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Dark Clouds for the Economy?

Jason Stipp
Robert Johnson, CFA

Jason Stipp: I'm Jason Stipp for Morningstar. A recent string of lackluster economic data has some worried about the health of the U.S. economy. So how concerned should we be? Here to offer his insights is Morningstar's Bob Johnson, our director of economic analysis.

Bob, thanks for joining me.

Bob Johnson: Great to be here.

Stipp: We have a string of some disappointing economic reports that have some of the bears worried about the economy. Let's tick through some of the recent ones, starting with last week's GDP data out of Europe--not so hot.

Johnson: We had the third quarter in a row where GDP was down in Europe. So that certainly has got people concerned about the European situation.

Stipp: And over here in the U.S., retail sales for January looked pretty weak as well. It might have come close to expectations, but it certainly didn't look great.

Johnson: No, it was a relatively flat type of number, and people were thinking maybe we would have done a little better than we did, but those were the official government numbers. Some of the shopping center data was better. It was kind of odd. It was hard to say it was a truly awful report, but it certainly wasn't a robust retail sales report. And then we follow that up on Friday with the rumors out of Wal-Mart about the worst start to February they had seen in many years, and certainly that's got people very concerned about the retail sales environment.

Stipp: Then we look at real estate. We got a couple of pieces of data this week that you might have hoped would be a little bit better?

Johnson: Yes, builder sentiment ticked down just a little bit, but it was down, not up. Housing starts were off dramatically from what they were the month before--even though [the prior month's] number was revised way high up--but we had a pretty steep falloff there. And then housing starts didn't look so hot.

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Stipp: OK, and I also saw in the news recently that some folks expect gas prices will continue to tick up even into April, so that's putting a damper on folks' expectations for disposable income.

Johnson: Yes, absolutely. Gasoline prices are a factor in everybody's point of view, and we've had a pretty dramatic increase from kind of the $3.20-$3.25 range at the beginning of the year, all the way up to kind of $3.72-$3.75 today. That's a big number for people that spend a lot of money on gas.

Stipp: And then on Wednesday, we got some minutes from Federal Reserve meetings, and it called into question how long the Fed is going to be willing to continue to do some of the stimulus efforts that it's been doing. The market did not like what they found in the minutes.

Johnson: They really hated it; the market was doing OK until then, and then the market sold off over 100 points. And basically in the minutes it came out that they're really arguing pretty hard with each other about how much is too much in terms of the QE4 program that was kind of slipped under the radar while we were watching the budget deficit talks at the end of last year. Now some are wondering if maybe they went too far and maybe we might even have to move rates up even if employment doesn't get better, and so that's scared a lot of people. They are fearful about the Fed tightening and raising interest rates.

Stipp: So, Bob, I have to be honest with you, this is a pretty big worry list of recent data that hasn't look so hot, but one thing I always appreciate about you is that you look a little bit longer-term, you have some perspective on these numbers. So, let's get your take on some of these recent reports that have caused worry. Let's start with Europe. So that GDP report, it's hard to argue with. It just doesn't look that great, but how are you looking at European GDP with respect to the U.S. economy?

Johnson: Europe doesn't have a big impact on the U.S. economy. We've said it time and again, and last year we proved it out: The U.S. economy did well, accelerated growth in 2012, despite a decline in Europe and continuously bad headlines. So, in terms of direct impact on the U.S., the slowing in Europe is not a big deal, and by the way it's not totally unexpected.

Stipp: So, what how bad would it have to get before you would worry about the U.S. economy?

Johnson: The thing that would trip up Europe is if the whole economic system falls apart, if they talk about breaking up the euro again. But now, frankly, it seems like it's a little bit broader weakness across Europe, and it's not because Greece is so terrible and everything else is fine and we are going to throw Greece off the boat. I think that the thought today is that the whole economy over there is a little bit weaker.

Stipp: So, unless we get that real crisis moment in the financial system and the contagion, Europe is not necessarily topping your worry list for the U.S. economy here.

Let's talk about the retail sales. There were a lot of concerns about consumer spending power because of a few factors that are happening here in January. How much of a worry is the discretionary income, the spending power, and how much do you think those weak reports we saw might continue into the future for consumer spending?

Johnson: Well, I think the bad news is that we've probably got another month, or maybe even two, of some softer consumption numbers. I think initial reads of January [data], especially out of the shopping centers and a couple other things I watch, were that maybe [the softness] wasn't a big deal. But then some of the February numbers looked a little bit weaker now that we've seen some of those. And a 2% payroll tax increase is a pretty big deal, and certainly that's had some impact--maybe a little bit delayed from what we thought.

One that nobody is talking about is tax refunds, and they're at least 10 days delayed compared to normal, and that's money that's just not there for people to spend. Now, I'm optimistic--you could file as of Jan. 30, it takes about three weeks to process--that maybe that money … today is Feb. 21, [maybe] we are going to start end up seeing some of that money out there and available, and that's money that was deferred or delayed, not forgone so to speak.

Stipp: Anything in these early retail sales reports that cause you to rethink your whole year forecast for 2013 on the consumer portion?

Johnson: I'm not there yet. Autos have held up OK. The shopping center data is a little weaker than it was, but we're still in positive territory despite the trifecta of the refunds, gas prices, and the payroll tax increase. And those are pretty significant things, and we'll get through those, and I think we'll move on.

And the other thing that people forget, too, is that we went in … the last three months of December were relatively strong for consumer incomes, and frankly relatively soft in terms of spending--they adapted beforehand, if you will. So, I don't think there is as big a worry … we're going to fall apart in the U.S. economy here. But the numbers will look weak.

Stipp: Let's talk about real estate. There are some interesting things going on here. Real estate had been a bright spot for the economy; some of these reports, are they trouble signs? How are you viewing that sentiment number and that other [housing starts] number that we got? How are you interpreting those?

Johnson: I think there are a lot of interesting things happening in the housing market. And remain convinced that it will be a very good year for housing in 2013. And it will be a major driver of economic improvement.

That said, some of the recent numbers …, again we've had huge run. The last part of 2012 was helped by favorable weather conditions. Now we've had string of unfavorable weather conditions for real estate, and that's affecting both the year-over-year data, which I'd like to use, and the last quarter data. So, that's making things look a little tougher there. And on top of that, now we've also got a supply issue. There isn't enough inventory on hand to meet demand, so there are no transactions, and all the things that fall out of the transactions aren't happening.

Stipp: How big a worry is that supply issue? Will the market correct for that because the existing stock of home prices will go up, because there aren't as many homes out there?

Johnson: Here is how I think it's going to play out: I think we've probably got, again, like the retail sales data, we've probably got another couple of months of bad data. February weather-wise is probably worse than January. So, that means the data we will get out of February isn't going to look so hot.

Then we'll have a bigger spring bounce. We haven't had a decent spring bounce the last couple of years, because the weather was so mild during the winter and snow-free, and now this year it's been exactly the opposite. So, I think that we may get to see a little bit of a spring bounce, but we may have to endure one or two months of bad data.

But then as you mentioned, prices are up, and we're up, according to CoreLogic, about 8% in 2012. And as people get more towards the selling season and the homebuilders think about starting new homes, they are going to be looking at that data and saying, gee, it's up 8%. Maybe I should put my house on the market, or maybe I should start an additional house.

So, the higher prices will bring supply. If we don't get supply, prices will go higher yet, and that will put more money into consumers' pockets and give them more confidence. So, it's a little bit of a win-win there, but it may look like some of the data is soft for a month or two.

Stipp: So, it may take a little bit of time for those market forces to get to work.

Let's talk about gas prices and inflation in general. This is one of the biggest worries for a recovery, as you've mentioned before. The recent gas price going up and up and up, how does that change, or not change, your outlook for the economy in 2013?

Johnson: Well, it certainly has had an impact already. And I think Wal-Mart's reported weakness, whether that story is fully true or not, but it's a big deal to Wal-Mart, because people [who have to] drive a long way to get to Wal-Mart [may] either consolidate their trips, maybe will not tend to get as much, or maybe they fill in their goods at more local stores and not drive the 15 miles to a Wal-Mart. So, gas prices are big deal to Wal-Mart, and they are a big deal to a lot of the economy.

But I think it's a self-correcting mechanism that we see here. Today oil prices are down, thinking Europe is little softer or maybe the U.S. is little softer, and maybe we will start to see that back off. Now, that will take another month or two to work through the chain, but I think by April, we might be back to more normal gasoline prices.

Stipp: So in some respects, a little bit of bad news could be good news for commodities prices, if they pull in a little bit because there are some concerns about overall economic health?

Johnson: Correct.

Stipp: Let's talk about the rate situation. So, again, the market sold off when they thought that there were questions within the Fed about how long they should continue some of their stimulus programs. What's your take on the rates? If the Fed pulls back a little bit, is that going to be a big problem for the economy?

Johnson: It may be to the psychology, or it may be to the stock market, and it may be to some select commodity prices that have gone up a lot on the speculation, and some might argue the stock markets and bond markets have been driven a little bit by the Fed's looseness.

But I really think that rates could go higher and the economy will survive. The housing economy, in particular--we had one of our biggest booms in history when rates were double, maybe even triple, what they are today.

So, I think the housing market can easily endure a 1%-1.5% increase in interest rates without a problem. Higher interest rates also put some more funds in the hands of consumers, especially savers, especially the older part of the population that tends to save a little bit more.

So, I don't think interest rates being a little higher is [entirely] a bad thing. It also gets people off the fence who [may think] that rates [will be] cheap forever, so I am just going to wait until the very moment I need it, and when everything is settled in the Congress. And now they start to see rates moving up, [they may say], I better lock this in now. So, I think there are a few things that make higher interest rates not a disaster.

I don't think rates are all that far off of where they should be, either, because remember in the report on inflation we got this morning, inflation was running at 1.6% year-over-year. That's incredibly low. So, when people say, [interest] rates used to be 10%, but you have to remember, inflation used to be 3%, 4%, 5%, too. So, it's a big difference. Maybe the 10 year instead of being 2% should be 3%. But should it be 6% or 7%? No.

Stipp: So, a lot of the recent reports, if you have a little bit of perspective on them, you can understand what's at work, and maybe all the pessimism that's come from those recent reports isn't warranted. But one thing you mentioned is, we may still see some week reports to come. So, how important is the psychology element here? If we see a few more weak reports, that's not going to do very much for investors' psychology and confidence, and consumers as well.

Johnson: Right. If everybody is convinced that we are in another down cycle and businesses … I'm more worried about businesses getting scared and panicked. The consumer seems to spend along in a certain pattern. Last year when we had the various federal budget scares and so forth, it seemed to be businesses pulled up and down a little bit more actually than the consumers did.

So, I would say probably the stock market and business spending might be more influenced by the up/down psychology, but I don't want us to talk ourselves into [thinking] we're going into another recession, and maybe I won't spend now because I'm worried about this. I really don't want to see that take root. We just busted that a little bit, and we've got people thinking that housing prices are going up and the market is going up, I'm feeling little bit better about my position. I really would hate to see that psychology develop. The press seems to pick up on a lot of the negative news, and boy, even I could write a helluva negative story right now.

Stipp: All right, Bob, we'll try to keep our hopes up, and keep a good perspective on the data that's coming in. You help us out with that every week. Thanks again for joining me.

Johnson: Thank you.

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

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