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2Q GDP: Down But Not Out

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar. On Friday we get the initial government report for second-quarter GDP. A lot of economists are expecting to see a slowing in GDP growth.

What should you expect? Here with me to offer some insights is Morningstar's Bob Johnson, director of economic analysis.

Thanks for being here, Bob.

Bob Johnson: Great, to be here.

Stipp: So, we are seeing a consensus opinion for slower growth in the second quarter. What is the range of opinions that you see out there for second-quarter GDP and what are you thinking that you're going to see on Friday?

Johnson: You know it's really a broad range this time. Usually the numbers are pretty narrow because you do have lot of the components in, but this time it's more difficult to project. I've seen numbers as low as 1%, I've seen numbers as high as 2.3%, the ones I look at closely. But I think the range might even be between 1% and 3% overall. So, quite a diversity this time around.

Stipp: You are little bit more bearish than some of the other economists out there. What range are you looking at?

Johnson: I am looking at a narrow range of 1% to 2%, and the main reason I am a little bit more negative than most is that I focus a lot on auto production, and auto production contributed 1.2% to the 1.9% GDP growth we saw in the first quarter, and this quarter I project that it will take off at least 0.5%. So, it's a big swing factor that basically wipes out all the GDP growth we had in the first quarter.

Stipp: Autos are actually a pretty important piece. So even though the manufacturing economy in the U.S. is smaller than it once was, you see a lot of knock-on effects from the problems that we had with supply chains in autos. How has that been flowing through some of the results you've been seeing?

Johnson: Well, it affects so many different things, and again, even though auto manufacturing is not big, it touches on steel, plastics, rubber, cloth, all of those things are used by the auto industry. So, it's touched a lot more than people think. Direct auto production might be a relatively smaller percentage of GDP, but when you think of all the things that supply up to into it, it gets to be a bigger number, maybe up towards 4% to 5%.

Stipp: And then from the consumers point of view, we did see auto sales trail off because there was also higher pressure on prices because of some of those shortages, right?

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Johnson: Right, exactly. You mentioned what are the other knock-on effects of the whole auto situation, which by the way is precipitated by the Japanese supply shortage. And because they've got a shortage of supply, that means that the dealer is going to be more stringent in what they try to get out of each car on a lot, because they are potentially selling their livelihood down the street.

So, what they are doing is raising prices and reducing incentives, and that of course has scared away the consumer. So, it's raised prices, which is bad for the CPI; it's reduced demand because of the high prices, so that's affected the consumption number. And what happens with inventories will also be affected because they had to draw them down just a little bit here. So, that's going to have another effect. So, it's kind of the effect that goes on and on.

Stipp: So we have reason for optimism on some of these fronts looking ahead, and I want to get to that in a moment. But let's stick just right now with the second quarter. Autos could potentially be a negative here, but there are couple of things that might help boost the second-quarter GDP; what are those?

Johnson: Yes, you are right. I mean if we just took the autos alone, I'd be saying GDP should be down just a little bit for the quarter, and that's clearly not going to happen.

Certainly we had a good export number and kind of minimal imports, which is kind of the converse of the Japanese problem. They aren't sending more cars here because they didn't produce them. They didn't send some parts over here.

So, clearly the import-export number will look better and be a contributor. The mystery number will be defense spending, which was a big killer to first-quarter GDP. It actually took off seven-tenths of a percent, which is kind of unheard of, and I think it was down 11% on an annualized rate. So, it was a big number, and I doubt it will be as bad this time around. So, that will be a second big aide to the number this time around. So, that will get us back, I think, over 1%, but maybe not up to 2%.

Stipp: So Bob, we've talked about some of the anomalies that have happened in the spring quarter with the bad weather, with the higher oil prices, with the Japan disaster and supply chain disruptions. Let's assume for a moment that those things didn't happen, that we had a more normal quarter. Do you still think that we see slowing in the second quarter absent some of those effects? A lot of people feel like the economy has slowed down. How much of it is those anomalies and how much of it is a little bit of a fundamental slowing here?

Johnson: Well, I think there has probably been a little bit of softening, but if you look at some of the retail sales numbers, it would seem to indicate that people have kind of hung in there. Things certainly probably haven't accelerated, but they haven't gotten any worse, either.

So, I think if we hadn't had all these special things, we would have had an accelerating GDP rate. We would have been looking at something like 2.5%, maybe even 3%, and these factors took some things off. And certainly the debt ceiling arguments going through Congress right now certainly haven't helped confidence and helped move business confidence or consumer confidence along at all.

Stipp: So turning now to look at the second half: You're more optimistic about what we might see. You think that we'll see an acceleration. ... What do we need to see in the second half to get there?

Johnson: I am looking at a range of 2.5% to 3% for the full year, which implies quite an acceleration in the second half, if we're thinking 1.9% [for Q1] and another 1.9% [for Q2], for example. To get all the way to 2.5% to 3%, I am going to need a couple of quarters well over 3%, and I think we'll get that.

Stipp: So, what do need to get there? What are you looking for?

Johnson: Well, auto production has to step up, and they've all pretty much said that they are going to step it up. The Japanese have said that they'll be back to normal production on everything except a few select models by Aug. 1. So that will certainly help on that end of it.

I don't know if it's going to be enough to help much of 2011 yet, but certainly the order book and some of the production things out of Boeing are looking better, and that's a major part of the U.S. manufacturing base.

Certainly the manufacturing of trucks is looking better this quarter as well. So, that's another thing that may move the manufacturing economy along a little bit in the second half.

So, I think those things are all positive. Certainly weather will have helped retail sales as measured by the International Council of Shopping Centers, as you know one of my favorite measures of short-term consumer confidence. It's had its four best weeks in really sometime. We've had more than 4% growth for four weeks in a row, and that's really kind of unheard of this recovery. Some of that air conditioners, yes, and some of it's probably fuel usage, yes. But still that's a great number to see, and the consumers have not given up yet and that's why I have optimism about the second half.

Stipp: What about risks to your forecast? What are you worried about? What do you not want to see?

Johnson: Well, the big worry right now that's got everybody spooked a little bit, and I suppose given the importance of exports in this recovery, I should have at least some concern, but everybody is reporting some slowing in China. We've seen it from companies like Terex, we've seen it from companies like Caterpillar and maybe even Cummins said, well maybe things weren't as strong as they were. And some of them are saying, well it's a sign of a slowdown  in terms of manufacturers and other manufacturers are saying, you know what, we are growing at 10%; if we grow 7% or 8% in the Chinese economy, is that a slowing that's going to kill us? And some of their answers are no on that. So, I think that's a factor that's in there.

Another thing that's kind of crept up here is part shortages. I don't how quickly they'll cure themselves, but we heard it in the trucking industry that they could have shipped more volume if they had had more parts. We heard the same thing out of a major crane manufacturer saying if they only had more parts, they would have been able to do better. And this isn't all Japanese related. Some of it may be, but more of it is probably related to the fact that we hollowed out some of our manufacturing capabilities during the last recession. And now that things are kind of booming again, if you will, they can't meet demand for some of the parts, and so that has crept into a few companies, hopefully not enough to really affect my second-half forecast.

Stipp: All right, Bob. Well, thanks for the insights on the second quarter report that we're going to get on Friday and for your look ahead and for joining me today.

Johnson: Thank you.

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