US Perspectives: Not Your Normal Recovery

The recovery has been slower than expected, but it may also be longer and more sustainable, says Morningstar's Bob Johnson.

Robert Johnson, CFA 03.08.2010
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The alleged big news of past week, the GDP report, turned out to be a relative nonevent. The 2.4% growth split the difference between the bulls--including me--that were looking for 3% growth and the bears that were looking for just 2% growth.


Perhaps more bullish news was that growth for the first quarter was revised to up 3.7% versus the more measly 2.7% estimate of a month ago. Consumers have been relatively consistent spenders, growing between 1% and 2% each of the four quarters in this recovery. Meanwhile, inventories, exports, and imports have jumped all over the place, creating volatility in the overall GDP figures.


This quarter, there was an almost unprecedented 29% increase in imports, which was the primary reason the GDP growth rate fell between the March quarter and the June quarter. Consumers have been spending a lot of their cash on electronics this recovery, and a lot of those goods are manufactured overseas, raising the U.S. import bill dramatically.


While everyone was busy anticipating and micro-analyzing the GDP report, there was a flurry of other positive economic news last week. Initial unemployment claims fell, the Chicago Purchasing Managers report was positive, and weekly retail sales were up again. And in a true demonstration of consumer confidence, July auto sales are showing renewed strength after a relatively slow May and June according to our auto analyst David Whiston.


Even Europe managed to add some good news, with Germany's economy now recovering almost all the jobs that were lost this recession. That was on top of news the previous week that German exports were up close to double-digit levels. Finally, the Case Shiller home price index managed to show some growth during the most recent period.


Not Exactly a Normal Recovery

At the one-year mark, this recovery appears slower than normal. Since bottoming in June 2009, the inflation-adjusted gross domestic product (the broadest measure of economic activity) has grown at an anemic pace, just above the 3% mark. The good news is that this places it above the recoveries from the 2000 and the 1990 recessions but slower than the other post-World War II recoveries and below the mathematical average of 5% for those recoveries.


Given the large decline during the recession, I had expected a bigger bounce coming out. I suspect that limited improvement in both auto spending and housing, major drivers of past recoveries, has been responsible for this relatively slow recovery.


However, I believe a slower recovery may mean a longer, more sustainable recovery than in the past. In the past, drops in interest rates meant huge unsustainable spikes in housing and auto sales. Those sectors often pushed up against capacity limits, driving inflation higher and short-circuiting recoveries. This time around, housing and consumer auto purchases have barely budged off their bottoms. Autos and housing could represent the fuel for the recovery next year just as exports, inventory adjustments, and manufacturing begin to moderate from their early strength this recovery.


Current Mediocre Recovery from a Hard Fall in GDP

Recovery From

First Year GDP Growth (%)

Contraction During Recession (%)


































Source: Bureau of Economic Analysis, Morningstar


Recovery Slower Than Past Recoveries in Most Categories

Of the four major indicators of current economic activity, only the retail sales category, adjusted for inflation, has made a significant recovery. Employment and real income are up but still dangerously close to the worst levels of the recession. Meanwhile, industrial production has made a nice bounce off the bottom but still has recovered only about half of what was lost during the recession.

With incomes and employment so lethargic, it is a combination of increased spending by those that have jobs and a lower savings rate that has brought the economy this far. That spending has started to drive more production and production-related employment.


Looking specifically at individual GDP accounts, the table below displays the economy's biggest losers and the recovery's biggest gainers.


Economy's Biggest Losers

Segment (Q4 2007 to Q2 2009)

change in $Bil

Nonresidential Business Investment


Personal Consumption


Residential Investment










Biggest Gainers of the Recovery

Segment (Q2 2009 to Q2 2010)

change in $Bil





Personal Consumption


Nonresidential Business Investment




Residential Investment


Source: Bureau of Economic Analysis, Morningstar Calculations


The declines demonstrate what I call the crack-the-whip phenomena. In this skating game relatively small movements and slow speeds at the beginning of the line are amplified to huge movements at rapid speeds for the unfortunate skaters at the far reaches of the line. In this case the huge but slow-moving consumer is at the beginning of the line. Consumer spending declined a relatively modest 2.4% this recession. However, because the consumer represents 70% of the economy, the dollars involved in the decline are still large. Meanwhile, the much smaller business investment category (only 10% of GDP) was down a whopping 19%. The dollar decline in investment spending was larger than the change in consumption. The consumer gets a cold, and investment spending gets pneumonia.


Once the consumer gets better, the crack-the-whip principle works again, amplifying small gains into massive benefits, albeit with a delay.


Inventories and exports in addition to the consumer have been the stars of this recovery. Business investment and residential building have been laggards thus far. But I believe that's beginning to change.


Business Spending a Potential Source of Strength in the Months Ahead

While the consumer accounts for about 70% of GDP, I believe that increased business spending and investment may prove to be the real sleeper at this stage of recovery. Consumers have recovered more than two thirds of the pre-recession spending levels.


Meanwhile, industrial production has recovered only about half of what was lost during the recession. Shipping from inventories instead of new production is largely responsible for the mismatch between consumer spending and production. As production levels increase to match demand, so will employment and eventually consumer spending.


Even more depressed is business investment spending, which is typically the last item to show improvement during a recovery. The leader of our industrials team, Eric Landry, has floated the theory that U.S. businesses have seriously underinvested in capital goods and will need to sharply ramp up spending in the months ahead. Select capital investment accounts have fallen from a high 4.2% of gross domestic product in 2006 to mid-2%. Even with a year of recovery under our belt, the investment percentage is still within 10% of its bottom as of the March quarter.


Our analysts are finally hearing signs that this investment backlog is beginning to break. Intel and Microsoft, which both benefited early in this recovery from increased consumer spending, reported that corporations opened their wallets in the second quarter. Additional corporate spending has been responsible for many of the second-quarter earnings surprises in the technology sector. With stunning amounts of corporate cash laying idle, corporations certainly have the ability to dramatically ramp up capital spending. So while all eyes were on consumers and housing, the real action in the months ahead is likely to come from corporate spending.


Consumers Earn More, Spend Less than Previously Announced

Last week's GDP report contained a lot of revisions to the previous three years of economic data. On the whole, the changes were small and generally showed the recovery was modestly smaller than previously thought.


However, patterns in consumer incomes and spending changed a fair amount. Past reports indicated that consumers were now spending as much as when the recession began. It now appears that consumers have been bigger penny-pinchers than previously thought. The latest data show consumers decreased their spending by 2.4% during the recession and have now increased spending this recovery by a slower 1.6%. In other words, consumers have only recovered two thirds of what was lost, not the full 100%.


The good news was that incomes were also revised upward, meaning consumers have more wherewithal to spend in the months ahead. In the most recent quarter the savings rate reached a stunning 6.2%, up from the low of 1.8% for the third quarter of 2007 and 5.5% last quarter.


Employment Is the Key Data Point This Week

Based on continued improvement in various regional purchasing manager surveys and recent earnings conference calls, I suspect that private sector employment will have grown a little faster than in June and that private sector job growth should be greater than 100,000. Census-related layoffs are expected to continue, so the headline total employment number might be negative yet again.


This week, I will be on vacation and won't be publishing my usual column. My column will resume on Aug. 14.

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About Author

Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis with Morningstar.

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