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Recovery: Slow But Durable

Jason Stipp
Robert Johnson, CFA

Jason Stipp: I am Jason Stipp for Morningstar. As expected the second read on third-quarter gross domestic product showed a jump from 2.0% to 2.7%. Here to talk about what was behind that jump in the second read of GDP, and what we may expect for the fourth quarter and beyond in the economy is Morningstar's Bob Johnson, our director of economic analysis.

Thanks for joining me, Bob.

Bob Johnson: Great to be here.

Stipp: We did get the jump, it maybe wasn't quite as high as some of the economists had expected, but it was a sizable jump from 2.0% to 2.7%. This is the second read on third quarter GDP. What was your take on that 2.7% number?

Johnson: First of all, let's talk about the number generically, the 2.7%. It came from the same sources as we saw in the first read really, which is a good consumer and a poor business-spending environment. Business structure spending on equipment and software were week; consumer consumption was relatively strong. And then there was a bigger-than-usual kicker, if you will, from government spending.

Stipp: And inventories was another one that was kind of behind some of the adjustment factor, but that's not necessarily entirely good news, right?

Johnson: Right, exactly. So, as I mentioned, the key themes really kind of really held, but this time we've got some jumps in the individual categories between the first read and the second read. And consumption came down from a little over 2% to under 2%, so that was the bad news that consumption was a little weaker. But some of that was gasoline spending going down, which is, I believe, a good thing for the economy.

The second thing that was really notable in the report, as you mentioned, was inventories. There was a very big swing there, and there is always kind of an interaction between inventories and imports/exports. Things kind of come in and they tend to go into inventories or out of inventories. So, we knew there was probably some good news coming in exports, which actually is a little less good than we thought than imports, but we've got some better news than we expected on the inventory data. And of course, some people will posit that inventory is piling up on the shelves and blah, blah, blah, blah, we've got a soft economy. And that's really not what I believe is happening here. I think we've had some changes in production to just move things around it a little bit.

Stipp: And government is also a big contributor in the first read. That stayed the same, but at 0.7% that's a pretty big number for the government contribution. What's your read on that?

Johnson: It's probably not likely that it will recur. It's mainly at the federal level, and it's mainly from the defense spending portion of the number, which had a big jump. The end of the fiscal year is September for the government, so that may have contributed a little bit to how the number looked in the September quarter. Certainly, I wouldn't expect defense spending to be up in the fourth quarter, so that's going to be a headwind that we're going to have looking into the fourth quarter.

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Stipp: Maybe some special factors there in that third quarter number, but overall do you think that there'll be a physiological impact that we did see some factors behind GDP looking maybe better than some folks expected for that third quarter?

Johnson: Absolutely. And I think that people will look at these numbers and say, "Gee, we're not falling apart. We're not on some kind of downward slope, that indeed things were better and quite a bit better." It's one of the better quarters of the recovery, frankly, in the September quarter.

Stipp: You mentioned looking ahead to the fourth quarter, we may see that government contribution reverse itself. What are you expecting for that fourth quarter? We don't have any of that foundational data on that fourth quarter yet, but what you're thinking will happen? And I think a lot of economists expect a fall-off here.

Johnson: Right. I think most economists will probably start with the viewpoint that we started at 2.7% in the third quarter, and then the government is going to not be a factor, so that brings it down to 2%, and it may even be a small negative. So, you're down to kind of 1.8%. Then you get some Hurricane Sandy effects of at least a couple tenths of a percent, and voila, you get the consensus of 1.5% for the fourth quarter. I'm at a higher number. I think we'll do better. I think we'll do about 2%.

And one of the big reasons I am saying that is that auto production took a full 0.5% off GDP calculations in the third quarter for some very unusual reasons about when the plant shutdowns occurred, and it almost looked like you are in a recession from the production data in autos. And we know by measuring over time, that's not really true, but the government data and the seasonal adjustments kind of messed it up.

I think we'll get that same 0.5-point negative as a positive in the fourth quarter. So, I think that's going to offset entirely the change in government, but I don't think we'll get the full impact that we had from inventories this time around. So, we'll be lower than the 2.7%, that's for sure. But my single point will be 2%.

Stipp: And you mentioned Sandy in there. You said that we should be on the lookout for some Sandy-affected data coming out here. So, we've got some pretty good news on GDP and the revision, but we're going to have a string of storm-affected data that's not going to look so great coming up?

Johnson: Yes, that's all a little scary. When you look at the numbers, and I just peaked ahead to next week a little bit and looked at the consensus for employment, which is next Friday. And the numbers are for only 25,000 jobs added, and that's pretty close to zero. And given how bad the jobless claims were the week they took the actual measurement--which doesn't get you to the end of the month, it only gets you to the middle of the month--[the claims were] still pretty storm-affected.

So, it won't shock me if we even saw negative employment growth in the month of November, which, of course, would come as kind of a shocker to folks. And then some of it comes as early as Nov. 30, I think with the spending data. We've already seen the retail sales report, which was kind of flat, and I think we'll probably see more of that Nov. 30 when we get the personal income and consumption number. And that may disappoint people, as well. So, you've got this string of things that are going to be affected by Sandy.

Stipp: This 2.7% number is probably a little bit better than we're actually seeing in the economy because of some special factors. Some of this negative data that we're going get is going to look worse than actual fundamentals on the economy because of storm-related factors, so keep some of those adjustments. . .

Johnson: Keep that in perspective. I think [the fact that] we've got the underlying core growth rate at 2% that we just can't seem to shake ourselves from either way is really what's going on here. And don't let the 2.7% get you all excited on the downside, and please don't get depressed tomorrow or next Friday when we see some pretty bad numbers.

Stipp: Speaking of that 2% growth rate, it's a slow one. Can you put that in context of how our growth rate from this recovery compares with other recovery growth rates?

Johnson: Well, we've recovered just over 7% from the bottom right now. In a typical recovery we might have at this point in time been up more or like the 12%, 13%, and 14% growth rate. So, we're kind of half, but we've done better than a couple of other cases. But what's interesting is we've had 10 recoveries, excluding this one, and four of those recoveries had already ended by this point. So, while we've got slow growth in this recovery, it looks like we're going to get one of the longer recoveries because housing didn't kick in at first, so we had the slow start. But now housing is beginning to kick in, and it's going to extend the life of this economy for longer than it might have otherwise been, so some good news and bad news there.

Stipp: All right, Bob. Well, thanks for your insights on the second read on third-quarter GDP, and what we may expect to coming ahead.

Johnson: Thank you.

Stipp: For Morningstar, I am Jason Stipp. Thanks for watching.