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Some Winds Shifting in the Economy

Jason Stipp

Jason Stipp: I am Jason Stipp for Morningstar.

Although all eyes have been on the eurozone recently, we've noticed some interesting trends here at home in the economic data. Here with me to dig into those trends and what they might mean for GDP and inflation in 2012 is Morningstar's Bob Johnson; he is director of economic analysis.

Thanks for joining me, Bob.

Bob Johnson: Great to be here.

Stipp: So there are several trends that you track, and we have seen some shifts--I wouldn't say major shifts--but some shifts in some of these. And I'd like to start with the big division that we look at in the economy, which is the manufacturing versus the services sectors. We'd seen strength in the former for quite a while, but we are starting to see a little change there. What is that?

Johnson: Absolutely. We've gone two years through the recovery, where manufacturing and durable goods have been the very strongest part of the economy and have literally trounced the services side of the house. The growth rates have been roughly double in the goods-producing side of the house versus the services side of the house, which is okay, but the bad news is that services is two-thirds of the economy, and that's been a real laggard.

Well, in the last quarterly GDP, we finally had quite a bit higher growth rate in the service sector, and it actually beat out the goods side of the house. And so we started a trend where the services part of the economy is doing better: a) that's bigger; and b) those jobs that are generated by the services sector tend to be in the United States.

We called the earlier times, the "iPad recovery," because a lot of people were taking their special money out and buying iPads with it, or other electronics, phones, etc., that came from overseas. And so that was kind of a subtraction from GDP because those things came from overseas. Services jobs almost by definition are here in the United States.

Stipp: So, if we are seeing services do a little bit better, does that mean that we are seeing some bad weakness on the manufacturing side?

Johnson: I think certainly manufacturing has kind of come off its boom times a little bit. It always booms when you come out of recovery, and we're two years in here, and we got initial inventory restocking--they take inventories down too far and then they build them up too fast. And that tends to usually burn itself out in about a year, which was about the same trend this year.

This time around, some overseas demands for exports also helped pull along the manufacturing sector, so we actually had the manufacturing sector having, really, what I call very strong growth for two years running.

But this summer we really did have a bit of a pause. Some of that pause was related to the Japanese tsunami, which really did affect auto production and all the supply base--some of which is in China, some in the United States--and caused problems around the world, frankly, that I don't think people fully recognize. So that certainly caused a pause in manufacturing.

But the inventory restocking is done, and so that's over. And the exports maybe have slowed just a little bit, and those two things have really slowed manufacturing, and we're kind of along the flat line right now, about a 50% level on the PMI.

Stipp: But not like we have gotten off a cliff.

Johnson: But we aren't going off a cliff.

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Stipp: OK. So, obviously the consumer plays a very important role for both manufacturing and the services side of the house. So what have you seen with consumer spending trends? Any differences in how consumers have been spending over the last several months?

Johnson: Well, I think one of the things that's interesting to me, besides buying more services that we just talked about, but it's interesting: We'd call it the tale of two economies. We'd have the high-end consumer doing well, and Nordstrom and Saks and all those retailers doing exceptionally well. Louis Vuitton couldn't keep their purses and stuff in stores. Meanwhile, Wal-Mart has eight consecutive quarters of decline in their same-store sales.

Now, that's kind of turning. Wal-Mart is calling the end to their same-store sales decline, and then on the other end, Nordstrom has had kind of a so-so quarter, and ... looking at some of the bigger data, the luxury goods manufacturers are still growing, but certainly not at the rate that they were. So, maybe it's beginning to turn a little bit.

Stipp: Would you say that retail sales as a whole, though, is continuing to look pretty good? Is it holding up? Or are you seeing that high-end is bringing the whole thing down?

Johnson: No, I would say it's more of a shift, because I look at the weekly data--as you know, my favorite piece of data these days is the International Council of Shopping Centers--and we continue to grow in that 2.5% to 3.5% range every week like clockwork, and so it has not come back in.

Stipp: So, the fact that it's a little bit more broad-based, actually, could be a good thing.

Johnson: Absolutely.

Stipp: So, Bob, I think that another thing that sometimes will hold consumers back or could be a headwind is commodity prices. And we certainly have seen fluctuations there. What has the trend been with commodities, and how has that changed and maybe affected purchasing power?

Johnson: Sure, I think we've had a lot of the important commodities come in. Again, that benefits the low-end consumer, and we talked about how the low-end spends 30% of their income on necessities, like oil and food and so forth. And in the high-end, less so. So, now to see those come back is a good thing. I think we've got cotton off its highs. I think we've brought even some agricultural commodities like corn back from over $8 a bushel.

So, we've seen some of those commodities come back in, and, you know, the consumer has been so savvy this time around about pricing. They'll see one commodity go up or one category, and they won't spend that month on it. We saw the apparel industry raise prices drastically because of cotton prices a few months ago, and the sales of apparel at clothing stores fell off a cliff.

So, consumers are reacting to higher prices. When gas prices went up, demand went down. Cars, when Ford raised prices three times this spring, sales went down.

So, it's pretty amazing that ... not amazing, I mean it's economic truth ... that prices go up, the demand goes down, and we've really seen that in spades this time, which is not so good news for companies necessarily.

Stipp: So, speaking of companies, we've talked about the consumer. How are companies doing with their spending? Where are they putting money to work? We know they have money to spend. Are they spending it on anything?

Johnson: Well, a huge shift there. At the beginning of the year, they were spending their cash hoard on acquisitions. We had 80% growth in the first quarter of acquisitions. Now for the full year, we're down in the low double digits. So, it's really come back in again in terms of acquisition demand. Now they seem to be investing more in plant and equipment type of things, especially the equipment and software side of house.

We had two quarters where we had single-digit growth in what we call business investment type spending. Now, this quarter we had double-digit growth again. So, that's some good news that businesses have the confidence to do that. The only bad news is, they may be investing in those machines instead of investing in people.

Stipp: So, I want to talk about some of those potential implications in a moment, but last thing where you might have noticed some changes are in imports and exports. What was the trend there that we were seeing and what's the trend we're seeing now?

Johnson: Well, there was some good news and bad news with imports and exports. The net number, the net of the two hasn't changed very much--maybe it's come back a little bit in the last few weeks, but the import-export number, when you cancel one against the other--we've had great exports led by agricultural commodities and industrial equipment--but we also saw a boom in imports early on, especially electronics, which is now flat. And now we're shipping less capital goods and we're importing less electronics in general.

So, again, the net number is still roughly the same, but the exports certainly aren't as booming as they were, and imports aren't just booming as they were.

Stipp: So, I know that we saw import and export and that balance of trade have a sometimes-outsized impact on the GDP rate. So, when you're looking at that and you're looking at some of these other changes and shifts that we've discussed, what do you think the effect on GDP could be? Could GDP be different than maybe we thought a few months ago?

Johnson: I certainly think that I had some fear that as exports came in ... obviously China is trying to slow things a little bit and some of the other markets around the world ...were until recently raising rates to try to slow things up a bit. So I was a little fearful about the export accounts, and sure enough, they have come in a little bit, but the good offsetting thing is that the imports have come in, too.

Stipp: What about inflation. So you mentioned that commodity prices have come back a little bit. Have you maybe sliced your inflation expectations a little bit because of that?

Johnson: Well, this year we're going to see something over 3% for the full year on inflation, which was a little more than I would have looked for at the beginning of the year, a lot of that's oil. But it was still a big number. I'm thinking next year, we'll do a little better, more like 1.5% to 2%.

Stipp: So, good news for consumers on that front.

Johnson: I hope so.

Stipp: So, lastly the employment situation. So you mentioned if we have more demand for services, that could be a good thing for employment here, yet you also said that companies are maybe spending more on machines and equipment and less on hiring right now. What's the balance of that mean for the employment picture?

Johnson: Well, let me give you the number two ways. I think we're going to grow about 160,000 jobs a month, and I think that's kind of the rate we've been at for the last six months. You might not tell it by looking at any one individual month, but that is the trend--about 160,000 jobs a month, which equates to about a 1.7% growth in employment every year. So, a little bit faster than population growth, but not a lot.

I think you'll see the number of jobs go up, but I think you'll see more people drop out of the workforce, so I think you will see a decline in the unemployment rate, probably more than people are looking for.

Stipp: I know one of the things that's held us back on employment is housing. How much of a drag is that still going to be for us?

Johnson: Housing is still a big drag. It usually accounts for a meaningful part of the recovery, and it's ... still really, over the whole course of the recovery, not a net contributor. I think I had said 2012 would probably be the year for housing, and it's certainly not going to be the early part of the year based on the data I've seen so far. More like middle of the year next year before we'll see any hope of help from that.

Stipp: All right, Bob. Well, thanks for your input on some of these shifting trends that we've seen in the economy and your forecast and outlook for 2012.

Johnson: Nice to be here.

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