China may be the proximate cause of the recent stock market carnage, but Morningstar's Bob Johnson doesn't see signs yet that the country's slowdown is having an impact on the fundamentals of the U.S. economy.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.
We're seeing further carnage in equity markets today. I'm here with Bob Johnson, our director of economic analysis, to look at some of the data that could be underlying the weakness.
Bob, thanks for joining me.
Bob Johnson: Great to be here today.
Jeremy Glaser: Let's talk about what's driving this most recent fall in equity prices. Is this just continued worries over China, and worries over oil falling below $28 a barrel? What do you think the proximate cause is?
Bob Johnson: We always have to be careful when we do this, because markets are very complex, and many factors go into them, but I do believe that China may be at the root, again, of today's weakness. We started out the week with their GDP numbers, which showed the slowest growth in many years, in the high 6% range. Actually, there was some initial relief that the numbers weren't worse and we didn't have a disappointment, and there was some positive reaction to that yesterday.
Then today, it sunk in that even though these numbers weren't so great, the Chinese government really didn't do anything about it. They didn't lower interest rates or change borrowing percentages or do anything to support markets. I think everybody had thought, we'll get a number that is mediocre, and then they'll announce something, and we'll all be happy. But we didn't get that extra fillip of stimulus from the Chinese government, and that's what got things started. We had the Asian markets down first thing in the morning their time, and it followed through to Europe, and we already knew in pre-market that the U.S. was down a lot. I would say that was probably the biggest proximate cause.
Deflation reports, which came later out of the U.S. and out of Europe, both seemed to indicate that deflation was a bigger problem than some people thought, and then compounding that was the IBM earnings report. I saw a lot of other companies, like Netflix, that looked a little better, but IBM is a much larger company, a much larger employer, and that didn't help matters when investors were already a little bit nervous. And it certainly raises broader fears about corporate earnings.
Jeremy Glaser: One of the big questions throughout this sell-off, and in the sell-off this summer, has been, are China's problems contained to China, or are they going to spill over to other emerging markets, or into the U.S. or other developed markets? What kind of data have we seen from the U.S. to show if the economy is holding up, or if it's starting to feel the impact? There was a somewhat disappointing, at least on its face, retail sales report last week.
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Bob Johnson: Things get complicated if you look at some of the quarter-to-quarter volatility, and we caution, there's so much inventory and odd numbers in some of the quarterly data, you do have to be careful. But anybody who wants to put a negative spin on it, it certainly looks like growth in the fourth quarter will be well below what it was in the third quarter, and that sunk in a little bit more last week. We may now be lucky to get 1% GDP growth in the fourth quarter, which will fit in with the idea that China is slowing and it's influencing us.
But that's not what's really driving the U.S. economic number down. It's more to do with inventories and the very warm weather that we've had, which has driven utility usage and apparel both through the floor. And when you're dealing with seasonally adjusted, very short-term numbers that you end up multiplying by four, those problems all get exaggerated in the statistics.
But certainly, there is some realization that growth in the U.S. will be slower, but it's not a result of China. If anything, I think import/export data is likely to be net-neutral on the fourth-quarter GDP report, so certainly China is not having any direct impact on that.
Also remember that some of the times when China was the strongest weren't the best days for the U.S., and especially Europe. And now that they're a little weaker, certainly Europe--in terms of their GDP report--has been getting stronger recently, even in the face of a slowing China. I really don't think that China has spilled over as much as people are giving them credit for right now.
Will it affect other emerging markets? That might be a broader impact. And anybody that sells them commodities, which are many emerging markets-related companies; that is a bigger issue.
Jeremy Glaser: You mentioned that one of the compounding factors today were some of the inflation reports out of the U.S. and Europe. When you look at U.S. inflation, is there anything in that report that changes your thesis on what's happening with the U.S. economy?
Bob Johnson: It was more of the same, with a whiff of deflation. I think the 0.1% deflation month-to-month was relatively in line; when you did the rounding, maybe it was a a little bigger deflation number than people expected. The deflation in this report looked much broader based in terms of goods. It was hard to find a goods category that was up at all. Meanwhile, on the other hand, services inflation remained relatively high at about 2.9% on a year-over-year basis.
In fact, year-over-year, inflation was up 0.7%. Food was up a very similar amount, up 0.8% year-over-year. Energy was down about 13% year-over-year, and "other" was up 2.1%. So it's an interesting set of statistics behind what's driving those numbers.
Jeremy Glaser: When we saw that disappointing retail sales report earlier, you said to be cautious. Wait until we get the inflation data to see what that really looks like. Now that we have that data, do you have any insight on what's happening with the state of the consumer?
Bob Johnson: I think the effects may be even more profound than I thought last week, because the goods category took a real shellacking this time around. Recall after the retail sales report, everybody was writing headlines saying the U.S. consumer isn't spending. What's he doing with all his gas money?
Well, as it turns out, when we adjust for inflation, I now believe that the retail sales report last week, which showed a 0.1% decline, when it shows up in the consumption report at the beginning of February, [we will see that] retail sales increased at a 0.2% to 0.3% monthly rate in December, because of the deflation adjustments. Food was a category that looked soft [in the retail sales report], which always kind of surprises us, because people eat the same amount all the time. And sure enough, grocery prices were down 0.8%, so that turns the small decline that we saw in groceries [in the retail sales report] up [after adjusting for deflation].
We had already surmised that apparel had some pretty hefty deflation, because there's leftover stock in the winter clothing goods, and apparel prices were down 0.2%, so we have to add that back to the [retail sales] number. Motor vehicle prices were down 0.1%. Drugs--drugstore sales in the retail sales report--actually fell 0.4%. Medical equipment was down 0.6%, something else that moves through drugstores.
You can add those numbers to whatever the reported sales were to get the inflation-adjusted number, and you're going to get some pretty hefty numbers. Even though building materials did relatively well, we noticed tools and hardware prices were down 0.3%. So, as good as that number was, it's going to get a little bit better [after adjusting for deflation]. Toys over the holiday season were down 1.9% in terms of price. Not year-over-year, but month-to-month. So that's going to factor into the retail sales report as well and make those numbers look a little bit better.
Jeremy Glaser: Briefly, we also saw housing starts. Any signs that there's going be big weakness in the housing market, or are we still muddling along?
Bob Johnson: We're still muddling along. December is not a great month [for analysis]. It did miss the forecast by a little bit, but we did have some revisions in the earlier months.
What's interesting, too, is that permits remained relatively strong even though starts didn't quite have the big bounce that we had hoped. We thought maybe the warm weather would bring up the number a little bit. We were a little optimistic on the start side, but we still got to where we thought we'd be for the full year pretty much in terms of housing starts--about 1.1 million housing starts. But permits were running more like 1.2 million right now on an annualized rate. So, that bodes well, and I think 1.2 million to 1.25 million may be the number we see for housing starts next year. It will be a contributor to growth next year, but certainly not an accelerating factor.
But we cautioned and warned people last week: It's hard to look at December numbers with all the holidays and so forth. It's not a big month, and things can blow that number around a little bit, but the fact that it hung in there, and permits actually looked a little better, that's fine with me.
Jeremy Glaser: Bob, thanks for your analysis today.
Bob Johnson: Thank you.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
