Is the Economic Slowdown the Real Deal?

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. Stocks over the last week have had volatility that we haven't seen since the height of the financial crisis. I'm here today with Bob Johnson. He's the director of economic analysis, and we're going to talk about what's driving that volatility, what investors are focusing on, and what metrics he's going to be looking at in the coming months.

Bob, thank so much for joining me today.

Bob Johnson: Great to be here.

Glaser: So, certainly we've seen this volatility, what's driving that exactly?

Johnson: Sure. We have seen a lot of volatility; these 400- or 500-point days are big news. That's kind of 5%- or 6%- type moves in the market, and we haven't really as you said seen that since the financial crisis in the 2008-09 timeframe. But what I think is driving is that right now we're kind of in a slow new season, if you will. There isn't a lot of earnings news out there; there isn't a lot of economic news.

So, with the data that is coming out, everybody latches right on to it. And then you've got the normal thing with summer in which people don't want to hold things, people are on vacations, and whatever. So, all of that's contributing to the volatility, and certainly, everybody, is afraid that maybe we're going to back in the 2008 or 2009 again. They're kind of on-again, off-again deciding if they are or they aren't.

Glaser: So, certainly we haven't got a lot of news, but some of the pieces have been somewhat, if not monumental, unusual. Things like the Standard & Poor's downgrade and the continued European sovereign debt crisis. Are these issues that are not really all that important to the people who are focusing kind of underlying strength? What do you think people are really focused on when they are evaluating this situation?

Johnson: Well, let me take the S&P downgrade first. I mean I think that one is a really fascinating case. I mean, yes, markets did happen to move around the day that that was announced. But you look at what S&P did: It downgraded U.S. debt. And since it has done that, bond yields have come way down, and buying of U.S. bonds has gone through the roof. I mean it is one the biggest bond booms that we've seen in some time. If we just downgraded, and it was all that a big of deal, why is everybody buying our bonds?

I think certainly some of it is because maybe the U.S. debt isn't perfect, but the rest of the world might be a little bit of worse and we're kind of hearing some of that today with maybe talking about downgrading some of the French banks and may be who knows what set of banks it maybe tomorrow. But certainly, the European situation is not settled yet, and that's partly what's behind this.

Glaser: So, the Federal Reserve came out this week, and finally it put a timeframe on low rates. That timeframe is two years into the future. Do you think that's having an impact on investor sentiment?

Johnson: Well, I think it's a very creative approach, if you will, rather than saying we're going to QE3 or whatever. The Fed instead focused on not how we do it but said the rates are going to be low for the next two years. I think that might have put a floor under the market, and certainly Bernanke has some reaction every time the market comes back to something that at least modestly helpful.

I suppose the market is a little bit upset in retrospect looking at Tuesday's announcement that there was more disagreement than there has ever been in the Fed between what we should do next. That uncertainly probably helped unnerve people a little bit on Wednesday.

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Glaser: Now other than the change in the date of long rates will go, another big change in the statement was that the Fed thinks the economy is much weaker than it had thought before, and the Fed directors really downgraded their discussion around the economic recovery. What are people focused on there? Why do people think that this recovery is slowing right now?

Johnson: There is a lot of data that says it has become weaker, and frankly, it has when you look at the numbers. What the big argument about is, is the slowdown kind of a Japanese tsunami/whether/oil price deal that's reversing itself very quickly? Or is this a truly dramatically slowing economy, that's going to sink us back into some type of big financial problem?

One day, we get one piece of information where it kind of looks like this side is wining, and the other day it look like other side is winning. That's probably part of the volatility too. But we've seen weak consumption numbers in particular, but those have been driven a lot by the auto sales and lower gasoline sales, which have both contributed to some of the consumption numbers looking so weak, which I think are the key numbers to focus on.

Glaser: So if we look at that tension between the two, which one do you think in a few weeks or in a few months are we going to see winning? What you're going to be looking at to let you know whether really this is temporary or if this is truly a serious slowdown or maybe even a recession?

Johnson: Well, one that I've been watching, what I felt it's been somewhat benign is I look at the data from the International Council of Shopping Centers. It comes out every Tuesday with weekly year-over-year growth rates in the shopping center. You do have to look at the year-over-year series. Again, this week, we were up over 4% from year ago. At the beginning of this year, we were running 2% or 3% above year-ago levels.

Maybe people at the low-end are having problems, and people buying and Saks are doing very well. But on the whole, the buying is better today than it was at the beginning of the year, and that's one set of data that I watch and will continue to watch very, very closely.

I'll be watching gasoline prices. I don't like the idea of a third round of quantitative easing; it would help inflate commodities and that in turn hurts the low-end of the consumer. So now, I really enjoy seeing the fall in gasoline prices, despite what it might it do to the oil stocks that are in the S&P 500. But I do like the lower oil prices because its going to make gasoline come down to lower prices, and I am thinking it would go down to at least $3.40 a gallon. It got as high, if you recall, as $3.99. So, I am very hopeful that that will provide a little bit of a boost.

I am also watching other commodity prices, hoping that those come in, especially on the food side. And I think we're going to have better news there in the months ahead, so I think that's another thing that I'll be watching. Certainly employment continues to be important, so I'll watch that data, as well. With auto sales, certainly, we've had high prices of autos, lack of supply, and so I am looking for a big boost from autos, as well. We may not get it this month yet, but I'll be looking for those rebates from Toyota and Honda, when they get back in the market again.

Glaser: So when it comes to the economic recovery, the consumer really remains king?

Johnson: Absolutely. Everybody's so focused on the manufacturing data, and that's wrong place to look. But by the way I think news on industrial production might be better this month than most people are suspecting too, because you're going to have better energy demand, because of utilities running at high, because of the hot weather in many parts of the country. And were off of a somewhat lower number; we got better auto production factoring in there.

So, I think industrial production will be a better number than we've seen in some time, and even the durable goods orders will, well, almost automatically it look good because of the big American Airlines order to Boeing. So, a couple of the manufacturing numbers are actually going to start to look better in just a couple of weeks.

Glaser: Bob, thanks for insight, and we'll definitely circle back later and see how these metrics are progressing.

Johnson: Thank you.

Glaser: For Morningstar, I am Jeremy Glaser.