping. I think a lot people think, well, I'll get more bargains, I can wait. And there's been some indications that maybe December will also be a halfway decent month retail sales wise. But could we back off a little bit to more like the 3% trend? I think that's certainly possible.

Stipp: Okay. So, obviously, another big important part of the consumers' behavior is, how much they have to spend. What have you been seeing on the income front, and is that a positive for us?

Johnson: Yes. I think one of the things we've seen, and I think a lot of people mistake that this time around, but over the last year the savings rate is about the same. It's been in the kind of 6% range. So really hasn't changed that much. So the recent increases that we've seen in consumer spending aren't that they are going more in debt, or they are back to their old borrowing ways. The savings rate has been pretty steady. We've had volatility from month-to-month, but if you look over a stretch of time, incomes are up more than consumption; the consumer has been good.

Stipp: So, maybe they are not adding to their debt, but I know a lot of people have been worried about just the general debt level, even if it hasn't increased. How indebted, how leveraged is the U.S. consumer today? Has that been manageable and is it as bad as everyone says it is?

Johnson: Well, I think if you look at, when you do ratios of how much dollars of debt you have and you compare it to your assets, the number has improved, not a lot, and it's still certainly what I'd call elevated. But I like to look at another ratio, what it is that people are actually paying out for all their debt service, for all their items that they buy? And we are seeing some pretty dramatic improvement there.

We peaked out at 19% of income went to those fixed obligations, your mortgages, your credit card payments, your car payments, your lease payments--all of those things combined, at the peak, were at almost 19% of consumer income. The last reporting point that we have was we were down to 17%, and I think when the number gets reported in mid-December, it'll be down to 16.5%.

That number over a 30-year periods has ranged from the low 15% to just under 19%, and now we are going to be back at 16.5%. It's a number that clearly was manageable through most of the '80s, clearly manageable now in my opinion, so I think we are in better shape than a lot of people give the consumer credit for right now.

Stipp: At least that's one upside of the low interest rate environment is that maybe some of those interest payments are less right now than they might have been in the past?

Johnson: Right. The good news is a lot of those payments are locked in 30-year fixed mortgages. So even if general rates go back up, you are not going to see that ratio go way back up.

Stipp: And that mortgage being probably a pretty big chunk of most people's debt.

So the last thing that I want to touch on with the consumer is their confidence. And so I know with the confidence numbers, sometimes the consumer will say something and then they'll do something else. But there are some other ways to gauge the consumers' actual confidence and what is it looking like from your perspective?

Johnson: I talk about the Shopping Center Council, and those numbers have been good for some time, and I can look at those weekly and monthly, and so those are clearly, "what are you actually spending" is what I like to look at, and it's a good indicator of the retail sales report that comes out later, and it's a better forecaster of consumption as well. So it's a great series of numbers to look at.

The other number that I am looking at recently is auto sales have gotten so much better. We got down to, in the worst of the crisis, to 9 million units from something close to 16 or 17 million. Now, that number for two months in a row has been over 12 million. So we are a third of the way back up again. So I am glad to see that, and that's a big ticket item, and if consumers have the confidence to buy a car, I am hoping that transfers through to other goods as well.

Stipp: Well, certainly some goods signs as the consumer takes center stage that the performance might continue.

So, thanks so much for the overview, the pros and the cons, and thanks for being here with me today, Bob.

Johnson: Thank you.

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