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U.S. Economy Can Survive Eurozone Slowdown

Jeremy Glaser

Jeremy Glaser: For Morningstar I am Jeremy Glaser. Last week, U.S. stocks had a wild ride as investors considered all sorts of economic data and the potential of an economic slowdown, both in Europe and the United States. I am here today with Bob Johnson. He is the director of economic analysis for the Morningstar. We're going to take a look at some metrics that we have seen come out this week and if investors should continue to be worried about a slow global economy.

Bob, thanks for joining me today.

Bob Johnson: Nice to be here.

Glaser: So, let's start in Europe, I know that that's certainly an area that was of particular concern with both the sovereign debt crisis and also of just incredibly slow growth. We got some gross domestic product data from Europe. Can you talk to us a little bit about it?

Johnson: Sure. This week, the market got set off very early in the week because of some European data on GDP which was very poor in their minds. It grew at 0.2% quarter over quarter. So, that's about 0.8% annualized, which is by the way about the same as the first half was in the United States. So it's not that far off where we were here but certainly a disappointment there.

There were some components that were particularly disappointing. Although they didn't have individual parts, but the feeling is that the consumption was the major reason that the number came back down. We did see the French portion of the data, and consumption in France was actually down in the second quarter. So with all of those economies, Germany, France, and so on, many of them are seeing decent export growth, but the consumer has never been particularly good. Now as exports have slowed a little bit, those countries' economies are feeling a little bit of pain.

Glaser: So this could be tough for Germany because the hope was that Germany would have enough economic strength to kind of bail out and to help drive the rest of the European economy.

Johnson: Exactly, Southern Europe and Eastern Europe, both, because Germany is a major export market for those economies.

Glaser: So, if Germany were to slow considerably either because its export markets are slowing a lot or because it's having a falloff in domestic consumption, is that something that worries you for the rest of Europe?

Johnson: Well, certainly for the rest of Europe it does because Germany and France have been the strong parts and obviously Italy, Spain, and Greece have all been softer. It has been kind of the Northern European countries that have been driving the growth and at least they had been strong, helping support the others and now they are seeing some weakness, which certainly doesn't bode well for the European situation.

Again, is that enough to ruin the whole worldwide recovery? That's a more interesting question. And I think Europe is a relatively small part of U.S. exports. Most of ours go to Canada, Mexico, Asia, so forth, but they still are a small portion of what we do. And so slowing their certainly won't help our exports either.

Glaser: So, let's then turn our gaze to the United States manufacturing sector. We've seen some reports that have shown a little bit of weakness or potential weakness in the PMI report that I know you have been watching closely for a couple of years now. Do we see any data this week that maybe points to a continuation of that trend, or things are looking a little bit stronger?

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Johnson: One of the interesting things this week is that we got the industrial production numbers from the Federal Reserve, and that goes through and calculates what the growth in our manufacturing economy has been. And the very interesting thing was the number for July was 0.9% growth, that's from June, so that was a nice increase, one of the best that have seen this year, and we also saw revisions up in the prior months.

So, now we've got a pattern where we had a very negative April, we were down 0.3%, then we grew 0.2% in May, 0.4% in June and then 0.9% in July. So, if you look at the actual what's-being-produced data, we are actually in a little bit of an uptrend, and whether that will continue next month remains an open question. But certainly it is good to see that the PMI was perhaps just a little bit too negative and a little bit too early in the numbers, and I think this industrial production number puts some of that to rest.

Glaser: We also had some data from the Empire State manufacturing survey that didn't look as good. Why are these different reports disagreeing? What is one of them taking into account that the other ones aren't?

Johnson: Well, the industrial production report is actually what is produced, and the PMI reports all are constructed by going around and asking purchasing managers "Are things getting better or worse?" The industrial production numbers are a more thorough analysis of manufacturing data. They actually calculate numbers of what's produced. The PMI, the beauty of it is, they just ask guys, "Are things better or are they worse? Up our down?"

The beauty of it is, you can get the numbers very quickly. We get them right at the end of the month for the national survey. So, you don't have to sit around and wait for everybody to figure out how many decimal places to put behind something and what is actually shipped. The IP numbers give you a more thorough explanation, though not as timely.

Glaser: So, is it possible that just concerns of over growth have been leading purchasing managers to maybe have more negative sentiment even though there actually are more boxes going out of the door?

Johnson: Exactly, and I think a lot of that might be what's happening out there. We'll see if the numbers get better here as we move into the further months, but given that auto production is still picking up at some of the automakers, I'm optimistic. And we still had a relatively warm August, which should help that number a little bit. Inventories are a little light, so maybe things will get a little better. Now the export economy will probably be a little rougher for the reasons we just talked about earlier.

Glaser: Now, let's talk about the U.S. consumers who might be purchasing some of these manufactured goods. You know the consumer, really, you've said before, is the driver of this recovery, and there are a lot of worries that with falling 401(k) balances or just continued worries of unemployment that the consumer is going to stop spending. Have you seen any evidence of that in the last week?

Johnson: You know the numbers are still pretty good there. As you know the International Council of Shopping Centers has a weekly set of data, and you know you've got to be careful about using weekly data. But I always do look at it just to make sure that nothing is falling out of bed, and you know in the middle of all the downgrades and all the stuff that was going on, we still had 3.5% year-over-year growth in retail spending. That number has generally tended between 2.0% and 3.5% for most of this year; in fact, most of the last two years we had a couple months where it maybe got as high as 4.0% or 5.0%. But still this 3.5% rate that we're seeing the last couple of weeks is still fine. I'm very pleased with it. Now with a little bit cooler weather that we are having and a little bit lower gas prices, all of those things might actually help for a decent back-to-school season, if not for the retailers, at least for the consumer.

Glaser: Then looking at housing, which has been another trouble spot for the economy for few years now. Have we seen any indication that housing prices have really bottomed and that we're going to start seeing rising prices again or are we still looking at secular declines in the sector?

Johnson: The affordability indexes that are out there are again so much more positive than they were, and so many people focus about people underwater on their mortgage, but what's interesting is that people that are buying homes today their monthly payments can be 20%, 30%, or 40% below the numbers of when people bought that same house four or five years ago. Now we've got a matter of a number of people buying a house and getting the good rate offsetting the other people. So that would be a very interesting race to see.

There was an interesting article in the Wall Street Journal talking about how relative to incomes, housing is beginning to look quite undervalued in many markets throughout the U.S., certainly not necessarily in all of the, what I call, the sand states, the Californias, Arizonas, and Floridas. But in a lot of markets you're seeing very low house prices relative to income, lower than they were even before the recession started.

Glaser: Certainly rents on rental properties have been rising pretty quickly. Some people have stepped out of the housing market, so those rising prices maybe will get people to take a second look at buying a place.

Johnson: Again, we've had a couple good months of pricing data, and we probably have at least another month or two of decent pricing data in front of us. Again, there's no big boom in housing; it's not going to drive the economy this year. But I think next year it just might.

Glaser: Turning to inflation, there seems to be some disagreement at the Federal Reserve as how big of a problem inflation is going to be. Chairman Ben Bernanke seems not to be terribly concerned about it. They put in some easing language in the Federal Reserve statement last week, but there were three governors who rejected that and said that they would like to at least reserve the right to tighten rates if needed. Is inflation going to be a problem; have we seen any evidence there?

Johnson: Well, certainly we've had a couple of better months in terms of inflation. This month again oil kind of ticked back up in the month of July, and that's what we'll be seeing data for this week. And the early indications on that is that we'll might see a little bit of a step up in both Consumer and Producer Price Indexes after a very benign number for June, and I think this is probably a one-off.

Already in August we've seen gasoline prices come back down again, oil prices come back down again, and some commodities come back down. But it's really been pretty volatile on that front frankly. But I think the inflation numbers this week probably won't be so good, and the Producer Price Index we've already seen certainly indicated that we're back in the up-mode again, 0.2% which isn't awful--that annualizes the 2.4%. So that's still in the realm of I think pretty good, but it certainly was a little higher than some people were looking for today.

Glaser: Bob, thanks as always for your take.

Johnson: Yes, thank you.

Glaser: For Morningstar, I am Jeremy Glaser.