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Consumers Not on Last Leg

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar.

We got revised GDP data for the fourth quarter. It showed that GDP grew 3%. Here with me to dig into the numbers is Morningstar's Bob Johnson, director of economic analysis.

Thanks for joining me, Bob.

Bob Johnson: Great to be here.

Stipp: When you looked at the revised numbers, you did pick out a few important details; one of them had to do with incomes. That was a different number than we saw in the first report. What did that tell you?

Johnson: A lot of things are in this GDP report. It tells us a lot of different things. It is a very comprehensive report, and there are a lot of adjustments they made this time.

But there's one that really stood out, and that was the personal income number, the real disposable personal income number, was much better than we had previously thought. They had thought kind of 0.8% [growth] and now they are thinking 1.4% instead on that number.

So that's a very large increase, and it in fact begins to explain the mystery of why holiday shopping was as strong as it was--because we have looked at the numbers and said, "Wow, where did all this [spending] come from?" Even I was a little dismayed. How it appeared was that we had dipped into savings.

Stipp: I know that was a big concern that people were spending their savings. Initially... market watchers thought that people were spending into savings, and it wouldn't be sustainable, but this would tend to counteract that. Did the savings rate change as well? Do we have any more insight on that?

Johnson: Yes. When you looked at the savings rate number, it was 4.5% [in the revised report] instead of 3.7%. So a major revision from one to the other, and now even less drastic compared to the year ago, when we were in the mid-5% range. So much less of the [spending] growth came from dipping into savings or taking out more loans. Combined, those factors were much less of a factor than we thought one month ago.

And that's really the key news, that the consumer is not on his deathbed just spending his last dollar on holiday shopping, now to go off into nowhere. It turns out that income was a lot better than people thought.

Stipp: Any insights on why income was better? What they missed in the first report that they were able to catch in this revision?

Johnson: Yes, the first run of the personal income numbers are done off of the employment report from the Labor Bureau. And they just take those and multiply them by an average wage and get a number. Of course, you've seen the revisions that we've had in the jobs reports over the last few months--we'll add 50,000 here and 50,000 there, and all of a sudden they add up to big numbers, especially when you start to annualize relatively short periods of time.

So that's what really helped, and we'll even get a read when we get out towards June, and then they go back to payroll data, and then eventually we go to W-2 IRS tax form type of data to get the wage data. But at first, they estimate it off of employment, and that's been drastically revised upward.

Stipp: Any other things that contributed to that upward revision when you looked at the new fourth-quarter number?

Johnson: There were a lot of little things in there. Consumption was a little better, and specifically services were better. As you know, I like services because that means less imports eventually. So I'm glad to see the services number acting a little better. So that was probably the biggest revision in the numbers.

The inventory was just a little bit less of a factor. It was still a very large factor, but not as big a factor as previously thought.

Imports were a little bit smaller than people thought, so that’s a net add to GDP, so those were all good numbers.

Non-durable goods, food type stuff, was a little bit worse.

Stipp: And we also saw that government spending was a headwind for GDP. How did that affect the number?

Johnson: Defense spending took away 0.7% from the GDP number. That number is a volatile series. I don’t think that number is ever going to be a big adder, or maybe it's on a slow downtrend, but it was a big subtraction this time around. I doubt that it's going to be that type of subtraction in the future.

Stipp: It likely will be somewhat of a subtraction just given the budget issues, but that's a pretty big headwind?

Johnson: The non-defense part--you think all the schools, the teachers, all those things were a small subtraction. The biggest part of the government shrinkage was the defense spending that came back in dramatically.

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Stipp: And Bob, just a more technical point on GDP: We've seen some reader comments when you've talked about GDP growth rate, and they say, "Inflation has been so high, this GDP [growth] is just completely wiped out by the inflation that I am seeing," but you actually say that these numbers are inflation-adjusted and that’s important to keep in mind.

Johnson: Yes, they are absolutely inflation-adjusted. If you were looking at the nominal or current dollar ... GDP rate, they'd be absolutely right. You have to strip out inflation, and the government doesn’t even really think about [the nominal rate]. It's only as an afterthought at the very end of the report that they even talk about what that [nominal] number is. But ... when I said we grew 3% in the fourth quarter, that is adjusted for inflation of about 1.2% already. So we actually grew over 4% and then subtracted 1.2% from that number, and that's how we get there.

The other comment I get frequently that's paired with that inflation question is, "Well, but we have population growth, so that really means that 3% is really nothing." But that population growth number has really come back in over time, and we're now somewhere in the 0.8% to 1% annual population growth. And so really to say we grew 3% is considerably faster than population growth. So that’s some good news.

Stipp: So that revision for the fourth quarter certainly seems to indicate that we're continuing to pick up some steam in the economy.

Bernanke also this week had some comments about the economy, though he said that we are getting some mixed signals. But he generally was focusing on some of the signals of strength, and also what that could mean, potentially, I think market watchers are wondering for interest rates. What's your take on his comments this week?

Johnson: Well, I think that he's seeing improvement in some things, and he doesn’t want to get carried away and go overboard and say everything is just perfectly fine, because just a month ago he was saying that we've got to be careful, we want to keep rates low to 2014. So he's got to keep things in balance a little bit.

But he certainly said that there were some metrics that are beginning to look a little bit better to him, and I think the market took that [Thursday] morning ... the minute he started talking and his talk became available online, the market went into a nosedive because I think he pretty much indicated there would not be a QE3 unless things got worse from here. And I think that tends to hurt commodities and some of the speculators out there, but my personal belief is that QE3 would be a huge mistake, and I think it's pretty much, from what I see of the data, looks like it's off the table, and it looks like he's even thinking it might be off the table.

Stipp: So, Bob, fourth-quarter GDP looked pretty good, but you are not expecting a repeat in the first quarter. What do you expect for first quarter and why might it be less than what we saw in the fourth quarter?

Johnson: Well, we had the 3% in the fourth quarter, which was really a little bit of a catchup from [earlier in 2011]. We had some poor numbers early in the year related to the tsunami and high oil prices, and those combined really hurt us in the first half, and then we really bounced back in the second half.

For the full year 2011, we were at something like 1.7% for GDP, and that type of number--something in the 1% to 2% range--is what I'm thinking for the first quarter. Again, we're going to have oil prices hurting us a little bit because gas prices have gone up again. Offsetting that a little bit this year, will be the fall in natural gas prices. So that may take away some of that pain, but that's certainly one of the factors.

We saw a lot of [activity] rushed at year-end in durable goods to get a tax credit and a lot of stuff ships in the fourth quarter anyway, in the last month of the quarter, so everybody doesn't have to carry it on their balance sheet. So, there's naturally a slowing, probably more than is in the seasonal adjustment for January. So, those numbers, the durable goods part of it, may look a little soft, too. So I think we're safe in the 1%-2% range, and we will grow a little faster on the back half [of 2012].

Stipp: So, let's say that first quarter at 1.5% growth--when I see the headline that says GDP has been slashed in half from the fourth quarter, I shouldn't panic. I need to keep a longer-term perspective.

Johnson: Absolutely, I think you've got to watch a lot of numbers, you've got to watch the retail sales, you've got to watch some of the employment things, all of those. Don't take that one number out of context.

Stipp: OK. And last question for you, Bob, we also got housing data this week. Some of it looked pretty good, but then we also saw some really negative headlines on Case-Shiller. What's your take on the housing reports?

Johnson: The good news, first pending home sales were up, the second best of the recovery, I think, and sequentially they were up about 2%. So that means well for existing home sales, it's another good indicator that consumer confidence has picked up a bit, and that may be we're off of dead center in terms of the housing market.

The bad news, if you will, we got the Case-Shiller number, and there are many ways to look at numbers, but certainly in their report what got trumpeted was that we hit a new low in housing prices. And you've got to be a little careful. Last week we spent a lot of time analyzing the Federal Housing Finance Administration numbers. Their fourth quarter to fourth quarter number and Case-Shiller's were relatively close to each other.

But looking at the monthly numbers, which struck everybody as being so negative, the Case-Shiller uses a moving average. So they included a couple of the softer months in there, whereas the FHFA number is not [a moving average]; it's a single-point number. So that number is going to tend to turn up a little bit before the Case-Shiller numbers, and I think the Case-Shiller will look a little better in the months ahead, but they really aren't opposite or pointing in different directions. It says that housing has pretty much flattened out. They are not saying we're booming, but we have flattened out.

Stipp: All right, Bob. Some very good insight on the housing reports as well as the GDP revision. Thanks for joining me today.

Johnson: Great to be here.

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