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Too Soon for Recession Talk

Jason Stipp
Robert Johnson, CFA

Jason Stipp: I'm Jason Stipp for Morningstar.

After a 2.7% third-quarter GDP read, which looked better than most people thought was reality, most economists are now expecting the fourth quarter to slow down, and some are even talking about recession.

Here to give his view on the possibilities of recession for the U.S. economy is Morningstar's Bob Johnson, our director of economic analysis.

Thanks for joining me, Bob.

Bob Johnson: Great to be here.

Stipp: We have heard the R word creep into the discussion of some economists and some economy-watchers. What's behind that? Why do we expect to see a slowdown in the fourth quarter, and why are some people even expecting a recession type of slowdown?

Johnson: I think a lot of people are probably looking at a combination of reports. We've had two back-to-back weak retail sales reports [in September and October], and as I've always talked about, the consumer [being] a big part of the economy, so certainly that's got people worried.

Personal income has been soft in the last couple of reports. We had one bad month of auto sales, now we've had one good month. … We had poor industrial production numbers, and we've had continuing poor numbers from the Purchasing Managers Institute.

Stipp: And also government spending was a big part of that 2.7% third-quarter GDP, and we don't expect to see that happen again as well?

Johnson: That's going to go away, but then again, there was a soybean inventory effect that was almost the same size as the government effect, and then auto production took 0.5% off of GDP in the third quarter, and that will probably reverse itself here in the fourth as well.

Johnson: OK. So, I want to talk about some of those positives in a moment, but before we get there, there is a lot of noise in the data right now. You've written about this on Can we even tell if we're actually slowing down when we try to pick apart all of the things that have really messed with the data recently?

Johnson: We really can't, and there are a few factors for that. One is, we've had a shifting inflation rate, and sometimes inflation spikes one month, but the benefits and the harms happen in another month. And so, we've clearly gone from two months where we had 0.5% of 0.6% price increases, then we had a month of flat, now we'll probably have a month of down. So again, that will start to be better for the consumer. So, vibrating inflation rates. When we look at all these numbers, the best way and the way most people look at them is inflation-adjusted. So, that's certainly one factor out there.

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Sandy has been another, and here is the real problem with Sandy. It happened at the end of a month, so it hurt some of October, and it hurt the first part of November. So, you look at the numbers back-to-back, and you say, oh my goodness, this lasted two months; what a disaster. People may say, OK, I can take one month of a bad number, but you see two, then people begin to panic and … take out their rulers, and draw a trend line. And what's really happened is that [the storm] happened the first week of one [month] and the last week of the other, so it has a continuing, ongoing effect, so that certainly messed with the numbers.

Changing automobile production schedules had a big effect on the numbers, changing the summer shutdowns, ramping up inventories post-tsunami and so forth, all messed with those numbers as well. So, there is a number of factors there that have really hurt us in making the numbers comparable.

Stipp: And Sandy is not only affecting the consumer numbers that we get, because people just weren't going out and shopping in the midst of the storm, but they might do more shopping later, so that's an adjustment, but also imports and exports had an effect from Sandy likely as well.

Johnson: The export numbers came out yesterday, and they were a little light from what people have been thinking, although the trade balance was in pretty good shape, which actually probably says to me that the imports and the exports out of the New York and New Jersey area probably weren't fully in the numbers. And [some may say], oh, the exports, the world economy is falling apart; so are we." No, not true. Exports were a little slower, but some of that was soybeans and some of that was the closed ports. I don't know how people can draw the conclusion from that that the economy is getting weaker.

Stipp: And when you're looking at consumer or retail sales, it's also important to consider that there is some differences in the way consumers are shopping. They're doing more shopping online. They're also doing more layaway, and that can affect the retail sales data?

Johnson: You've got to consider the source, but the International Council of Shopping Center's number was a little weak for November, but they're maintaining their 3% to 4% growth rate for the full holiday season, saying, it's going to bounce back in December. And the reasons that the numbers are mucked up is because of the way Cyber Monday fell in the December period, and since more sales are moving online, December is going to look better than it usually does, and November looked worse, so that was probably the biggest factor.

Then you've got layaways, which are [more common] now, unfortunately, because of the slow economy, and those don't get counted until they're actually picked up and paid for. And the same with gift cards don't count until they are used. So, those type of things have all shifted a little bit from November to December, and the International Council of Shopping Centers is adamant that they think they're still going to get the 3% to 4% for the full year. So I am not worried.

Stipp: The other big factor out there, of course, is the fiscal cliff, which we're reading about in the headlines every day. We do expect that there will be a headwind from the fiscal cliff next year. We don't know what the magnitude will be yet. The contours of the deal are still yet to be decided. You've written about this.

But what about right now? Is the fiscal cliff concern having an effect on the real economy right now by causing consumers to really step back from spending and causing businesses to pause everything until we get this sorted out? Is it slowing us down right now?

Johnson: Well, I think on the business side, I've been pretty clear that I thought it had, and you really look at some of the durable goods and capital goods order cycles, and they probably have stepped back there a little bit; that's for sure.

It looked like at one point midyear that maybe they were getting a little afraid about hiring people, because of the cliff, but now the last few months on the hiring data look pretty consistent with things [being] OK. But businesses are clearly more worried than the consumer, who--other than the Sandy-related weeks--has really done pretty well. And the only other thing [about] the consumer that's maybe just a little weak is the [holiday shopping] completion rate: a couple percent below average have finished their shopping so far for Christmas. So that means they're probably a little bit more fearful and holding back. But on the other hand, if they do actually go out and spend the money, it'll mean a better December number.

Stipp: When we look ahead at some of the factors that could be positives for the economy, some of them could be adjustments from some noisy data that we saw before, and others are more fundamental, and you have a few of them here. One of them is that hiring, as you said, although slow, still continues throughout some of this volatility that we're seeing elsewhere.

Johnson: We've had six months in a row where we've grown employment about 1.8, so it doesn't look like anybody is backing off or getting scared, and certainly that's going to put more money in consumers' pockets, and that's why, from time to time, we've seen consumer confidence look better.

Stipp: And autos, which had looked weaker in some of the recent reports, you expect to look better because of a bounce-back from what was an abnormally weak report?

Johnson: Right. And we had a really great report on the sales end of the equation in November, some of that obviously was helped by Sandy. But you average the two months together, and the sales for October and November were great, and production appears to be ramping up again in the auto industry. The recent employment reports showed that the auto industry was hiring more people again, which means we'll finally get a better number in auto production, and why we'll see a better industrial production number on Friday.

Stipp: Something else that's been noisy is the import-export related to soybeans, and you expect that should look better as well after it looked weaker than maybe it should have.

Johnson: Absolutely. I mean that's the number we wish we didn't have to think about, but it took 0.5% off GDP in the third quarter. It wasn't helpful for this month's export report, but I think in December, we'll probably be the usual yo-yo and we'll be back up again. Again another volatile factor out there.

Stipp: More fundamentally, gas prices are easing back off again now and that should put some more money in consumers' pockets.

Johnson: Absolutely. We had an early fall spike in gasoline prices, which really put the consumer behind the eight ball again, almost back to the springtime levels. And now luckily we've fallen back to where we were during the last holiday season, a year ago. So, I think the consumer is going to have a little bit more money in his pocket just when he needs it at the end of the year.

Stipp: And retired consumers should have a little bit more because of Social Security cost of living adjustments early in the year?

Johnson: That happens in January, that's right.

Stipp: And also you mentioned the consumer balance sheet overall, their debt and where their money needs to go, that's looking better?

Johnson: Yes. Their net worth, so to speak, had a nice improvement in our last reading, which we got last week, and now we're almost back to where we were before the recession began. We've had a rising stock market. We've had home prices look like they'll be up 6% for the full year, and consumers are suddenly realizing that money is there, and some of it is getting spent and some of those homes are getting refinanced, and the extra cash flows can be used for retail spending.

Stipp: And lastly, I don't think I'd call this a positive, but it's more a reality check about the fiscal cliff--you wrote about this last week. It's not really a cliff, not all these things will happen immediately and we'll be thrown immediately into recession. What do you mean by that?

Johnson: There is a few things. One is, the biggest chunk is taxes, and all the President has to say is, the Treasury department has to [put] an order out and say, don't change the withholding tables just yet. We'll save that until we know we get a little closer on the negotiations. In other words, there is some flexibility. The law says how much taxes we have to collect in a year, but nobody says exactly how we time out the tax tables to adjust for that. So, that's certainly one of the items that's out there.

The sequesters, you don't stop building on day one; people tend to push it off to the end. The taxes that you're going to pay on your investment income won't happen until March and April of 2014.

So again, we talk about a cliff, and yes, certainly the laws [would] go in effect, but the actual impact in the dollars is spread out over a longer period of time. But it will be a headwind next year and maybe, perchance, a little bit bigger than the headwind this year.

Stipp: So, it will be a headwind, but it won't be a wall of headwind immediately on Jan. 1?

Johnson: It won't be the brick wall.

Stipp: All right. Thanks, Bob, for checking in today with your take on some of this noisy data and outlook potentially for what we'll see ahead.

Johnson: Thanks.

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