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Johnson: Slow-and-Steady Economy Continues in 2015

Jeremy Glaser
Robert Johnson, CFA

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Many people, including the Federal Reserve, are beginning to get worried that the U.S. economy is slowing down. I'm here with Bob Johnson--he is our director of economic analysis--to look at some of the numbers and see if that's really the case.

Bob, thanks for joining me.

Bob Johnson: It's great to be here today.

Glaser: Are these concerns, including from the Fed, well founded? Are there signs that the U.S. economy really is slowing from the growth levels that we've seen recently?

Johnson: I think everybody became overly optimistic on the economy. We had certainly a very good June quarter a year ago, and a lot people said maybe that was weather. Then, things really got strong in the September quarter, and we had close to 5% growth. Some people said, "Maybe this is the real deal." Everybody started thinking maybe we'd grow 3% or 3.5% in 2015 in terms of GDP.

Well, when the fourth quarter came along and the economy only grew about 2%--though, we have one more revision coming and I think it will be closer to 2.5%--but anyway, the economy still slowed by about 0.5% in the December quarter. And I think the way the data is setting up so far is that the March quarter of 2015 will also be in that 2% range.

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Glaser: So, let's look at some of the underlying metrics here that you look at. First is manufacturing, an area that really was a driver of the recovery for some time but is now showing weakness. What are you seeing there?

Johnson: With manufacturing, I think the data is weaker; but as we've warned readers for a long time, we think that that rate of slowdown is normal and to be expected, and I still expect [manufacturing in 2015] to grow above the long-term average. But it won't be the banner year that we had in 2014, where they benefited from a lot of oil exploration; they benefited from a really strong auto industry. [Exports were also strong] because the strong dollar hadn't really kicked in yet and there are a lot of long-term contracts there. You've got Boeing (BA) doing some interesting things.

If you roll all of that together, it would be really hard to top what happened in 2014. And now with the dollar stronger, I'm certainly a little bit more worried about the manufacturing sector.

And, frankly, the data shows it. This week, we got durable goods orders, and the news there was that they declined 1.4% between January and February. It's not a terribly awful number in this volatile series, but that's even excluding airliners, which are the volatiles part. We're also still down 1.4%.

If you exclude defense orders and those aircraft, you're actually looking at six months in a row of decline. This is for real. I think we're not going to grow as fast manufacturing-wise, and that's kind of in our GDP forecast. That's one of the reasons our forecasts have generally been lower than most of the Street.

Glaser: Has oil been a big impact there?

Johnson: It absolutely is. But the hard part of it is that there is no single box in it that says oil. This is durable goods, so it's obviously not oil itself, but it's the drill bits that drill for the oil, it's the computers that drive those drills, it's the tubular steel that goes to the site. So, almost every category is touched, but you can't add them up and say, "This is what energy did to [the numbers]." But it's making everything look a little weaker than it otherwise would.

Glaser: Look at housing, there has been some gloomy data there as well.

Johnson: We've had a series of bad news that started last week where we had some poor news on housing starts. The permits looked a little bit better, but we had some bad news on starts. And then we started this week with bad news on existing home sales, which remained under 5 million units on an annualized basis again and came in below Street expectations.

So, clearly, the housing numbers are off to a bad start. If you look at a lot of the numbers--and especially the starts data last week--you could see the slowing was in a lot of the areas that would be affected by weather, and some of the other parts of the country did a little bit better.

Interestingly, we've got two counterpoints to that, which is why I'm still optimistic about housing for 2015. Lennar (LEN) certainly said they've seen a good spring selling season, and people are particularly interested in lower-priced homes. So, if builders can build something in that arena, they'll probably do a little bit better.

But the new-home-sales data, also out this week, was above 500,000 units. Now, this report is often revised, so we've got to be a little careful with this. But we've had two months in a row with sales over 500,000. And the last time that happened was way back in 2008. So, that seems to indicate that maybe we'll get a little bit of improvement.

This series is incredibly volatile; but if it's correct, it would be a better series to have because it includes people buying homes that are already completed and sitting on a lot, or it's [a home] that's on the drawing board but hasn't even been started yet because it's a lot number on a map. And so this tends to be a little bit more comprehensive, but it also is more volatile.

Glaser: Let's look at inflation, then. Obviously, a concern. The Federal Reserve is concerned about not being at their 2% target yet. What do we see from inflation data? What does it say about economic growth?

Johnson: I think you've always got to be careful about looking at a single month of data; but certainly after several months of decline in the CPI inflation rate, we actually had a tick up to 0.2%. So, the number did go back up and everybody is saying, "Well, maybe we've seen the best of the inflation number for a while."

If we exclude food and energy on a year-over-year basis, we're up about 1.7%. So, inflation is beginning to move back. People are thinking about that 2% target. We're not all that far off of it. In fact, I'm actually quite worried about inflation. I think we'll probably be OK for the next couple of years, but as we approach theoretical capacity in the economy, that's going to certainly push inflation up. And certainly, rents continue to be an issue. Rents were up about 3.5% year over year, and that's a meaningful part of the index. I don't see any signs of those abating. And so I'm a little worried that inflation will move higher. Probably a year from now, we're going to be talking inflation of 2% to 2.5%--not about under 2% and not about deflation.

Glaser: Taking this all together, how do you think about the strength of the economy? Does it seem like weather and some other issues are kind of impacting it in the short term? What are you going to be watching to see if there is a real slowdown--a fundamental slowdown--or if it is just these temporary factors?

Johnson: You certainly have some things shifting around with manufacturing and housing and so forth. I think the housing betterness later in 2015 will offset the manufacturing part of it. But I don't think we've got this accelerating growth that a lot of people are thinking. I think we're going to have a pretty steady, staid economy in 2015 like we did in 2014.

What I'll be watching is, obviously, I need housing to get better. We know manufacturing is not going to be so hot. So, either manufacturing has to be better than I think or housing has to kick it into gear. I'm thinking housing will come back. I think we have seen some early signs that maybe it will look better; some of the year-over-year data and some of the new-home data looks a little better than some of the other data. I'm optimistic that we've still got a lot of room to move in that sector.

So, I think that will be one of the key things that I'm watching. Retail sales have certainly been sloppy lately, and people have said, "Why aren't people spending their gas money yet?" I think higher utility bills may have hurt that a little bit as well as higher food prices. But I think, maybe not in the next month or two, but getting toward June and July that the retail sales numbers should start to look better or else, then, I'm a little bit more concerned.

Glaser: Bob, thanks for the update today.

Johnson: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.