Another Spring Thaw for the Economy

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We've got some positive economic news this week and I'm here with Bob Johnson, our director of economic analysis, to see if this is a sign that the economy is coming back or if it ever really went away in the first place.

Bob, thanks for joining me.

Bob Johnson: Great to be here today.

Glaser: So, once again, we seem to have this pattern where the first quarter, the winter, looks terrible and then we get into April data and all of a sudden things start looking positive again. Why do you think this keeps repeating itself?

Johnson: Yeah, I think it's taken a while for seasonal factors and the statisticians to catch up with shifting patterns of what people spend things on and what months they spend it on. I mean, it's a terribly difficult job. And then in addition, you've got weather impacting the first quarter data. Cold weather is bad, warm weather is bad and everything is different. And sometimes January is better, sometimes February is better and that shifting data really screws up the statisticians.

So, the first quarter is very tough to get right. It's been the lowest growth quarter of the year, four of the last five years. So, we're never surprised. I mean, when the winter months look so bad, we always remind people, you know, it's not as bad as it looks. And now, in April and May, when the data starts looking better, we start to get more cautious and say, remember, this pop happens every year and I think that's a situation we're in right now. And I think everybody is excited and worried about bond rates and everything now that the economy looks stronger, but I really think it's been a more steady keel economy than anybody gives it credit for.

Glaser: So, what's your full year forecast? Does it change when you see a positive data? It sounds like it doesn't.

Johnson: It really doesn't. I've had forever a 2% to 2.5% long-term growth rate. I think this year I'm still a little conservative. I think we'll be more at the lower end than the upper end of that because of demographics and as we get more into the economic cycle where it's harder to get growth. You put those things together and I think that we'll be more likely at the 2% than the 2.5% for the full year. I think one interesting aspect is that last year employment did a lot better than GDP and I think this year it may end up being the reverse. And I won't necessarily let that scare us, but it may some people when they see the employment numbers in the months ahead, which are likely to be a little bit weaker than we're it used to, will throw people off track.

Glaser: Let's look at some of this positive data we've seen. Let's start with inflation. This got maybe some of the market kind of excited, but you say this was actually one of the least surprising pieces of data we got this week.

Johnson: Yeah. I think that the inflation data we've been worrying that services inflation has been high and it remained high this month. It was at 3%. Goods inflation was actually a small deflationary number. Food prices remained well-contained with under 1% year-over-year growth as prices are still influenced by falling beef and pork prices from the drought several years ago. So, all of those things are trends that we've seen for some time.

We've seen some tick up in the year-over-year growth rate which may have been negative at 1 point on the headline number and now we're kind of back to 1% year-over-year. And because of the way energy plays into the cycle even if the services get a little worse in here, we'll probably be at that 1% or so level for a few more months. But then the core inflation rate will start to shine through which will look like something more like 2%.

Glaser: So, let's look at industrial production, another number that looked like it was, if not looking great, getting a little bit better. What's driving that?

Johnson: Yeah. I think where the manufacturing cycle is, we're kind of working through some of the energy stuff and many things that weighted on the report, especially on the machinery category, which is pretty large and you had a couple of things go bad, kind of construction, especially commercial construction, around the world slowing. At the same time, you had issues in agriculture as the cycle kind of passed and farm incomes went down and they had less money for equipment. So, you had those type of things--and the oil and energy related machinery which goes in that category.

And you roll all those together and we've had really tough months and now we've started--we actually had a positive month in machinery and I think that's probably what kicked the number back up in the month of April. I don't know if that's really totally sustainable, but at least that category seems to be flattening out just a little bit. So, that was one of our key worries. Year-over-year, industrial production has now been kind of ticking up for four or five months here and we're not at anything great. We're at 0.6%. But it's at least something. It's not negative.

Glaser: So, some stabilization there. How about housing scenario that you hoped would be able to provide some boost to GDP?

Johnson: Yeah. Well, I guess, I'd say some stable contribution. It's been a great contributor for a few years here. And again, in a world where you're only growing 2% to 2.5% where you get 0.3%, 0.4%, maybe even 0.5% in some quarters from housing, that's a really big deal on kind of that new smaller base. And I don't think--this year we're not going to add any more than last year, but I think the mix might be a little different. We might see more single-family homes instead of apartments being built and that was kind of evident in today's report. So, we've seen a lot of things going on that suggests that housing will continue to do well and maybe even slightly in favor of the economy as more of it shifts to the high economic impact of single-family homes.

Glaser: Then looking back to last week, kind of the data that got this positive trend off was our retail sales. What were consumers doing?

Johnson: Yeah. I mean, clearly, at 70% of the economy what the consumer does is really important. So, last week's report was really the one that topped all of the others. Again, it showed consumers were spending and they were shifting more of that spending to online outlets and away from apparel.

We've had a lot of questions over the last week on our analysis of that and certainly, people said, oh, what's the big deal? We all know it's been going online. Well, the trend appears to have accelerated a little bit and that's got broad ramifications for employment. We may see employment in the retail sector grow weaker. It wasn't great in the last report and it may even get weaker than that. I think there was a lot of hope that maybe it was weather and it's not. And I think that we now may see some more layoffs there and that may push initial unemployment claims up. It may bring the hiring number down net. And again, that shouldn't surprise us. People are spending in different ways on different things and certainly, some of that's going to warehousing people, to delivery people that deliver online goods. But we probably won't get all the way there and we'll probably have some dislocations from that. So, there are some negative impacts as many readers pointed out, not just positive to this online shift that we mentioned last week.

Glaser: Well, Bob, as always, thanks for your analysis today.

Johnson: Thank you.

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