Economy Not as Volatile as GDP Implies

Jeremy Glaser: For Morningstar I'm Jeremy Glaser. The U.S. economy grew by 1.9% in the fourth quarter and 1.6% for all of 2016. I'm here with Bob Johnson, our director of economic analysis, to see what drove these lower numbers, and also his expectations for 2017. Bob, thanks for joining me.

Bob Johnson: Great to be here today.

Glaser: Let's look at this fourth quarter, 1.9%, below what a lot of people were expecting, below consensus, below what GDPNow thought. What caused this miss?

Johnson: I think the biggest thing that happened is the kind of funkier numbers that you usually see in these reports were unusually strange this time around. Net exports took off 1.7%. In other words, GDP growth would have looked more like 3.5%, 3.6% if the net export adjustment had been there. Offsetting that, as it often does, inventories were a big add to the GDP. They added 1%, and it often happens. We always say this is a mismatch between is this thing on the dock, is it on the boat, is it in the inventory? In any case, inventories were a big add, which isn't unusual when you have a bad net export number. Again, both very odd numbers, but there's something that comes out in the wash. Inventory, for the full year, probably took off about fourth tenths of a percent, a little more than it usually does. It usually nets out something a little bit closer to zero. Nevertheless, in the back half of the year, inventories were a net add to GDP after really killing it in the first half, when it was a big subtractor.

Glaser: The export side, do you think this is the case of a strong dollar hurting the export market or is there something else going on there?

Johnson: No, I think this is primarily related to the big boom and bust in commodities and, in particular, soybean exports, which were a huge help to GDP in the third quarter. Then you take that small change and put it into the fourth quarter and then you multiply it by four to get back to a full-year number. It's a big deal. I think exports would actually look up if you took that food category of exports out of there, which had that big gain in the third quarter, mainly soybeans, and then had a huge decline in the fourth quarter. I wouldn't make this out to be a matter of the dollar whatsoever.

Glaser: Let's look at some of the other categories, maybe the more important ones like the consumer. Any surprises there?

Johnson: Absolutely not. You look at GDPNow, you kind of average the numbers that you might look at and make your own guess. I don't think anybody was off more than a tenth or two on the growth rate in the contribution from the consumer. The number was exactly as expected. Down just a little bit from the previous quarter and the quarter before that, which had some really good consumption numbers, but, again, volatile from quarter to quarter. They tend to even out more over a full-year period. Nevertheless, consumption growth this year was a little bit less than last year.

Glaser: And what was that fourth-quarter growth?

Johnson: I think we were looking at something more like 2.5% consumer growth and so you take that times 70% and you roughly get the contribution that you got to GDP from the consumer. You can see it's a big number.

Glaser: You saw some glimmers of hope in business investment, something that has been a weak category for some time.

Johnson: It has been, and there's been a variety of different causes. Certain commodity markets were soft, so there wasn't a lot of equipment that needed to be exported to process those commodities. Having a lot of excess capacity. There were a number of things that really kind of kept that number down. This time around equipment was up in the fourth quarter and a contributor to the GDP. Intellectual property, usually software, is almost always up and was up again in the fourth quarter, and structures were about as they always are. It was a time when it didn't hurt GDP. We've at least turned that corner. Like many of the sentiment indicators on business investment, it's better, not a lot, not huge, but at least it's not a subtractor anymore.

Glaser: On a sequential basis we continue to have these pretty big swings quarter to quarter. Do you think this is reflecting the reality of a very uneven economy, or do you think we have a measurement issue, or what's going on here?

Johnson: I think we have a huge measurement issue. I think if you look at the numbers on a same quarter this year versus the same quarter last year, so you've got kind of the same seasonal things going on, the same rough patterns, and you've just got one period you're dealing with, you're not thinking about what's happened over the last 20 years when the seasonal factors have slowly evolved. You look at those numbers and they're rock-steady. All four of the quarters in 2016 were between 1.3% and 1.9%, an exceptionally narrow range. You look at those sequential numbers and they have those seasonal factors so you can compare Christmas sales to sales in July and have some thought about what's going on.

You really have to do the seasonals if you're going to compare things sequentially, but it's really hard to get those right. We saw the GDP go from eight tenths of a percent in the first quarter all the way to 3.5% in the third quarter and then back down to 1.9% in the fourth quarter. I assure you that's not what happened in the real economy. You just have to look at the employment numbers to figure out that that's got no relation to reality.

Glaser: Even looking at the year-over-year number, that's slow growth. Do you expect that to continue next year?

Johnson: I do. I think that there's a few things going on. We've talked demographics forever on these calls. We continue to think there's more baby boomers retiring and that's certainly driving down the available workforce, and the workforce is the raw materials to grow the economy. If you don't grow the workforce, it's very hard to grow the economy. I think that's going to put a terrible headwind on the economy. That's always my big concern, and I think that my second concern for this year in particular is not that inflation is going to spin out of control, but it's probably going to be 2.5% for the full year when all is said and done, headline numbers.

That's considerably up from what it was in the middle of 2015 and 2016, so as we move along, wages are going up, we all have talked about that, but not nearly as much as inflation, which is up almost 2%. Wages from their levels where they were, wages aren't up nearly as much. I think that's going to put pressure on consumption. We just talked about consumption being 70% of the GDP. That really was the only thing that grew for the full year in 2016. That's why we're worried about 2017 not being a great year.