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Lower Prices: Bad Thing or Good Thing?

Jason Stipp
Robert Johnson, CFA

Jason Stipp: I'm Jason Stipp for Morningstar. CPI data for the month of March showed prices drop 0.2%. So how should we read falling prices? Good news or bad news for the economy and the consumer? Here to offer his insights is Morningstar's Bob Johnson, our director of economic analysis.

Thanks for joining me Bob.

Bob Johnson: Great to be here.

Stipp: We did see prices come down in March. Last week we talked a little bit more broadly about inflation and what the expectations were. You said that inflation pressures were pretty much under control right now. This report would seem to bear that out.

Johnson: Absolutely. The headline numbers showed that the CPI was down in the month March, a couple of tenths of a percent, driven primarily by gasoline, but there were a number of other energy-related categories that were also down, as well as apparel was down 1%, as well. So, it was a nice report. There were some increasing price items too. But again it was a nice balance and I think inflation remains under control. That was the message.

Stipp: A key one; food prices were pretty stable in the month of March, and I know that's one that you've been watching pretty closely over the last year.

Johnson: Yes. I always mentioned gasoline is the one that I look at as a critical one when I walk in in the morning. That continues to move on a downward path which is great news. Now, we've got kind of food prices kicking in.

We had three bad months at the end of 2012 because of the drought. It wasn't as bad as it could have been because certain things went up one month and other things in other months. So, we never had [prices for] livestock and grains and fresh fruit all going up at the same time. So, we got a really nice balance, so it didn't really kill us at any point last year.

Now, we've had a lot of the agricultural commodities come in, in terms of price. We've had some reports on crops, and certainly the inventories were a little bit higher than we thought in several categories. Corn, wheat, and a lot of the starches are down. A lot at ag commodities are down, and that is really good news, because it helps food prices here in the U.S. which is a substantial portion of especially low earners' income. So this gives them more money to spend elsewhere in the economy.

And the low prices are even more beneficial to people overseas, especially in emerging markets, where food is a huge portion, maybe 30%, 40%, 50% of their incomes. One of the reasons a lot of people in Asia had cracked down on their economies a year or two ago was because of food inflation. Now, we've kind of come back down in terms of food inflation, and that is absolutely great news.

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Stipp: So, let's take a step back here. So, you're saying, in some respects, lower prices are good for the consumer. It frees up some money that maybe they can spend on something else. But when you look at it broadly, when prices are coming down doesn't it also mean that there's less demand, that the economy might be slowing down, and people just aren't interested in buying as many things? How should we read lower prices? Good or bad, or a little bit of both?

Johnson: Well, I think it's probably the latter; a little bit of both. And there is no doubt about it that prices of some items are pretty indicative of how strong the economy is. I know a lot of people happen to like copper, which is kind of fallen a little bit out of favor because of stockpiling in China and a couple of issues that made it less representative than it used to be. But you look at some metals commodities, and some of those are very weak. And that tends to indicate a weaker manufacturing economy. And I think that's probably true and that's not a good thing, especially like in Europe where their manufacturing industry is on its tail. And I noted this morning on the way in that auto sales in Europe were down, something like 10%. So, it's no surprise that some of those commodities are weak, and that's probably not entirely a good thing.

Stipp: When do falling prices become alarming to you from an economic perspective?

Johnson: When you start getting people holding off buying and say, "I want a bigger sale." And then it starts impinging on demand. Then you get the vicious cycle where nobody wants to manufacture, and frankly, it's something that looks like the Japan situation.

Stipp: So, let's talk a little bit about then the actual core strength that we're seeing from the consumer. So if somewhat lower prices on energy, for example, and on food, stable prices there, frees up some money for them to spend elsewhere, are we seeing that? So what's the impact that you're seeing, the tie between the inflation data and the retail sales data they've been looking at?

Johnson: Well, certainly the retail sales data has been a little weak so far. And I think part of the reason some of that was weak is because gas prices were particularly high in February.

Stipp: And those numbers aren't inflation-adjusted.

Johnson: Right. And then they started coming down again in March. So, in March, we had kind of the double whammy of the prices being down, and yet people kind of were still worried about all those high prices they paid in February. So, I think if we got through March, we may be OK in April.

Stipp: And the retail sales data that you follow, as you said, has looked weak, but it's also seemed to stabilize a little bit. We're not in a free fall, certainly no robust strength, but kind of a stable slow [movement]. It's a little bit weaker, but essentially more the same with consumer?

Johnson: Yes. Let's talk about the data set that I liked the best, the International Council of Shopping Center weekly data that I use, and they use the five-week moving average year-over-year. And the numbers typically run around 3% on average year-over-year growth. And we kind of dipped back to something more like 1.8% at the bottom, and some of that was payroll tax, and some of it was gas-related, weather, seasonals. There were a couple of things in there that really made the number look pretty bleak. But it didn't go below 1, and it didn't go below zero. We still had growth, but it was at a slower rate.

The last week of data seems to suggest that maybe we've bottomed. We now brought that weekly average up from 1.8% to 1.9%, so now we're off the bottom, despite a pretty stormy week last week, and now I'm thinking maybe it will be even little a bit better this week.

So, I think we've kind of turned the corner on some of that retail sales data. And again, you have to be careful with all of this data because sometimes you say we had 4% growth in retail sales, but you had 3% inflation, so what's the big deal? This time we've got really low inflation. Apparel, in particular, is one item that's pretty big in the shopping basket, and that actually was down in prices in March which may explain some of the weak numbers that we saw out of some of the individual store data.

Stipp: So, definitely important to think about both inflation and retail sales together…

Johnson: Together.

Stipp: …looking at the data. And speaking of looking at consumer data and the effect on the economy, we're going to get the first read on gross domestic product next week. You say there is something interesting that we're going to see in that data that might be a little bit confusing to people.

Johnson: Yes. Now we've heard everything is weak and everything is soft and everybody has kind of agreed it isn't the world's greatest economic environment right now, and yet next week we're likely to get a GDP number that shows about 3% growth adjusted for inflation. And here is the real kicker that as a leader of that recovery and why the number is so high is that the consumer number will be very high.

Stipp: So, how is that? Because we've been tracking a weak consumer in the springtime here and you've seen in the shopping-center data some weakness. So, how are we going to get this number on GDP that's going to look strong?

Johnson: Well, it's kind of a wonky answer, if you will, but the GDP numbers are calculated quarter over quarter, so they take the October, November, December report, and compare it to January, February, March. And the December quarter was off to a very weak start. It built in November, then it had a really good December, and so we started from a relatively high number. Things didn't change any from November. January, February, and March still would have looked a lot better because it wouldn't have had the crummy October in there.

And then on top of it, we had a couple of good months before the bottom fell out, which was basically March. And so the numbers will look a little bit better when you look at them that way because it doesn't have the bad October in the data set. And so, it makes the numbers really kind of confusing. You might think, "Bob is crazy. Last week he told us retail sales were [bad], and now he said it's the best part of GDP."

Stipp: It's the time period they're looking at that's going to have an effect.

Johnson: The way that they look at, and also a little bit is the inflation adjustment, as well.

Stipp: All right, Bob. We'll look forward to checking in with you on that GDP data. I know you will be writing about it and commenting on it next week, but thank you for your insights today on the inflation data and retail sales.

Johnson: Thank you.

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