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Too Soon for Doom and Gloom

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar.

After a series of some disappointing economic reports, there seems to be a growing sense of pessimism emerging about the economy. Here to give a reality check on that and tell us if we really should be worried is Morningstar's Bob Johnson. He is director of economic analysis. Thanks for being here, Bob.

Bob Johnson: Great to be here.

Stipp: So, I do feel like there is a little more doom and gloom after a few recent reports. I wanted to get your take. Do you feel that there also is some doom and gloom out there that maybe we hadn't seen before, and if so, why?

Johnson: I think statistically, the numbers are there indicating a slowing. We had GDP coming lower than expected and considerable slowing from the fourth quarter. We've had some regional purchasing manager's reports and the industrial production report that indicate that the manufacturing sector, which had been so booming and such an important part of this recovery, was beginning to slow. We saw the initial unemployment claims for a while creep continuously upward, and we've seen some weak data out of the housing market. So there is been a number of areas that look like on the surface that there has been weakness.

Stipp: Okay, let's taken them one by one, then. So, GDP report we got the first look at that; it did show some slowing, and I think that did concern a lot of folks. Did it concern you?

Johnson: No, I don't think the report concerned me as much because I think there is a lot of underlying data there that people didn't realize. The biggest slowdown was from government spending. If you added back government spending, GDP was roughly equal in the first quarter as it was to the fourth quarter. So it's a special effect from government spending, and it was defense spending, it wasn't everyday spending, so it's something that's going to come back.

So, I wasn't worried initially, and now we've got some data that indicates the number may have been substantially understated, and when we get the second look at the number, when they revise it at the end of the month, that it will be revised upward to as much as 2.5%. The reason that's going to be revised up is because a big part of that report is retail sales, and the retail sales number for February-March period was revised substantially upward after the fact. So, I think there is a good shot that GDP is going to get revised upward because of the strong retail sales data we've already seen.

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Stipp: So, important to know that that first number we got on GDP was just the first look; we are going to see a revision on that. You expect it to go much higher.

So, secondly manufacturing. Now, manufacturing had hit some doldrums last summer, and then we saw an improvement, but now it seems like it's weakening again. Should we be worried about that?

Johnson: Well, again, I always say watch the consumer, not manufacturing. Though it's nice to have manufacturing, it's good high-paying jobs that does tend to get the economy moving again. But at this point of the cycle, it's a little bit less relevant, and as you pointed out, it did pause last summer, and as I always like to say, the last three downward moves in the PMI have resulted in exactly one recession. So, the number does tend to get a little oversensitive because it is weather and different things affect the numbers.

This time in the manufacturing number, the outlier, if you will, is the Japanese auto situation and the supply chain operation. It had a meaningful effect on this week's industrial production number. Auto production was down as much as 10% because it couldn't get parts. That's a short-term phenomenon; whatever doesn't get produced now will get produced in a later period, and Toyota has already indicated some pretty good comebacks on that--maybe as early as next month.

Stipp: So it doesn't mean that demand is gone, it just means because of that natural disaster, we might see supply just isn't able to keep up for a little while, but eventually you feel like that demand will come through for us?

Johnson: Absolutely. We're talking production here. The sales have continued along pretty well.

Stipp: Okay. Let's talk a little bit about housing, because this seems to be a perennial laggard, and every time we get the data, it doesn't really show much improvement at all. What are you seeing on housing, and a big part of what caused the big financial crisis was the housing, and we're not seeing it improve yet. That surely is a worry sign, right?

Johnson: Well, absolutely a worry sign and something that is the slowest part of the recovery. We've seen retail sales get better, we've seen car sales get better, housing not so much. It's more of the same in terms of the housing data. Although lately I will say, people have been more afraid because prices have gone back down again. We've kind of had a double-dip in housing prices. Now, we bottomed a year, year and a half ago, went up 3%, now we're back to where we were a year ago, according to some data.

Now, I think that number is probably taken a little bit out of context, and I think it's actually gotten considerably better recently. We look at real-time Multiple Listing Service prices, what they go into the system at. Our housing analyst, Eric Landry, it's been one of his favorite metric. And that number actually turned positive sometime in March and has been positive ever since week-by-week.

The Case Shiller data, the gold standard, if you will, of housing data is also from March, but it's for the three months ending in March, so it's like driving in the rearview mirror. What's happened since then is considerably better, and so I'm not so worried about the pricing.

And the units--we saw existing home sales were a little soft, new home sales have been soft for some time. Again, those numbers do not have a big impact on GDP. Maybe a little bit psychologically on the consumer, but not drastically so.

Stipp: Okay, so we talked about GDP: You're expecting a revision there based on some of the retail sales data that we had more recently than that first look.

We talked about manufacturing; you said, not the most important thing to look at right now, and there was also the Japan situation.

You just talked about some of the issues that maybe you've seen with some of the housing data.

So, when you're looking at the real economy, then, are you seeing signs of optimism apart from some of the anomalies that we've seen in some of those earlier data sets?

Johnson: Well, my number one thing that I'm excited about is the recent employment data, and it's really been relatively consistent on that front, and I'm pleased about that. Remember, early in the recession, I said, don't pay any attention to the employment data; it's not important. Now, it's in the absolute driver's seat. And we've seen over the past three months, about 2.5% growth in employment and on an annualized basis, and that means GDP will grow that much or a little bit faster based on employment data. The number there has been consistently good.

The employment parts of those very same manufacturing surveys show some pretty drastic improvement. If you look at the national survey from a month ago, New York or Philadelphia, all of those showed an uptrend in hiring and at an accelerating rate at numbers that we haven't seen in quite some time. So, I don't think the employment is going to start soon, and I think the fact that manufacturers are actually hiring people is a really good thing, and they are hiring because their current people are burned out; they are hiring because they are anticipating better sales. And so that's really good news.

So employment, if that's what I'm really looking at, and consumer incomes in the months ahead, that's looking really good to me.

Stipp: Okay, so, some of the doom-and-gloomers that are out there right now; you would say to them, things are not falling apart at this point based on what you're seeing?

Johnson: The consumer is certainly not, that's for sure. We've looked at the weekly shopping center data, and those numbers are steady as a rock. I mean, I'm a little surprised with oil prices up where they are that we haven't seen some deterioration.

Stipp: You mention oil prices; I did want to check in with you on that one last point, because earlier when we talked this year, you said inflation was one of your biggest concerns. It's what undoes recoveries; it's what causes recessions. Where are we with inflation?

Johnson: Well, the good news is that the latest data on the consumer price index has backed off a little bit. It's still increasing at a rate that I really don't want to see, but at least the rate of increase has slowed down, and we've certainly seen the same thing happen in the manufacturing reports, where prices paid have come down.

All these rumors of all the slowing--not rumors, but the data that's indicated a little slowing along with some margin increases in a couple of commodities--have popped that commodity bubble, and commodities have been the key driver of inflation. It's been those raw industrial materials--it hasn't been labor cost--that really boosted inflation.

So, the fact that we slowed enough to scare people, and we've had the margin, has really brought some commodities down as much as 25%-30%. Even oil is down from $115 to $100, so we've certainly had a big fall-back there, and maybe the consumer is going to see a break here, and he has done well so far. So now maybe when we get the lower gas prices in the next two to four weeks, we'll see even better news.

Stipp: So that commodity pullback a bit of a silver lining on some of the slowing data that we'd seen before.

All right, Bob. Well, thanks for giving us some perspective on those numbers and for joining me today.

Johnson: Thank you.

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